Leading crowdfunding platform Crowdcube found themselves in trouble with the Financial Ombudsman Service over a due diligence matter that led to a retail investor being refunded his investment in a failed start-up.
In what could prove to be a potentially landmark ruling, the Financial Ombudsman Service upheld an unnamed investor's complaint that Crowdcube's lack of due diligence led to the individual receiving inaccurate information about his investment in a new business. When Zing Zing, a Chinese takeaway start-up, failed to use the investment to aid their expansion plans as outlined in their business plan, the investor complained that their pitch was misleading. Ombudsman Ben Waites ruled that Crowdcube should return the unnamed investor's £18,000, as they had not met to meet their regulatory obligations of acting in their client's best interests.
Talking about the case, the ombudsman said: 'The pitch didn’t provide sufficient detail to give Mr S a balanced indication of the benefits and the risk involved in Company A. As far as Mr S was concerned, Crowdcube had factchecked Company A’s plans for expansion in line with its due diligence charter and it was reasonable for him to believe these included plans for opening new sites. There was no reason for him to believe these weren’t sufficiently substantiated or that there was a risk that Company A might not open up any new sites.'
Commentators believe that the ruling could encourage other investors to pursue compensation over misleading pitches and result in a shake-up of the crowdfunding industry's due diligence standards. It is predicted a flood of compensation cases could now follow. It also highlights the importance of due diligence on both sides – investors to ensure that they are asking the right questions, and asking them both robustly, but also on the investee company to ensure that they are not misleading.
At Harper James, our team specialise in supporting businesses who are seeking investment and we have advised clients across many sectors with crowdfunding finance. Corporate partner Jas Bhogal says the Crowdcube ruling underlines how important it is for businesses to provide accurate information to investors and platforms during the due diligence process. She said it also reaffirms the need for those seeking investment to create watertight business plans, which can stand up to scrutiny and clearly set out the intention of the company’s future progression (based on the information available at the date of the business plan) and use of investment proceeds.
Jas said: 'This is a really important and interesting ruling, which could prove to be a landmark case. There have been concerns for a long time about crowdfunding, so the fact the ombudsman has now taken action could be highly significant. All investors using crowdfunding platforms are required to self-certify that they are either high net-worth individuals or sophisticated investors, with experience in investments. Under most platforms, the investor has the right to select which investment it proceeds with. Each investor should read the pitch documents presented on the platform and make their own assessment as to whether they want to invest. It always makes sense to do some digging on the company online. Check to see if what is presented on the platform is in line with the information available online. If you have doubts as an investor, then it is best not to proceed.
Effective due diligence will give investors some idea about the company, which can help form the basis of the decision as to whether or not to invest. But any information available online cannot be relied on, unless it is included within the legal documents detailing the terms and conditions of the investment. It is worth noting that companies are not required to give forward- looking statements, as no-one can predict the future, especially at this time.
If a business plan is presented with "uses of funds clause", then this should be very clear or flexible enough to cover what the funds are actually going to be used for. Take care when drafting your business plan, especially when it comes to warranties. Above all, good legal support will help alleviate and help manage the risk on both sides.
It is not up to the investee company to manage the relationship between the underlying investor and the platform, as this will be subject to the terms of engagement of the platform itself. The platform will agree the material terms under which it invests and will normally guarantee certain rights to the investor eg the benefit of EIS relief, pre-emption rights on the issue and transfer of shares etc. And platforms normally only focus on these areas when identifying prospective investee companies. This decision places an obligation on the platforms to be more thorough in their due diligence process. Companies can assist platforms with this process by providing detailed responses to the due diligence questionnaires and ensuring any pitch documents presented on the platform accurately reflect the proposed investment terms in the company.'
If your company needs guidance about any of the legal aspects of crowdfunding, get in touch. Our corporate team can put your mind at rest thanks to our expertise in this area of investment.