Financial Conduct Authority to press ahead with crowd funding crackdown. Why that's good news for the industry

There is the potential for a major scandal as novice investors rush in, and the industry would be hurt as much as they would be if that happened

Andrew Bailey: Chief city watchdog plans new rules on crowd funding (PA)

When it works, crowdfunding can be a thoroughly good thing. It gets financing into the hands of businesses that can struggle to get it by more conventional means.

It should, in theory, also work for the funder, if those businesses go on to be successful. Trouble is lots of them don’t go on to be successful and when that happens novice investors can get badly burned. That has been worryng the Financial Conduct Authority. Its chief executive Andrew Bailey has just signalled that the watchdog plans to further tighten rules first brought in back in 2014.

Data on crowdfunding success rates has been quite hard to come by but last year industry website AlfFi and law firm Navarro produced a report looking at the performance of 431 capital raising efforts by 361 companies.

The results were mixed. Some 41 were rated amber (exhibiting some level of distress) and 29 red (ceased trading). The failure rate for investments (because amber companies are likely losers for investors) was therefore just shy of 20 per cent.

That actually isn’t too bad as far as start ups go. Plenty of banks’ small business departments would be happy with that.

But even though the majority of the capital raisings (302) were rated “green” that only meant the crowd funded company was still in business. The report couldn’t say whether they were trading in line with expectations. So, for the most part, it was too early to say whether they were winners or not. In fact, there had only been one actual cash realisation for investors out of the firms studied.

That did pay of handsomely - 2.5 times initial investment. But it’s hardly what you’d expect from a British Google or Facebook, and it’s in hopes of landing “the big one” that often draws people in to the sector. That, or at least the prospects of returns by lending to companies via peer to peer platforms that far outstrip what even the very best paying savings accounts currently offer.

Against that backdrop, the FCA found that some promotions weren’t always “clear, fair and not misleading”. As a result, it plans to consult on instituting more prescriptive rules on disclosures - and in particular risk warnings.

That's probably no bad thing, not just for investors, but for the industry too.

Critics of the FCA may argue that if it is too tough it could kill off some potentially superstar companies before they have even got going.

But most companies aren’t superstars. Success stories to match those of Google or Facebook are vanishingly rare, otherwise we wouldn’t talk about them so much. By contrast, failures are quite common.

Crowdfunding has become hugely popular, to the extent that, having been around for a while, I fear that a really big scandal could be on the way. That seems to be the way of things with financial services, and with novel products (which crowdfunding is) in particular.

If, by acting now, the FCA can nip problems in the bud that would be a thoroughly good thing and the crowd funding industry should recognise that. It would be done no favours by a big mess that ended in lots of people getting hurt.