Here we explore this relatively new – but increasingly popular – means of financing and explore the compliance considerations you need to bear in mind.
What is self-funding?
You will be familiar with crowd-funding, the concept of leveraging a crowd to finance an investment opportunity.
Self-funding is the next evolution of this; the idea of using your own customer base and your digital assets (online channels) to finance your growth and do so independently to that of a third party platform.
What are the benefits of self-funding?
The benefits of this approach to raising capital can be numerous – for both issuer and investors.
For the firm attracting investment, it can provide a more cost-effective and efficient alternative to crowd-funding. Businesses do not need to undertake the promotional activity required to source the ‘crowd’ – they already have their own crowd, in the form of their customers and contacts.
Because they have a range of existing communication channels with their contacts, and almost certainly interact with them regularly via content marketing, social media, lead nurturing and other marketing and client communications initiatives, many businesses today have an unprecedented relationship with their clients and customers. The digital revolution has enabled this often daily contact, driving improvements in brand recognition and loyalty for those who get it right.
Allowing your most loyal customers and brand advocates to invest in your business seems like a win-win situation.
The firm has a potential funding source that is naturally pre-disposed to them and keen to see them succeed. Sourcing finance via an existing customer base requires very little marketing and negates the need to engage in an expensive marketing campaign that directs traffic to a busy crowdfunding platform.
The customer has an opportunity to invest in – and therefore share in the success of – a business they support. The exercise can also reinforce and strengthen the brand in the eyes of customers, both those who invest and those who simply become aware of the investment opportunity and the firm’s expansion plans.
How does digital transformation enable self-funding?
It’s not an exaggeration to say that the digital revolution has made self-funding possible. The communication channels we mentioned above – social media, the firm’s own website, email marketing – have given firms regular interaction with their contacts and a wealth of contact data.
Alongside the huge contact databases which are a pre-requisite for self-funding, emails and firms’ own websites enable the investment opportunity to be marketed quickly and cost-effectively.
Crowd-funding is typically carried out via one platform that aggregates all funding opportunities on a single website. This can dilute the messaging from any single issuer – and in a worst-case scenario, can see firms effectively helping to market a rival’s investment opportunity!
Self-funding, on the other hand, is done via the firm’s own website and other digital channels.
As a result, the messaging is targeted towards those who are most likely to respond, and not confused by similar or competing funding requests from others.
It also saves the – not always inconsiderable – fees involved in participating on a crowd-funding platform, which as well as benefitting the issuer directly, has an added psychological benefit for investors, who see their money going 100% to the investment opportunity rather than being used to fund the capital raising.
Another advantage of self-funding is that it doesn’t exclude other sources of funding. Companies can have an ongoing self-funding channel alongside other traditional lines of financing.
If self-funding is executed correctly, it is possible that the self-funding channel will grow to the point other channels may not be required or are purely present as a contingency. However, ensuring that it is in place means the business diversifies the ‘funding risk’ and can aggregate funding needs across multiple channels.
What compliance considerations do firms need to consider when self-funding?
Arguably the most important consideration when self-funding is the need to carry out the process in a compliant way. Issuing debt or equity is a regulated activity, and so there is a mandatory requirement for FSMA 2000 Section 21 approval to be granted by an FCA-regulated firm.
One of the key aspects of the regulation is that the financial promotion prior to distribution is fair, clear and not misleading, in line with one of the main tenets of the FCA’s financial promotion rules.
The offer has to be structured in the right way, and approved before being issued. This is a complex process, with approval only granted once all statements have been substantiated and the content of the information memorandum (the document used to market the business to prospective buyers) is shown to be in line with the FCA’s stringent regulatory requirements.
Another crucial FCA compliance requirement is that an issuer receives funds only from appropriate investors. Even after a Section 21 approval, an issuer must still screen investors and ensure that they are suitable for the investment opportunity (in line with a broader FCA focus on suitability). The FCA requires that appropriateness tests are performed in line with COBS 4.2.
There are other compliance considerations for firms looking to self-fund:
- All the webpages used to promote the offer need to be compliant.
- Know your customer (KYC) and anti-money laundering (AML) checks on investors need to be carried out.
- Suitability and appropriateness tests need to be present.
- A receiving agent has to be in place.
In addition to the FCA requirements, firms also need to follow wider regulations – the GDPR, for example, when using contact data and communicating with customers and contacts.
Although not a mandatory requirement for debt issues, it’s likely that the issuer will enlist a security trustee. The security trustee acts as an independent intermediary and holds a charge over the issuing firm’s assets. If the issuer fails to make a coupon payment to investors, the security trustee would step in and appoint an administrator to liquidate the firm’s assets, and ensure any remaining assets are distributed fairly amongst the bond holders.
Self-funding is the future – but act with caution
Crowd-funding may be on its way to being displaced by self-funding. For the reasons we’ve outlined, a digital world makes self-funding possible and the most desirable option for many firms seeking investment. Intermediaries – which represent an additional cost to all parties involved in an investment transaction – are no longer the only option a firm has to raise funds.
Self-funding enables firms to raise capital more cheaply and leverage the digital assets and channels that they use daily to interact with their customers. Customers are given a chance to benefit financially in a cost-efficient manner from a company’s growth and invest for the future.
Compliance is key to maximising the benefits of self-funding without encountering any of the pitfalls. Follow the compliance tips we have outlined here and you will be on the right path to self-funding in a way that meets FCA requirements.
If you would like to know how Blue Water Capital can help you, please contact us at: email@example.com or call +44 (0)121 725 1951
Please note this article does not constitute legal advice and should not be used as the basis for any business decision.