The Cabinet Secretary to the National Treasury and Planning is proposing to make the Capital Markets (Investment Based Crowdfunding) Regulations, 2021. The Regulations will apply to investment-based crowdfunding platforms in Kenya. They will also apply to persons who are operating investment-based crowdfunding platforms in Kenya. 

The regulations are a welcome move in cognition of the opportunities that crowdfunding can unlock in the economy. Kenya is the region’s most active crowdfunding nation. In 2015, the country raised $22.0m, and is on pace to raise as much as $46.7m in 2016, representing 112% growth. That the country leads the region in crowdfunding activity is unsurprising given its relatively advanced economy and infrastructure.

The said proposed regulations were published on 13th July 2021 and since then there has been a call for public participation from the Capital Markets Authority in accordance with Section 12A (3) of the Capital Markets Act. The deadline for submissions is 11th August, 2021.

Herein below we provide a summary and highlights of the said regulations and their overall impact in the affected industries. 

Definitions: 

• Cooling off period means the period within which an investor can   withdraw   from   a   crowdfunding transaction without any restrictions;
• Crowd funding means the act of raising small amounts of money obtained from a large number of individuals or entities to either finance or re- finance a project or business through a crowdfunding platform;
• Crowd funding platform means a website, internet based portal or application operated by a crowd funding platform operator which facilitates crowdfunding; 
• Crowdfunding platform operator means an entity licensed by the Capital Markets Authority to operate a crowdfunding platform;
• Investment-based crowdfunding means the process of crowdfunding in exchange for shares, debt securities or any other investment instruments approved by the Capital Markets Authority
• Investor means any person or entity that seeks to make, or have made an investment through a crowdfunding platform with the expectation of achieving returns;
• Issuer means   a creator   of   the   security   or   investment instrument, which is hosted on the crowdfunding platform and offered to the public;
• Sophisticated investor means a high-net-worth investor with significant knowledge on capital markets investment products.
• Start-up means an entity that is less than ten years and established for the sole purpose of developing a unique and scalable product or service to benefit the market.
• Retail investor means an individual investor who is not a sophisticated investor.

THE CROWDFUNDING PLATFORM & OPERATOR

A person who operates or intends to operate a crowdfunding platform will be required to obtain approval and a licence from the Capital Markets Authority (CMA) to operate the crowdfunding platform. In order to be eligible for licensing an applicant for a crowdfunding platform operator licence shall be a company limited by shares with a minimum paid up capital of Ksh. 10,000,000.

The Rules of the crowdfunding platform operator will provide for:

• Criteria for on boarding its users including procedure for on boarding issuers and investors 
• Transfer of proceeds for each funding round and procedures for monitoring of the proceeds.
• Code of conduct and ethics for its users including misconduct and proposed penalties.
• General obligations and liability of its platform users.
• Cyber security, backup systems and disaster recovery mechanisms for the platform;
• Protection of investors and public interest.
• Promoting fairness and transparency in the market;
• Managing any conflict of interest that may arise;
• Promoting fair treatment of all its platform users; and 
• The resolution of disputes and provision for appeal to the Authority.

CROWDFUNDING PARTICIPANTS

Issuers:

Micro or small enterprises (MSMEs) registered in Kenya with a minimum of 2 years’ operating track record and a good corporate governance record will be eligible to raise funds through a crowdfunding platform in exchange for the issuance of shares, debentures, or such other investment instruments as the CMA may determine from time to time. Start-up entities with a good operating track record and a good corporate governance record are also eligible to raise funds through a crowdfunding platform.

The aggregate amount of investment instruments that can be offered by an eligible issuer within a 12 months’ period will be a maximum amount of:

• Ksh 100,000,000 for medium enterprises
• Ksh 50,000,000 for small enterprises 
• Ksh 25,000,000 for micro enterprises.

A crowdfunding platform operator may apply to the Capital Markets Authority for a no-objection where an issuer seeks to raise more than the set maximum amount within the given duration.

Entities that are prohibited from raising funds through a crowdfunding platform include:

• Public listed companies and their subsidiaries
• entities with a poor governance record
• entities that propose to use the funds raised to provide loans or invest in other entities

Investors:

People eligible to invest in crowdfunding investments include sophisticated investors and individual retail investors subject to investment limits prescribed by the Platform Operator up to a maximum of Ksh. 100,000. Permitted investment instruments for purposes of Crowdfunding include shares, bonds or debentures or any other instruments as shall be approved by the Capital Markets Authority.

CROWDFUNDING TRANSACTIONS

Requirement for issuers in addition, to any other obligations that may be imposed by a crowdfunding platform are:

• clearly outline investors’ rights and ownership of securities and ownership of securities or investment instruments; 
• offer its securities only through a crowdfunding platform of a duly licensed Crowdfunding Platform Operator.
• file a completed standardise offering document with the crowdfunding platform operator for approval to crowdfund on the crowdfunding platform.
• Disclosure shall be made about any entity or persons promoting the offering.

Requirements for investors

• Investors shall only be allowed to invest in the issuers hosted by the crowdfunding platform operator.
• Investors shall have a cooling off period of 48 hours from the date of close of the offer within which they may withdraw their investment.
• Where an investor cancels the offer or agreement to purchase securities or investment instruments, all funds, which may have been debited from or blocked in the account of the investor, will be refunded or released within 48 hours of the request to cancel.

The Crowdfunding transaction

A crowdfunding offering shall not remain open for more than 60 days. Where an issuer is unable to meet the prescribed minimum threshold for the targeted amount, the offer shall be withdrawn and the crowdfunding platform operator shall effect a refund of the monies to the investors within 48 hours. The issuer may only commence a fresh crowdfunding offering not earlier than 90 days after the said withdrawal.

Where the crowdfunding transaction is successful, the crowdfunding platform operator shall make the funds available to the issuer within 24 hours after the close of the offer. The crowdfunding offer by the issuer shall include a contractual right allowing the investor to withdraw an offer or agreement to purchase the securities or investment instrument by delivering a notice to the crowdfunding platform operator within 48 hours after the close of the offer. The crowdfunding portal shall take reasonable steps to ensure the funds raised through its platform are used for the stated purpose.

Crowdfunding platform operators shall ensure that a warning statement is prominently displayed to all visitors to its website, to every investor, on the subscription landing page of the issuer and on all application forms for investing through the crowdfunding platform. Crowdfunding platform operators should also ensure that every investor affirms a risk acknowledgement form prior to acceptance of the offer.

DUTIES OF A CROWDFUNDING PLATFORM OPERATOR

Every crowdfunding platform operator will disclose and display on its platform any relevant information relating to the platform and its use, including:

• Users rights and responsibilities
• List and information relating to issuers and investors hosted on the platform;
• Investor education materials and programs;
• Information on how the platform facilitates the investor’s investments including providing communication channels to permit discussions about offerings hosted on its platform;
• Information about complaint handling and dispute resolution procedures;
• Disclaimers and limitation of liability; highlighting the platforms legal liability for damages incurred by its users.
• Related fees and charges from using the platform;
• Information of any material adverse changes to an issuer’s proposal
• Ensure the disclosure documents lodged with the portal by each issuer is verify for accuracy and made accessible to investors through the platform; and
• Inform investors of any material adverse change to the issuer’s proposal or such other disclosure document.

The crowdfunding platform operator has to disclose all risks associated with the crowdfunding investment which includes information on general risk warning on participating in funding through the platform and restrictions on the ability to cancel the investment.

A crowdfunding platform operator shall carry out due diligence on its prospective issuers intending to use its platform. They are also obligated to monitor and ensure compliance of its rules, have in place processes to monitor anti-money laundering requirements, take reasonable steps to prevent fraud and maintain a register and records of all its platform users.

Crowdfunding platform operators are required to appoint a custodian, who shall establish and maintain a separate trust account for each funding round on its platform with a financial institution duly registered by the Capital Markets Authority as a custodian. A crowdfunding platform operator shall ensure they comply with data protection and privacy law.

Controversial clause

The proposed Regulations propose that crowdfunding platform operators should also ensure that every investor affirms a risk acknowledgement form prior to acceptance of the offer. This acknowledgement will mean that they surrender their ability to access the Investor Compensation Fund run by the CMA which covers losses as a result of a closed investment bank or broker.

BRIEF ANALYSIS

In general, the regulations are welcome in that they provide MSMEs with an opportunity to raise capital to start or expand their operations. Approximately 70 percent of all MSMEs in emerging markets do not have access to credit. Although the gap is very different between regions, it’s predominantly broad in Asia and Africa. The existing credit gap for formal MSMEs is projected to be US$1.2 trillion while the total credit gap for both formal and informal MSMEs goes up to US$2.6 trillion (World Bank, 2015). It has been estimated that 80% of startups in Kenya for example fail in their first year with difficulty in accessing financing attributed as the major reason for this high statistic. 

Through crowdfunding platforms, it is hoped that these concerns pertaining to access to affordable credit will be addressed. With investment-based crowdfunding, investors can buy shares, debt securities or any other investment instruments approved by CMA through an online platform and provides an option to translate customers into investors or lenders, bringing capital that facilitate growth.

However, crowdfunding platforms might not be appropriate for businesses with long payback revenue models and high cost structures, or those that need huge upfront capital overheads like large-scale infrastructure projects. Restraints on the cash amount that can be raised using crowdfunding platforms or a payback time horizon that is not near enough in the future to attract crowdfunding platforms investors, could limit such companies.

That said, in review of the stakeholder submissions, it is likely that these are some of the key considerations and concerns that are likely to be brought forth.