Italy was amongst the first countries to introduce dedicated equity crowdfunding regulations in 2013 – since then firms have managed to raise only €5.5 million in investments. A report on how legislators can smother innovation and what the current regulatory framework looks like.
Italy praises itself for being the first country to have regulated equity crowdfunding and in fact Consob, the Italian financial regulator already adopted its dedicated Regulation on “the collection of risk capital via on-line portals” in June 2013.
Traditionally, Italy is stifled by its structural problems and its infamous bureaucracy. So, it is somewhat surprising that the Italian legislator responded so quickly to this innovation. The results however have been flawed, to put it mildly. When investigative reporters looked at the state of things at the end of 2014, i.e. 18 months after the introduction of the regulation, only two projects had successfully conducted a fundraising through equity crowdfunding campaigns. Even after another 18 months Italian platform have managed to raise little over €5 million for their listed projects – in contrast, in the UK in 2015 alone the total transaction volume attributed to investment-based crowdfunding models was a whopping £250 million (even after excluding real-estate equity crowdfunding and debt-based securities). It isn’t for a lack of ideas or talent that other projects could not manage to obtain financing in Italy though: Young Italians are generally well educated and entrepreneurial as anyone with a good understanding of the expat community, for example, in London, Berlin or Dublin will confirm. Still, the Italian start-up scene has fallen behind in comparison.
The Italian funding gap
One thing that should be very favourable for FinTech newcomers like crowdfunding platforms is the poor state of Italian banks. Since the established institutions are struggling given their high amounts of debt to provide firms with much needed financing, start-ups and small & medium sized enterprises (SME) are in dire need of alternatives. SMEs itself account for 99,9% of the total of Italian firms, provide 80% of employment and 67% of value added. Compared to its European neighbours, Italy attracts little foreign direct investment to make matters worse. Italy seemed ripe for disruption, but the Italian lawmakers didn’t seem to think so, since its poorly designed regulation stopped the delicate plant of innovation in its tracks. The rules limited investments by individuals to €500 while firms were allowed to invest up to €5,000; anything above this threshold would require talking to a bank for risk profiling and making the investment through the financial institution. For something that is supposed to happen online, this isn’t a very innovative procedure and hinders the fundraising considerably. Furthermore, the regulation required that at least 5% of the total fundraising amount had to be invested by an institutional investor, e.g. a bank, otherwise the financing couldn’t be closed. The regulation permitted crowdfunding campaigns for so-called innovative start-ups (“start-up innovative”), which in turn were subject to certain requirements that limited the scope of potential companies in respect of a company’s purpose and age. One can only speculate about Consob’s reasons to restrict crowdfunding in such a way, but the outcome was easily predictable, so no wonder the results have been rather modest as we have seen above.
Another year, another amendment
Eventually, the regulator had to act and further to including innovative SMEs (“PMI innovative”) within the scope of potential recipients (eliminating at least the discriminating parameter of a company’s date of foundation) in a first amendment of the original rules, Consob introduced another update to the existing rules in March 2016. What are the key changes then?
Online MiFID appropriateness test
Individual investors that want to invest more than €500 no longer need to be directed to a financial institution to fill out the paper MiFID questionnaire that warrants the appropriateness of the investor. Instead crowdfunding platform can conduct this test now directly online. Given that one estimate considers the average investment on corresponding platforms in the UK at £2,500 it becomes apparent, why it is considerably more difficult to raise sufficient sums in Italy. Just imagine you had a very modest project that required €50,000 (not an astronomic amount by industry standards) you would have to find at least 100 investors to allocate up the maximum amount to conclude the campaign. Needless to say that this isn’t an easy task for any firm, but it creates difficulties for the business model of the crowdfunding platform itself. In particular in its early days it simply might find it very challenging to attract enough interested investors, not even considering the basic cost to do business for the FinTech startup.
Extension of necessary Institutional Investor participation
If you paid close attention in the example above, you may have said that one actually doesn’t need 100 investors since an institutional investors had to participate for at least 5% of the total financing sought in a campaign. Fair point, but unless the bank or fund commit significantly more than the 5%, it is still an uphill battle.
In any case, Consob has extended the scope for underwritings by more qualified investors. Other than banks and investment funds, the updated regulation includes the category of start-up incubators as well as professional investors upon request or by investors in support of innovation. Professional investors upon request have to give evidence on their sophisticated investment profile, in particular they will need to document that they fulfil at least two of the following three characteristics:
- the client has carried out significant transactions on that specific market with an average frequency of 10 operations per quarter over the previous four quarters;
- the value of the client’s financial instruments portfolio, including cash deposits, must exceed €500,000;
- the client works or has worked in the financial sector for at least one year in a professional position which requires knowledge of the operations or services envisaged.
It is probably too early to tell whether the latest regulatory amendments will have the desired effect and lead to significant growth of equity crowdfunding in Italy. Other factors that are not particularly favourable need to be taken in consideration, too: For starters, Italy traditionally sees more investment in debt instruments than equity and therefore has generally a lower acceptance for such securities. Major concerns for the prosperity of firms lie in the country’s very high levels of bureaucracy, weak rule of law and corruption. Notoriously, court trials take several years to come to a conclusion, and in the World Justice Project’s annual report, Italy sits nicely between Georgia and Botswana. According to the Italian Court of Auditors, corruption costs Italy €60 billion or 4% of its GDP each year.
This is obviously bad news with regard to foreign investments, too, which also struggles due to the perception abroad in respect of Italy’s low productivity – whether justified or not – and it takes hard work to overturn such views.
However, if you’re not put off by these arguments – and there are a number of good reasons why to invest in Italy (it is still one of the world’s top economies being among the top in manufacturing and trade plus a high quality of life and culture to start with) – read on in part 2 of our report for more on the rules for investors and FinTech firms, which you can find here.