Investment Crowdfunding and the Financial Instruments and Exchange Act: How It Differs From Purchase-Based Crowdfunding and How to Conduct an Offering

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

When a startup raises funds, crowdfunding is one of the strong options. It has the advantage of raising money from fans and supporters of a product while also building awareness in advance. However, even under the same name of crowdfunding, the actual rights involved and the legal positioning differ greatly by type, such as purchase-based, donation-based, lending-based and investment-based. Among these, investment-based crowdfunding, which deals with shares and fund interests, is an area squarely subject to the rules of the Financial Instruments and Exchange Act.

The Difference Between Purchase-Based and Investment-Based Crowdfunding

In purchase-based crowdfunding, what supporters receive in return is the product or service itself. Depending on the nature of the transaction, the Act on Specified Commercial Transactions, the Premiums and Representations Act and the Consumer Contract Act come into play, and depending on prepayment or point mechanisms, the rules of the Payment Services Act may also become an issue. Here, the core of practice is how to communicate when the deliverables will be provided, how their specifications are described, and whether refunds are possible.

In investment-based crowdfunding, on the other hand, supporters pay consideration for financial instruments such as shares, bonds or fund interests and expect future economic returns. Here the Financial Instruments and Exchange Act applies, and you confirm the application of business regulations such as Type I or Type II financial instruments business, or small-amount electronic public offering handling business. For handling offerings and the like, shares and bonds in principle raise the issue of Type I financial instruments business, and fund interests in principle Type II. Even for fund interests, where they constitute electronically recorded transferable rights, for example, the rules for Type I are checked. Note that this is also an area in which Cabinet Orders and ministerial ordinances have been amended, such as with respect to the upper limit for small-amount electronic public offering handling business, so the offering plan is built in line with the standards in force at the time. If you proceed without determining the nature of the rights supporters will acquire, you may fail to comply with investor protection rules.

Involvement of Registered Operators and Preparations on the Issuer's Side

When raising funds through investment-based crowdfunding, the legal structure differs depending on whether you go through the platform of a registered operator or conduct the offering yourself. If you merely issue your own shares and solicit investment directly, the issuer itself is not immediately required to register as a financial instruments business operator. However, if you engage in the self-offering of fund interests as a business, registration for Type II financial instruments business is in principle required. Check whether a special exemption from registration can be used and how much of the offering to entrust to a registered operator. Even if you use a platform, separate measures are needed if the solicitation you conduct yourself is subject to regulation. The application of disclosure regulations is also examined separately from business registration.

Using a platform eases the practical burden, but it does not eliminate the issuer's accountability or internal procedures altogether. The issuer itself is responsible for preparing to present its business plan, financial figures and anticipated risk information to investors in an easy-to-understand way. In addition, once shares are issued and investment is received, practical work such as shareholder management and providing necessary information arises on an ongoing basis, and this also directly affects future capital policy. The division of roles between the registered operator and the issuer must also be decided for checking for relationships with antisocial forces.

Marketing Expressions and Explanations to Investors

In an investment-based offering, the wording of communications to investors directly affects not only whether the offering succeeds but also its legality. Putting too much emphasis on future growth potential, sales projections, relationships with partners or technological strengths may give the mistaken impression that a profit is certain.

There is always the possibility of loss in investing. In addition to uncertainties in the business and finances and the difficulty of converting the investment into cash, where shares are issued it is important to clearly communicate, in the same place as the attractive pitch, matters such as the decline in voting rights ratio due to future dilution. It is helpful to switch perspective from ordinary advertising that conveys a product's appeal, and to check whether the legal risk disclosures are getting through sufficiently.

Impact on Future Rounds

When many individual shareholders join through equity crowdfunding, there will be situations in which this affects subsequent fundraising from institutional investors or M&A. This is because the more shareholders there are, the more effort it takes to send notices of convocation of shareholders' meetings, tally the exercise of voting rights, and explain matters when issuing class shares.

In addition, when carrying out procedures that are actually needed, such as the procedure for approving share transfers under the articles of incorporation and prior consents under contracts, a large number of shareholders can become a drag on decision-making. Because investors considering investment in later rounds may be concerned about the complexity of the shareholder composition, it is prudent to determine in advance not only the immediate amount to be raised but also whether the arrangement is sustainable as future capital policy.

At LegalAgent, as part of our support for startup fundraising, we help with designing investment-based crowdfunding, checking disclosures, and considering the shareholder composition with future capital policy in mind. When the method involves issuing shares, I think the choice should be made with a view not only to the amount raised but also to the shareholder composition that follows.