5. Collaborative finance
The third evidence session of the Scottish Expert Advisory Panel on the Collaborative Economy in August 2017 focused on collaborative finance, including fintech. Agenda and minutes of the meeting, as well as any submissions received, are available online  .
PwC  describe collaborative finance as “ individuals and businesses who invest, lend and borrow directly between each other, such as crowdfunding and peer to peer lending”. In 2015, it was estimated that collaborative finance in Europe generated €250 million in revenue and was valued at €5,200 million. Collaborative finance is also known as crowdfunding, two descriptions of which, from Nesta and the Financial Conduct Authority ( FCA), are provided below.
- Crowdfunding is a way of financing projects, businesses and loans through small contributions from a large number of sources, rather than large amounts from a few. Contributions are made directly or through a light–touch platform rather than through banks, charities or stock exchanges. Nesta
- Crowdfunding is a way in which people and businesses (including start-ups) can try to raise money from the public to support a business, project, campaign or individual. FCA
Crowdfunding usually takes place on a digital platform that allows businesses or individuals to raise money, and investors to provide that money. The business or individual seeking finance often explains their project in a pitch to attract loans or investment from as many people as possible. The FCA does not regulate all models of crowdfunding  . The models that are regulated are:
- Loan-based (also known as peer to peer lending), where consumers lend money in return for interest payments and a repayment of capital over time; and
- Equity-based, where consumers invest directly or indirectly in new or established businesses by buying investments such as shares or debentures.
The models the FCA does not regulate are:
- Donation-based, where people give money to enterprises or organisations they want to support; and
- Pre-payment or reward-based, where people give money in return for a reward, service or product (such as concert tickets, an innovative product, a computer game, etc.).
The collaborative finance market has not only seen huge growth in recent years, but it has relevance not just to businesses, including start-ups and SMEs, and communities, but also charitable institutions, foundations and the public sector.
With traditional financial institutions becoming more risk averse, new ways to access capital have been emerging. Collaborative finance is a sector that is growing fast and has yet to reach its full potential.
Nesta’s study of 94 crowdfunding and peer to peer lending platforms examined the growth, trends and dynamics within the UK alternative finance sector in 2015  . Nesta found that:
- Crowdfunding grew from £267 million in 2012 to £3.2 billion in 2015, of which £1.49 billion of loans to businesses, £909 million of loans to consumers, and £322 million of equity investments.
- The average size of peer to peer loans was £76,280, from an average of 347 lenders; the average size of equity crowdfunding projects was £523,978, from an average of 77 investors.
- The market is taking an increasing share of small business lending and start-up investment. In 2015, crowdfunding accounted for 12% of lending to small businesses and 16% of seed and venture-stage equity investment.
- The fastest growing models in 2015 were donation-based (up 507% since 2014 to £12 million) and equity-based crowdfunding (up 295% since 2014 to £332 million).
- The market saw increased involvement from institutional investors: 45% of all platforms reported some level of institutional involvement.
- Real estate is the single most popular sector: the combined debt and equity-based funding for real estate amounted to almost £700 million in 2015. Other popular sectors for peer to peer lending are manufacturing & engineering, transport & utilities, and finance & retail; for equity crowdfunding, technology, food & drink, internet & e-commerce, and media & publishing.
b. Scotland specific data
In Scotland, crowdfunding raised just over £27 million between October 2014 and September 2015. Peer to peer lending to businesses was the largest sector valued at £20.5 million, with reward campaigns raising £2.6 million and equity campaigns raising £3.9 million. The proportion of the value of UK crowdfunding raised in Scotland has risen from below 1% in 2013 to 4%  . Scotland is today the fifth most popular area of the UK for receiving funding.
Since its launch in August 2015 the Crowdfund Angus portal  on which more information is provided in the next section) has supported 40 local projects and has raised over £159,488 to the period August 2017.
c. Opportunities and benefits
In the evidence submission to the panel, a range of potential opportunities and benefits were identified in relation to collaborative financing:
- Scope for collaborative finance to expand the range of people engaged in the collaborative economy, for example enabling those in more rural and disconnected parts of Scotland to engage with a wider network of collaborators and customers, providing new funding opportunities for third sector and social enterprise development, and enabling individuals with minimal capital to develop new ideas.
- Potential to help addressing long-standing issues around the range of finance options available to smaller businesses.
- Opportunity to create a robust and inclusive collaborative economy that can benefit all stakeholders, enabling businesses and platforms to thrive, benefiting consumers, and addressing the needs and concerns of communities.
- Opportunity to exploit the digital expertise and entrepreneurial networks in Scotland to develop new approaches and ideas.
- Opportunity for local partnerships to use collaborative finance to provide funds to support community, business, sports and social enterprise, generating additional spin-off benefits such as community engagement, ownership and empowerment. Angus Council established a steering group between local community organisations, businesses and individuals, which engaged with Crowdfunder to create a bespoke crowdfunding platform, “ Crowdfund Angus”. Since its launch in August 2015 the Crowdfund Angus portal  has supported 40 local projects and has raised over £159,488 to the period August 2017.
- Opportunity for local crowdfunding to plug decreasing local budgets, particularly when led and/or matched by local authorities. From April 2017, the Angus Council Community Grant scheme has been used to match funds raised through Crowdfund Angus.
- Opportunity to develop innovative collaborative finance solutions such as mutual sick pay funds, cash-pooling schemes and collective insurance schemes, enabling providers of collaborative economy services to self-organise and mitigate the risks associated with the collaborative economy.
d. Challenges and barriers
The key challenges and barriers identified in relation to the growth of collaborative finance platforms were:
- Lack of or limited connectivity in some rural areas, limiting opportunities for rural communities to participate in collaborative finance projects.
- Digital skills as a barrier to some demographic groups, e.g. deprived urban communities, and concerns that entrepreneurial support structures can be focused on specific demographics.
- Concerns about financial risks and failure to honour obligations.
- Concerns about consumers’ limited understanding of the implications of investing or contracting with a collaborative finance platform.
- Potential for large scale fraud or consumer protection offences, facilitated by limited understanding of the legal implications of engaging with collaborative finance platforms.
- Research undertaken by the FCA identifies a range of potential issues in relation to collaborative finance: inadequate disclosure of risk and loan performance; due diligence standards; risk of firms testing the boundaries of the regulated crowdfunding perimeter to exploit arbitrage opportunities; risk of firms moving into unfamiliar markets to expand their market share; cross-platform investment (i.e. platforms allowing investment in loans formed on other platforms); and exposure to third-party risk.