Crowd sourced equity funding – coming soon to Australia?

Crowd sourced equity funding, or CSEF, means allowing companies to raise comparatively small amounts of equity funding from a spread of investors, usually using an online platform.

Currently this isn’t easy for start-up or entrepreneurs in Australia, but it looks like the government is moving towards reform to make it possible.  A press release a few days ago by the Minister for Small Business, Bruce Billson, flagged that this is very much on the government’s agenda.

If introduced, CSEF should provide opportunities for companies raising funds, intermediaries who operate the online platforms, and investors.  But of course there are some traps as well.

‘Crowdfunding’ and CSEF

‘Crowdfunding’ is a generic term for raising funds from large numbers, typically via the internet.  A quick Google search will reveal many crowdfunding sites devoted to raising funds by donation, without the funders necessarily expecting anything tangible in return.

CSEF, also called equity crowdfunding, is providing funds in the form of equity: you make your contribution and receive shares in return.  Crowdcube is an example of a UK-based platform, authorised by the Financial Conduct Authority in the UK, which adopts this model.

Current restrictions on CSEF

Under existing rules in the Corporations Act, your company can’t have more than 50 non-employee shareholders without becoming a public company.  And public companies have to be audited, accept half-yearly reporting and continuous disclosure requirements, and hold an annual general meeting.

And even if you are a public company, equity funding usually requires:

• a prospectus, which can involve more expense and attract more liability than small companies may want to accept, or
• the ‘sophisticated investor’ exception – investors limited to those who meet minimum asset or income tests, or
• the ‘personal offer’ exception – up to $2m raised from no more than 20 investors by personal offer only (so no use of an online platform to reach investors you don’t already know).

Reform proposals

Treasury put out a discussion paper in December 2014, seeking comment on three proposals.

1. Status quo. No change to the existing regime outlined above.
2. The ‘CAMAC model’, put forward in a report by the Corporations and Markets Advisory Committee in May 2014. It has the following features.
   1. A company wanting to use CSEF (an ‘issuer’) would convert to a new form of company, the ‘exempt public company’. This would be a half-way house between the existing proprietary and public company, with relief from existing public company requirements such as auditing and continuous disclosure for up to 3 to 5 years.
   2. An exempt public company could raise up to $2m in 12 months, with less disclosure than required under current prospectus requirements.
   3. Intermediaries – those running the online platforms – would have to hold an Australian Financial Services Licence (AFSL). They would not be allowed to accept payment in the form of shares of the issuer.
   4. Investors could not invest more than $2,500 in 12 months in any one CSEF issuer, and no more than $10,000 in 12 months in CSEF issuers in total.
3. The ‘New Zealand model’, which came into force in NZ in 2014. There are some similarities, but also some differences, from the CAMAC model.
   1. No requirement to convert to a new form of company – but no relief from public company audit or reporting requirements either.
   2. Level of disclosure required is variable. A minimum standard is specified, but becomes more onerous as amounts invested or amount raised increases.
   3. Intermediaries – no restriction on fee structures, so they could accept payment in shares from CSEF issuers.
   4. Caps on amount invested are voluntary, but high caps or no caps lead to increases in disclosure requirements.

Tbe government’s next steps

The Treasury discussion paper was open for comment for a short period, which ended on 6 February 2015.  The Minister’s press release flagged that he is now engaging in a series of roundtable consultations with industry, and reports ‘strong support’ for the development of CSEF and a regulatory framework for it.

This all suggests that the area is one where the government wants to act, rather than letting CAMAC’s report from last year sink without trace.

What does it mean

If the government adopts reforms along the lines of the CAMAC model or the New Zealand model, it should create opportunities for issuers, intermediaries and investors.

For issuers, companies wanting to raise funds –

• It should provide access to equity funding at an earlier stage in the company’s development, and with less initial and ongoing expense, than a prospectus and stock exchange listing.
• Crowd sourced equity might displace some bank debt – and, for a start-up company, that would probably be bank debt that could only be raised by providing directors’ guarantees and maybe a mortgage over the family home.
• Converting to ‘exempt public company’ status is unlikely to be difficult.
• But there may be traps for the unwary. The company will acquire a shareholder base that will need to be kept informed and could be more demanding than expected.  And under the CAMAC model, the exemptions from the full raft of public company audit and reporting requirements will expire eventually.

For intermediaries –

• There will be opportunities to profit from setting up and operating the platforms to launch CSEF issuers.
• Intermediaries will no doubt be hoping the final model is more flexible than CAMAC on fee structures, and that it will allow payment in shares or on a success fee basis.

For investors –

• Those who go in with their eyes open should have the opportunity to be involved as shareholders in interesting ventures that might otherwise be unavailable to them, with the possibility of profit for any that take off.
• Investments will be illiquid: there is unlikely to be a ready market to sell your stake unless the company eventually lists on the stock exchange.
• Your investment may be diluted by subsequent equity raisings undertaken by the company.
• It’s tempting to say that your money might be about as safe as if invested at the racetrack. Would that be such a bad thing?  After all, there is no $10,000 cap on spending on the horses or the pokies.

For all the rigours of current prospectus disclosure requirements, there are plenty of investors who have put money into IPOs at the small end of the market and seen most of it disappear.  This should be an interesting reform that brings together entrepreneurs with interesting ideas, and investors wanting some long-term fizz factor in their portfolio.

It will be interesting to watch developments over the next few months.