Crowdfunding is not new or innovative.
In 1713, Alexander Pope’s English translation of Homer’s The Illiad was essentially crowdsourced from 575 subscribers, each receiving an acknowledgement in the book. Further, a plaque for the Statue of Liberty in 1885 raised $102,600 from over 120,000 people, most receiving a replica of the statue in return.
But it has been the advent and proliferation of internet platform providers, such as Kickstarter, Indiegogo and Australia’s Pozible, and perhaps a cultural change among contributors, that has seen a paradigm shift in crowdfunding into a $16.2 billion industry (and with 112% expected growth to $34.4 billion in 2015).
Crowdfunding is essentially raising funds from a large number of people (“crowd”) to deliver on a project, product or a business.
It is not surprising that crowdfunding (including crowd sourced equity funding) is expected to develop into a $96b industry by 2025, or 1.8 times the current venture capital industry. And it is the raising of monies for a business via shareholding through crowdfunding platforms that has prompted a regulatory response.
The current legal framework in Australia for start-ups to raise capital without becoming a public company and issuing a prospectus generally begins and ends with the “excluded offer” provisions of the Corporations Act, which allow a company to raise up to $2m from 20 retail investors over any twelve month period (“20/12/2 rule”) through personal offers. Given that the offers must be personal, they cannot be advertised.
The very nature of the “crowd” in crowdfunding would lend itself to more than 20 investors and to people the start-up knows and doesn’t know. In fact, it would be expected that the crowd would be greater than 50 non-employee shareholders, which would require the start-up to be a public company. Public company status brings with it the added costs of compliance, which, for start-ups, whose net assets generally are comprised of sweat, are cost prohibitive.
The journey of the regulation of crowd sourced equity funding (“CSEF”) in Australia started in August 2012, when ASIC released a general warning to intermediaries regarding rewards-based crowdfunding potentially coming under the provisions of the Corporations Act. It created a level of uncertainty that has yet to be resolved, but prompted an independent review as part of the Federal Government’s national digital economic strategy.
Whilst crowdfunding, in the form of rewards and donation-based contributions, has been growing at 524% compound annual growth rate from 2009-2012, only recently have countries initiated the framework for CSEF. The USA, Canada, the United Kingdom and Italy have all put forward their own regulatory overlay, but it was with New Zealand’s model that our Corporations and Markets Advisory Committee (“CAMAC”) became most enamoured.
Perhaps equity crowdfunding is Helen of Troy? The most beautiful option for start-ups in terms of filling their funding gap which has been taken to our across sea rivals – substitute New Zealand for Turkey and Australia for Greece?
Whilst not advocating a war with our trans-Tasman rivals, we should begrudgingly respect their ability to note CSEF’s potential, take the initiative and bring it to their shores. And quickly. Australia now lags behind New Zealand (and many other developed nations) in developing and implementing a workable legislative framework for CSEF.
As one of its last rites, the report by the now defunct CAMAC in May 2014 was a welcome response, but we ought look to the far eastern states of Australia, the North and South Islands, for inspiration about how we can effectively implement crowdfunding regulation.
CAMAC’s final report on CSEF provided a detailed regulatory blueprint for the operation of soliciting small financial contributions from a large number of people.
The basis of the report was to determine whether CSEF should be facilitated in Australia – yes – and if so, do the existing laws facilitate it – no – and then finally, “the preferred policy options to introduce a regulatory regime specifically designed for the CSEF”.
CSEF includes three key participants – the Issuers (start ups / companies seeking to raise equity); the Intermediaries (the internet platform providers); and the Investors (the crowd).
The regulatory framework-balancing act submitted by CAMAC was to provide a more efficient means to raise capital for (start-up) Issuers, the roles and responsibilities of the Intermediary and the protection of the Investors. All this, whilst trying to limit major Corporations Act changes. The report was substantially well considered but will inevitably require legislative changes to facilitate CSEF in Australia.
Whilst the current Managed Investments Act could facilitate CSEF in Australia, CAMAC dismissed this possibility as being unattractive to crowd investors and not commercially feasible. Whilst there is some doubt about this premise in the eyes of the writer, the disconnect of a fund overlay between crowd investors and the issuers may be an impediment for investors. And it is the investors that will make or break crowdfunding in any of its forms. It has not, however, stopped one Australian entity from structuring its platform through an intermediated trust, albeit for wholesale investors only.
To relieve start-ups seeking funding from a mass market of some of the compliance and reporting costs associated with public companies, CAMAC proposes the establishment of ‘exempt public companies’. Combined with a templated ‘crowdfunding disclosure statement' for investors to compare and contrast each Issuer’s offering, this overlay is aimed at striking the balance between Investor protection, Intermediary responsibilities and Issuer disclosure and compliance.
THE TROJAN HORSE?
So as not to speak ill of the dead, CAMAC’s submission was a well thought out and productive endeavor, outlining the requirements on Investors, Intermediaries and Issuers (with emphasis on changes to Issuers and Intermediaries). However, there is a substantial amount of cherry picking from other international jurisdiction regulatory requirements, with Investor protection and conservatism the underlying factors. CAMAC has certainly leaned towards greater disclosure and risk mitigation as a whole than most jurisdictions (UK aside), with Investor caps and Issuer disclosure being potentially the major impediments to an efficient crowd sourced equity funding model in Australia.
The state of play for Issuers is more moderate upfront disclosure requirements than a public company issuing a prospectus. However, there are more ongoing disclosure requirements required than raising under the 20/12/2 rule. The main elements recommended by CAMAC include that Issuers:
- become an exempt public company (reduced compliance requirements as opposed to public companies) or public company;
- offer new shares in the company – recommended to be only one class of shares (namely, ordinary shares);
- do not exceed the issuer cap of $2 million in any twelve month period;
- comply with disclosure requirements. This is quite extensive and will be difficult for most Issuers to conduct independently;
- adhere to controls on advertising (basically, ensuring no misleading or deceptive statements are made and referring potential investors to the intermediary platform);
- do not lend to crowd investors to acquire its shares; and
- notify any material adverse change concerning the issuer.
In addition to the above, there are the normal public company disclosures to shareholders upon a successful crowdfunding campaign, subject to a few exemptions. Exempt public companies have certain obligations removed including: appointing auditor; half year financial reporting; continuous disclosure; and remuneration reporting; or significantly modified, such as shareholder reporting and the directors’ report.
Whilst intermediaries may be disappointed to come under the Australian Financial Services Licensing (“AFSL”) regime, it is an important element to ensure that intermediaries have the financial, compliance, IT and human resource capabilities to operate a crowd sourced equity funding platform. There are due diligence requirements, however these could be considered light as they relate to the Issuer and not the business or business plan.
- should be appropriately licensed (AFSL) and comply with the various obligations attached to that licence;
- conduct limited due diligence checks on Issuers;
- provide a generic risk disclosure statement to crowd investors (recommendation that this be a standard template disclosure across intermediaries);
- check compliance with investor caps in some instances;
- provide communication facilities between issuers and investors;
- have, and disclose information about, dispute resolution procedures and indemnity insurance; and
- disclose the fees they charge.
From an investor perspective, it is currently proposed that there be no major changes excepting the following:
1. investor limits on CSEF platforms of $2,500 per Issuer and $10,000 total in any one year; and
2. increased risk acknowledgement reflecting the lower Issuer disclosure requirements and the high risk nature of the investments
Unfortunately, the proposed investor limits do preclude friends of the Issuer investing greater amounts which, along with family, tend to be the major contributors to crowdfunding campaigns.
As with any regulatory overlay, there will be those that disagree with the onerous nature of the framework. Issuers may express concern that the initial and ongoing regulatory requirements of exempt public companies will be a financial and time consuming compliance burden. Intermediaries that were hoping to be a ‘facilitator’ will be somewhat taken aback by the AFSL, and additional financial, human resource and compliance requirements. Investors may feel aggrieved at the additional risk, investor caps (especially if the Issuer is well known to the Investor), disclosure and regulatory overlay to invest, or may feel there is not enough information about the Issuer to make an informed decision. But that’s the essence of any regulatory overlay – finding the right balance – rather than allowing a CSEF Trojan Horse. We would prefer not to see this opportunity go the way of recent aborted start up assistance packages, such as Commercialisation Australia.
GIVE ME A PLACE TO STAND AND I WILL MOVE THE EARTH
There are a number of issues that may be further investigated and changed by the Federal Government prior to bringing CSEF legislation through parliament.
Recent developments in the introduction of CSEF legislation in Australia have indicated a potential start date at July 2015 or perhaps even as late as July 2016. There appears to be bi-partisan support for CSEF in Australia, but the devil is in the detail.
Further consultations with industry have commenced, which is a positive (and roundtables were initially intended as part of the CAMAC review but were not progressed), but a start date extending out to 2016 would be detrimental especially given the cutbacks to a number of industry assistance programs to small business: the Entrepreneurs Industry Package not really assisting in this area despite its intended purpose.
One would suggest that with a 2016 start date, making it four years since the first real dialogue began in Australia about CSEF, and the fact that the CAMAC report recommends substantial parts of the New Zealand CSEF model be adopted, Australian Issuers may seek to raise money across the Tasman rather than in Australia until we get ourselves sorted.
Apart from timing concerns, other issues include revisiting the investor contribution cap issues, especially in relation to those that are “connected” with an Issuer, such as family and friends. Given that some industry statistics show that 50% of a start-ups capital is raised from friends and family, 25% from people one connection away and the other 25% from third parties/not connected), you will need either of both of a lot of friends or a large family. The limit of $10,000 may also need to be reviewed to allow for greater diversification by investors – the typical venture capital fund makes contributions to up to 20 portfolio companies (with a reasoned expectation that most will fail but that a couple will outperform significantly).
There may need to be further accommodations to Issuers as reasonable expectations of up to $5,000 for out-of-pocket expenses could ensue under the current CAMAC recommendations. These will include legal fees, crowd ready advisory fees and Issuer due diligence – not a small amount for a start up and with no guarantee of successfully raising money.
The CAMAC suggestion that Intermediaries look towards providing a secondary market appears flawed given the costs, ability to provide reasonable market information and that there are less than ten Australian Market Licences that have been issued by ASIC since its inception.
Overall though, the CAMAC report, with a few amendments, is an excellent initial blueprint for CSEF in Australia and a tremendous legacy. May CAMAC rest in peace.
And while Australia has been discussing their response to Helen of Troy, New Zealand has already started enjoying the fruits of their labour. The Kiwis have already implemented their own CSEF legislation and, at the date this article was written, had issued two crowdfunding licences under their equivalent of the AFSL regime.
Each man delights in the work that suits him best
The online crowd sourced equity funding model is a relatively new industry for the raising of capital in Australia. As with any new market, investor protection, disclosure and intermediary capabilities have been the focus thus far. The $96 billion question is whether this new market, assuming we overcome the regulatory hurdles, will have the demand, trust, quality and returns to build a sustainable industry over the long term and assist in the start-up funding gap?
Jon Spensley, Founder of CrowdReady, firstname.lastname@example.org
Chris Mee, Principal at CNM Legal, www.cnmlegal.com.au