Reforms to equity crowdfunding laws allow proprietary limited companies to raise funds without having to become public companies but it is high risk for investors.
By James Dunn
The Australian Government’s long-awaited equity crowdfunding reforms have finally been passed, almost a year after they were introduced to federal parliament.
The Corporations Amendment (Crowd-sourced funding for Proprietary Companies) Bill 2017 is the government’s third attempt at legislating equity crowdfunding. Its first bill was left stranded by the July 2016 election, and its second bill – which took effect in October 2017 – was criticised by the industry for requiring companies to become unlisted public companies before they could have access to equity crowdfunding.
That was the basis under which seven equity crowdfunding platforms were licensed by the Australian Securities and Investments Commission (ASIC) in January 2018. However, the public company requirement has been removed in the bill passed in September 2018, allowing proprietary limited companies to raise funds through equity crowdfunding without changing their legal status.
The new legislation, which took effect from October 2018, is “a huge step forward for the Australian fintech and start-up sector,” says Jonny Wilkinson, co-founder of crowdfunding platform Equitise.
Since January 2018, when equity crowdfunding became available for unlisted public companies, Equitise has interacted with over 1000 companies, 570 of which formally applied on its platform. Less than 5 per cent completed the process to be in a position to raise funds.
Equity crowdfunding is too hard
“Whilst some of these companies were not suitable for equity crowdfunding, a large proportion thought the time, cost and compliance for converting and managing a public company to be too onerous at a point where they needed to focus their energies on growing their business,” Wilkinson adds.
Not only has the need for public company status been waived, so has the rule under which Australian private companies are typically limited to a maximum of 50 non-employee shareholders; any more, and they must change status to an unlisted public company. However, under the new amendment, investors acquiring shares through a crowdfunding offer are excluded from this cap, allowing private companies to raise funds from potentially hundreds or thousands of investors.
The public company rules were there for good reason: that is, to provide some protection to investors. However, according to crowdfunding platforms, it significantly crimped the pool of equity crowdfunding candidates.
Matt Vitale, co-founder of crowdfunding platform Birchal, says public companies are estimated to make up less than 0.5 per cent of all companies registered in Australia. The reforms will increase the pool of potential companies wanting to raise funds through equity crowdfunding, he says.
“While interest in equity crowdfunding has been astounding so far, the need to convert to a public company has been a significant deterrent. We have been speaking with numerous companies that have been holding off launching campaigns until this announcement. This news [of the legislation passing] will be of immediate benefit to them.”
Although Australian private companies will no longer need to convert to raise funds under the equity crowdfunding regime, Vitale says there is a range of additional obligations of which private companies need to be aware.
“Private companies seeking to use equity crowdfunding will be subject to a range of additional obligations to ensure that investors are appropriately protected. These include related-party transaction rules and enhanced reporting and disclosure obligations, all of which are entirely appropriate for companies permitted to raise funds from the public,” says Vitale.
Allowing proprietary companies to access equity crowdfunding aligns Australia with a number of other jurisdictions, says Alan Crabbe, co-founder of Birchal.
“I think generally there is a perception in the market that opening it up to Pty Ltd companies will make it much more accessible.”
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Demand for crowdfunding
Wilkinson says there is pent-up demand among proprietary companies to use crowdfunding.
“We’ve had a lot of people come to us and say, ‘We want to use your platform, but for certain reasons we don’t want to convert to a public company’. There is definitely that sort of demand. The other consideration is, as well as opening things up, it will also formalise it and make it better for some of these companies to do some of the informal capital raisings that they’ve traditionally done by tapping friends and family.”
In this way, equity crowdfunding allows businesses to reach both more investors and higher-quality investors, says Wilkinson. Globally, he says, the statistics on equity crowdfunding indicate that about two-thirds of the money will come from first, second and third degrees of connection to the business, which means friends, family and customers, and people who hear about the idea and like it.
Investment in crowdfunding
“That’s the traditional source of equity crowdfunding money. But we’re starting to see interest from high-net-worth (HNW) and family office type of investors who are looking to extend the scope of their equity investments.”
Wilkinson says these groups have access to deals, but do have to analyse what they are offered.
“Several of them have told us that they like the fact that we’re serving up a somewhat homogenous product, and that they can compare it. Given that there is an offer document – a cut-down prospectus – that makes it a bit easier for them to assess the investment.
Wilkinson says that if he could help companies reach these sophisticated investors, in a disclosure-based environment with consistent process and structure and all of the legal documentation, that will improve the overall performance and governance and structure of that part of the market.
He will take deals to HNW and family office investors with a specific interest or appetite in a sector, or a stage, and offer to introduce them to the founders or offer a cornerstone investment.
“I think that is going to be an increasingly common way of structuring these deals – to take them first to sophisticated investors and people who appreciate this as an asset allocation strategy.”
Equity crowdfunding for small investors
Wilkinson believes it will take time for a broad base of smaller investors to see crowdfunding as attractive.
Crabbe says there are plenty of people interested in early-stage companies.
“We’ve been surprised at how many people are registering on our platform, following quite a few of the companies that are raising. Some of these people have previously invested in early-stage companies, but many others have not yet done so.”
Wilkinson says education will be required. “Even though this is equity, it is not like an IPO [initial public offer]. It’s great that we have a lot of interest, but we have to help potential investors understand that it’s not like the stock market – it’s not easy to track the performance of the companies.”
CPA Australia’s General Manager of External Affairs Paul Drum says it is important to be aware that many of these investments will be highly speculative in nature, and not governed by the same level of investor protections as other more mainstream investments.
“Further potential investors need to understand they may have difficulty disposing of their interest in the investment in the future,” he said.
“Anyone considering this type of investment should seek independent financial advice.”
He added that “CPA Australia is of the view that companies considering fundraising should also seek independent advice – as there are more than one way to raise funds and crowdsource funding may not deliver them the most optimal outcome.”
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