The regulatory environment of equity crowdfunding in Australia today

Crowdfunding has taken the world by storm, will Australian regulation catch up?

The use of crowd sourced funding for the purpose of raising funds for business development has become increasingly popular in a number of foreign jurisdictions. A number of commentators are of the view that “crowdfunding is one of the biggest financial changes in history” due the fact that it changes the way money is exchanged. The use of crowd sourced equity funding (CSEF) is an attractive option for start-up companies wishing to raise both working capital for their businesses and consumer product awareness. The theory behind the use of this model is to develop networks in order to attract sufficient capital and to break down barriers to facilitate direct connections between entrepreneurs and potential investors. However in Australia the use of this vehicle for the purposes of equity raising is limited due to our onerous and burdensome regulatory environment.

So what is the regulatory environment in Australia for CSEF?

The regulatory environment for CSEF is governed by a rigorous consumer protection regime of disclosure and licensing in order to protect retail unsophisticated “mum and dad” investors from intermediaries spruiking investment opportunities. The Corporations Act 2001 (Cth) (the Act) limits the opportunity for small proprietary limited companies from engaging in such capital raising activities from the general public at large.

The key elements in regulating such activities are as follows:

Disclosure: The Act requires that the capital raising activities by company requires full and continuous disclosure which will require the production of disclosure documentation prior to the promotion of a company’s securities (shares). The only exception to this requirement is where a company is making a small scale personal offer to where such an offer is made to no more than twenty (20) new investors within a twelve (12) month period and the raise is for an amount up to $2,000,000 (the Section 708 Exemption). With respect to this limitation on capital raising the Act excludes investors whom are defined as sophisticated investors (whom are defined as investors hold net assets in the amount of $2.5M or achieve a gross income of $250,000 in the last two (2) financial years). Accordingly, it is apparent that there are limited opportunities for small investors to gain exposure to small start up types of investment because of this disclosure requirement.

To date in Australia, CSEF legislation has not been enacted to regulate the activities of start up companies in their endeavours to obtain monies for their business development activities. It is apparent that they are solely reliant on the Section 708 Exemption in order to achieve their capital raising objectives without satisfying the disclosure documentation requirements under the Act.

Licensing: The second impediment to CSEF is the regulatory environment for intermediaries promoting investment opportunities in small start up as the Australian regulatory environment requires that Ch7 of the Act be satisfied by operators engaging in this activity must hold an appropriate Australian Financial Services Licence (AFSL). Due to costs associated with complying with the Act it appears that AFSL holders are not interested in engaging in this segment of the capital raising market due the fact that the small amounts being raised make it commercial unviable for them.

The Australian model and regulatory environment appears to be inconsistent with the CSEF as it requires a more nimble and flexible approach as the Act seems to only cater for larger transactions and corporations.

So what are the advantages and disadvantages of CSEF?
For investors examining the pros and cons in investing in start up companies which are ordinarily offered in CSEF, the potential investor must take into account the following:

 Pros:
o May be easier to obtain CSEF rather than through traditional debt financing methods.
o Able to obtain a goodwill interest in the company and therefore obtain greater than average long term returns for their investment.
o May appeal to one’s value of altruism and to help others in achieving their goals.

Cons:
o Such investment activity may divert funding and capital resources from more established businesses.
o The products and/or services promoted by start ups may not be commercially viable or mature enough for the current market.
o Investments in start-up companies are generally highly speculatively and illiquid.
o An investment in a start up may require additional capital in order to reach commercialisation of a product/service which in turn may in turn dilute an initial or early investor’s shareholding.

Future Australian Developments for CSEF

The Corporations and Markets Advisory Committee (CAMAC) has issued a report on CSEF which outlined the impediments to an effective CSEF regime and made the following recommendations in order to develop this segment of the business development market:

o  Amend the regulatory environment for proprietary companies.
o  Restrict offers to particular a class of investing.
o  Amend the fund raising provisions for other companies.
o  Introduce a new regime designed for CSEF which would facilitate a new business model (which have been implemented in NZ, UK and the US).

It is imperative that the Australian regulators and legislators draw on the overseas experience as commentators have expressed that the development of CSEF may assist in efficient job creation in start up businesses without being subjected to onerous and expensive disclosure and licensing obligations.

In the event that you have any legal assistance on any of the issues raised above please do not hesitate to contact Eakin McCaffery Cox on 9236 3000.

George Halikiotis holds special counsel at Eakin McCaffery Cox and is a legal expert on corporate and commercial, superannuation and private client law.

DISCLAIMER:
The views expressed in this publication do not constitute legal advice and are intended to be of a kind to be regarded as general information only. It is recommended that readers take specific legal advice before relying or acting upon the information contained in this publication to a specific set of circumstances or transaction.