Crowd sourced equity funding to gain traction with new legislation

In brief

After a difficult journey, both Houses have passed the Corporations Amendment (Crowd-sourced Funding) Bill 2016 – introducing a new funding avenue for Australian startups and an opportunity for retail investors to access equity in emerging companies. Managing Associate Valeska Bloch, Senior Associate Tom Griffin, Summer Clerk Katherine Tsatsaklas and Applied Legal Technology Head Paralegal Hope Williams report.

For the first time, certain small public companies have access to crowd sourced equity funding (CSF) – an innovative type of online fundraising allowing a large number of investors to make small financial contributions to emerging companies. This opens new doors for small businesses and startups, who might otherwise struggle to obtain affordable finance.
Retail investors, who are frequently unable to gain direct access to early-stage companies, also gain access to a wider range of investment opportunities. However, in contrast to New Zealand's scheme, caps apply which limit complete freedom of investment.
To access CSF, we may see a proliferation of private companies 'converting' to public.
However, while newly formed public companies will benefit from new provisions that provide relief from corporate governance and reporting requirements, it must be remembered this relief is temporary. Further, this process is likely to be costly and time-consuming.

Background

While CSF is technically legal in Australia, the previous regulatory regime had restricted its operation – allowing only a small number of online operators to offer investment into Australian startups and small businesses. The restrictions included:

A limit of 50 non-employee shareholders in proprietary companies meant such companies were not able to access the large number of small-scale investors typical of the CSF process.
Public companies were not subject to these restrictions, but had to comply with extensive corporate governance and reporting obligations – including use of a disclosure document to make equity or debt offers, which could be costly and time consuming to prepare.

These regulatory impediments and barriers were highlighted in multiple inquiries and reports, including the Financial System Inquiry 2014 (the Murray Inquiry), Corporations and Market Advisory Committee Crowd Sourced Equity Funding Report (the CAMAC Report), and Treasury Consultation and Discussion Papers.

Prime Minister Turnbull's Ideas Boom signalled a renewed focus to reform CSF (read our report on the Innovation Agenda here). Following a failed attempt to pass a similar Bill in May 2016, the Government introduced a new version of the Bill in November 2016, aiming to reduce current barriers to CSF while also ensuring appropriate investor protection. In practice, this approach is broadly similar to what we saw in the Bill's first iteration, and continues to take a cautious approach to this new source of funding.

The Bill met further controversy when Labor withdrew its support in December 2016, and referred the Bill to a Senate inquiry. Following a recommendation by the Senate Economics Legislation Committee that the Bill be passed, the Bill gained the Greens' support. This allowed it to pass through the Senate on Monday, subject to an amendment to the cooling-off period. Bringing a long journey to a close, this amendment was approved by the House of Representatives. The Bill still awaits Royal Assent.

Summary of new measures

Affected businesses

Unlisted public companies with less than $25 million in assets and annual turnover can engage in crowd sourced equity funding to raise capital. This marks a key amendment from the original Bill, which limited eligibility to unlisted public companies with less than $5 million in assets, and $25 million in annual turnover.
However, concessions are available for small companies that become public companies in order to access crowd sourced equity funding. This marks another key modification of the original Bill, and aims to increase accessibility and applicability. During a transition period of up to five years, these companies will be eligible for exemptions from certain onerous corporate governance and reporting requirements applicable to public companies – including hosting AGMs, and undertaking audited financial reports and half-yearly reporting.
In addition, offers can be made via a CSF offer document, rather than a more onerous disclosure document.

Fundraising caps

Eligible companies may raise up to $5 million in any 12-month period through licenced crowdfunding platforms.

Crowd funded services

Intermediaries operating crowd-funding platforms will be required to hold an Australian Financial Services Licence (AFSL), and will play a key gatekeeping role. This includes providing a communications facility, conducting checks on companies they list on their platforms, and providing generic warnings to investors.

Investor protections for CSF offerings

Retail investors are restricted by an investment cap of $10,000 per company, per 12-month period.
Investors have access to a cooling-off period of five business days after making a commitment. The five business day period was set by the original Bill, but amended to 48 hours in the second Bill. The Senate accepted an amendment by Opposition Senator Katy Gallagher to revert back to the original five business day window.

Reaching the middle ground?

Extensive industry consultation following the first Bill's failure was key to passing the second Bill. This consultation sought to compare three approaches to equity funding: Australia's status quo, New Zealand's model, and recommendations made in a 2014 report by the Corporations and Markets Advisory Committee (CAMAC). We reported on CAMAC's recommendations here.

New Zealand's model takes a different approach to that of CAMAC in a number of key areas. In particular:

New Zealand's regime is significantly wider in scope. Importantly, it is not specifically limited to small enterprises, and there is no investment cap.
New Zealand does not impose restrictions on intermediaries' fee structure, and these intermediaries are able to invest in issuers using their platform (although details must be disclosed).
However, there are no CSF-specific exemptions from public company compliance costs.

The new Bill combines elements of both the New Zealand and CAMAC model, as well as new elements. For example:

Businesses will be able to raise more funding through CSF in any 12-month period than both other models.
Investors have greater freedom, accessing a larger investment cap than the CAMAC model. However, this higher cap is still more restrictive than the voluntary caps on investors in New Zealand.
The Bill gives more flexibility to intermediaries than the CAMAC model, as they can operate under a preferred fee structure and invest in intermediaries using their platform. Like in New Zealand, these investments must be disclosed.

Who misses out?

Private companies and large public companies remain ineligible for CSF under this Bill. Private companies continue to face restrictions on public equity offerings, and a cap of 50 non-employee shareholders. Equally, public companies with a higher turnover than the cap will miss out.

While relief is available to companies who 'convert' to public to access CSF, it is not permanent. Some companies may fear the transition, in the knowledge that after five years they will permanently be a public company with no access to relief. The conversion process itself is also likely to be time-consuming and expensive.

When he was Communications Minister, Prime Minister Malcolm Turnbull indicated a preference for the wider ranging New Zealand approach. However, while the new Bill is a step in the right direction, it does lock many players out of the system.

Australia seems far off adopting a CSF model where any incorporated entity can access this kind of capital.