Regulatory Considerations for Equity Crowdfunding

Overview

Government policies are an integral tool in shaping the digital landscape and promoting the growth of the digital economy. This is particularly relevant when considering the financial services industry in Australia which is paralysed by “tired” regulation, dated security processes and cumbersome protocols which in some cases haven’t been changed in decade.

The issue that Australia is currently facing is how to design and implement strategies that will optimally support economic growth, productivity, innovation and employment, while also ensuring balance by mitigating core risks (Deloitte Access Economics, 2015).

"A strong policy framework will facilitate the growth of the digital economy and ensure it plays a role in providing employment, adding to productivity growth and generating consumer benefits." (Deloitte Access Economics, 2015)

Currently, there are significant regulatory constraints on private companies that wish to participate in public fundraising. The options are tightly regulated, costly and burdensome.

A regulatory framework that accommodates equity crowdfunding within the Australian corporate landscape will have positive effects on the entrepreneurial industry and more broadly, the SME landscape by increasing the flow of funds from investors not currently available or easily able to invest in private companies.

Current barriers in the Australian framework:

Proprietary companies are capped at 50 non-employee shareholders:

  • With average shareholder numbers in international equity crowdfunding campaigns equaling 96 (CrowdValley, 2015) in the US and 104 (Crowdcube, 2015) in the UK, the current cap of 50 non-employee shareholders is a material restriction in the ability to encourage meaningful amounts of capital (CAMAC, 2014). Especially as this is from limited historical data that is skewed towards sophisticated deals, we anticipate the average number will be much higher over time.

Disclosure to Investors:

  • The current disclosure requirements imposed on private companies are costly, cumbersome and time consuming. Proprietary companies are prohibited under the Corporations Act from engaging in any activity that would require disclosure unless the offer is being only made to existing shareholders of the company and employees.
  • Proprietary companies are able to make offers which do not require disclosure under the s708 exemption for small scale offerings. This restricts the issuer of making a transfer of securities to a maximum of 20 retail persons, raising no more than A$2million in any 12-month period.
  • A private company could also make an offer of securities for sale or issue to a sophisticated investor, which does not require disclosure. However, investors must meet high financial thresholds to be considered sophisticated.

These types of exemptions do not accommodate the type of fundraising facilitated by crowd-sourced equity funding models which typically involve a retail class of investors.

So…. What is happening to change this?

Following the release of a report from the Corporations and Markets Advisory Committee (CAMAC) summarising the current state of play and their suggestions to government in 2014[1] the Australian Government has made significant progress in working towards a proposed system that will work for all key stakeholders, without being overly restrictive to limit innovation and growth.

Milestones since the CAMAC report release include:

  • October 2014: The Government announced that it would consult on a potential regulatory framework for equity crowdfunding in Australia its Industry Innovation and Competitiveness Agenda.[2]
  • December 2014: The Government releases a discussion paper, inviting core stakeholders to respond to a series of questions pertaining to the rollout of equity crowdfunding legislation.[3]
  • December 2014: Special mention of the need to accommodate equity crowdfunding in The Financial System Inquiry, chaired by David Murray (Financial Systems Inquiry, 2014).
  • February 2015: A series of round table discussions directly relating to the core elements of the proposed legislative changes. This was hosted by Bruce Bilson the Minister for Small Business.
  • February 2015: The Minister for Small Business announces the Federal Government will be releasing the new model for equity crowdfunding in the Spring Session of Parliament.[4]

If executed properly in line with overseas market practice the legislation will assist private businesses in having the best chance to utilise the opportunities that CSEF can offer without dramatically increasing their costs or regulatory burdens. This will bring Australia up to date with other developed economies.

Considerations of crowdfunding and potential risks:

There are risks for investors in crowdfunding. However, its open and transparent nature when combined with the efficiencies of early stage markets equate to an effective and safe medium for pooling funds to achieve collective goals. Here are some of the risks:

  • Risky investments: The inherent nature of investing in private companies, it is risky; the securities are illiquid; the significant reliance on founders and the potential loss of all funds.
  • Fraud: however the director laws in both Australia and New Zealand provide significant protection and recourse for investors. Along with the fact that the crowd have proven to be effective at weeding out fraudulent companies.
  • Lack of education: Both investors and entrepreneurs might not know exactly what they are getting involved in and the expectations of the other parties.

Equitise has built into its platform many measures and structures to mitigate as much risk as we can throughout the process. Remember risk = reward!

[1] Corporations and Markets Advisory Committee, Parliament of Australia, Crowd sourced Equity Funding Report (2014)

[2] The Treasury, see: http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2014/Crowd-sourced-Equity-Funding

[3] http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2014/Crowd-sourced-Equity-Funding

[4] Smart Company, see: http://www.smartcompany.com.au/finance/45508-bruce-billson-equity-crowdfunding-framework-will-be-on-the-table-by-spring.html

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