Gerry Cawson, the head of our Mergers and Acquisitions team, talks about how the proposed new rules for Crowd-Sourced Equity Funding are likely to change the way early stage companies source capital and whether those rules are going to work for everyone.
You probably already know about crowd sourcing.
We’ve all heard about how people have raised money for causes or projects by using crowd-sourcing platforms like Kickstarter. Some entrepreneurs have already adopted crowd-sourcing as a means of raising money to fund their companies by offering gifts, rewards or early prototype products in return for cash.
However, until the law changes, the ability of a company to raise small amounts of cash from a large number of retail (or ‘Mum and Dad’) investors and issue shares in return is severely limited.
Currently, no issues without a prospectus
Under the current law, this isn’t possible without issuing a prospectus, the preparation of which can be time consuming, complex and give rise to significant risks for directors.
Currently, companies that want to raise funds in return for issuing shares without using a prospectus need to fall within certain exemptions: either the investors need to be high net worth individuals, professional investors or senior managers within the company in question.
Mum and Dad investors can still invest but only if the company makes a personal offer to them and the number to whom shares are issued is less than 20 and the amount raised no more than $2m in any 12 month period.
New legislation opens up the opportunities
Under the proposed legislation, start-up companies that meet certain tests will be able to raise up to $5m from any number of Mum and Dad investors without the need for a prospectus. Sounds great? Sure, but of course there are some conditions.
The company seeking to raise funds must be a small Australian unlisted public company with less than $5 million of assets and less than $5 million in annual turnover. They must also not be part of a group that meets these thresholds.
Proprietary companies cannot utilise the new rules, which seems appropriate to me. Proprietary companies don’t have the level of compliance obligations that give ‘Mum and Dad’ investors comfort that their interests will be protected.
Public companies that utilise a crowd sourced equity platform can benefit from an exemption from the obligation to hold an annual general meeting, they will need only provide financial reports to shareholders online and won’t need to appoint an auditor or have audited financial reports until they’ve raised more than $1 million from a crowd-sourced equity offer.
All dealings through an intermediary
Perhaps the biggest concern from the new rules is the new obligation on the operator of the platform through which crowd-sourced equity offers are made.
All such offers must be made through a platform operated by an intermediary that holds an Australian Financial Services License (‘AFSL’) and which complies with some fairly onerous obligations in conjunction with the offer. My concern is the imposition of these ‘gatekeeper’ obligations will deter potential operators of the platforms meaning that companies, instead of being able to engage the Mum and Dad investors, will be locked out from raising capital.
The platform operators need to:
- suspend and close offers if an offer statement is defective;
- ensure that the mandated risk warning appears prominently on the platform at all times;
- provide and regulate a facility through which relevant applications are made;
- provide a communication facility in connection with offers; and
- disclose any fees that the company will pay to the intermediary and any interest held by the intermediary in the company.
Practically, we’re hearing potential operators are finding it hard to obtain the insurance cover they’d need to take on these obligations which, when combined with obligations to comply with anti-money laundering obligations and the compliance obligations of being an AFSL holder, have taken away any excitement about the opportunities crowd-sourced equity may provide.
New opportunities for investors
Currently, the ability for retail or ‘Mum and Dad’ investors to get access to early stage start up opportunities is extremely limited.
If the intermediaries do take on the challenge of providing crowd-sourced equity platforms, then the new rules will make it easier for ‘Mum and Dad’ investors.
The rules do, however, build in a number of protections for ‘Mum and Dad’ investors who may not have the skills to fully assess the risks and benefits of early stage companies.
Accordingly, the new rules restrict the amount an investor can invest in a crowd-sourced equity offer to $10,000 and require the company to provide an unconditional cooling-off period of 5 business days following an application.
Companies and intermediaries are also prohibited from providing financial assistance in connection with the offer plus the rules put limitations on advertisements placed by a crowd-sourcing company. This restriction on advertising seems to undermine the general principle of what crowd sourcing is all about.
In summary, I’m excited about the opportunities that crowd-sourced equity funding provides to innovative business people but I have my doubts as to whether the new rules will really be the game changer that many are hoping for.
Gerry is regularly recognised by his peers for his work on mergers and acquisitions, capital raising and commercial law. He was awarded ‘Lawyer of the Year – Adelaide’ in the field of mergers and acquisitions by Best Lawyers twice in the last three years and also last year was awarded by Best Lawyers ‘Lawyer of the Year – Adelaide’ in the fields of Private Equity Law and Commercial Law.