Equity Crowd Funding – Are New Laws for Australian Entrepreneurs and Crowd Funding Platforms on the Horizon?
The potential for crowdsourced equity funding (CSEF) in Australia is not yet clear. CSEF refers to arrangements through which a business (the issuer) seeks to raise capital, particularly early-stage funding, by offering small debt or equity interests in the issuer to large numbers of investors (typically retail), sourced through a crowd funding online platform which serves as an intermediary between the issuer and the investors/internet users.
Although crowdsourced funding is not prohibited in Australia, certain arrangements could require a complying disclosure document and licensing arrangements which are regulated under the Australian Corporations Act 2001 (Cth) (Corporations Act) and Australian Securities and Investments Commission Act. Examples of such arrangements include offering or advertising financial product, providing a financial service or fundraising through securities.
CAMAC's Discussion Paper
On 10 September 2013, the Australian Corporations and Markets Advisory Committee (CAMAC) released its 'Crowd sourced equity funding discussion paper' which sets out CAMAC's initial findings in relation to its independent review of the regulation of crowd sourced equity funding in Australia. CAMAC's paper raises for consideration and comment whether the current fundraising, licensing and managed investment scheme requirements under the Corporations Act should be adjusted in some manner for CSEF, or whether a specific and facilitative framework should be designed in Australia for CSEF, taking into account approaches in other jurisdictions.
CAMAC's paper only considers CSEF, not other forms of crowdfunding business models where an individual may be invited to contribute to a cause or venture by donation or in receive a reward or pre-payment scheme, share of the profits of an investment or providing peer-to-peer funding.
CAMAC recognises that there are various approaches to CSEF that could be taken in Australia, including:
- no regulatory change
- liberalising the small scale personal offers exemption from the fundraising provisions
- confining CSEF exemptions to offers to sophisticated, experienced or professional investors
- making targeted amendments to the existing regulatory structure applying to proprietary companies, public companies and managed investment schemes for CSEF offers open to all investors
- creating a self-contained statutory and compliance structure for CSEF open to all investors.
Current Australian Laws
Currently, proprietary companies are prohibited from raising funds from a large number of investors unless they fall within the small scale personal offers exemption under section 708(1) of the Corporations Act which allows an issuer to make personal offers of securities to investors without a disclosure document, provided that no more than AUD2 million is raised in any 12 month period from no more than 20 investors.
CAMAC raises the question whether one possibility for reform might be to increase the number of investors (say, to 100), with or without some form of ceiling on the amount of funds (in total per year) that each person could invest in a particular issuer, combined with some adjustment to the ceiling on the total funds that each issuer can raise per year. This approach does not however deal with the ceiling on the number of shareholders of a proprietary company (being 50 non-employee shareholders). Further reform would be required to increase or abolish the shareholder cap for proprietary companies, which would also raise questions about the level of regulation of proprietary companies compared to public companies.
Public companies wishing to raise equity through CSEF would need to fall within the disclosure document exemptions of section 708 of the Corporations Act through a combination of the small scale personal offers and other excluded offer exemption categories. There is also the possibility of raising funds via an offer information statement, which is not a prospectus but still is a disclosure document that is required to be lodged with Australian Securities and Investments Commission (ASIC). However, there is a requirement for audited accounts and a cap of AUD10 million (when added to all other amounts previously raised) applies to offers of securities utilising an offer information statement.
Further, there is an ASIC Class Order (CO 02/273) that has existed since 2002 (and before the advent of CSEF) that provides relief from certain debenture, fundraising and financial product disclosure requirements to operators of business introduction or matching services and issuers of securities or scheme interests. Such relief is subject to the prescriptive requirements of the class order, which include a AUD5 million ceiling, reliance on a 20 offers within 12 months and other excluded offer exemptions, and that the operator or associate cannot have any pecuniary interest in the outcome of an investment decision by the users of the introduction service other than the charging of a fee for the provision of the introduction service or the payment of an introduction commission by the issuer to the operator. Such relief may not be applicable to CSEF offers where an online portal operator may take a more active promoter and shareholding interest in the issuer, charge the investor a commission based on funds contributed and access a larger number of retail investors through social media.
Unless a CSEF offer is able to be structured to fall within the disclosure document exemptions under Chapter 6D of the Corporations Act, the advertising of equity offers will also be subject to Corporations Act restrictions on advertising.
In exploring whether specific CSEF exemptions should be limited to high net worth or other sophisticated investors, CAMAC also asks the question whether the current test of sophisticated investor (AUD2.5 million net assets or gross income of at least AUD250,000 for last two financial years) should be changed in the CSEF context.
Managed Investment Scheme
An investment via CSEF could be structured such that the investor obtains an interest in a managed investment scheme, as opposed to a direct shareholding interest (whether voting or non-voting) in the issuer. Managed investment schemes are regulated under Chapter 5C of the Corporations Act, which generally requires all of the following:
- a scheme to be registered with ASIC if there are more than 20 members
- a responsible entity to hold an Australian Financial Services License permitting it to operate a scheme (or be an authorised representative of a licensee)
- the responsible entity to issue a product disclosure statement, unless only wholesale clients invest in the scheme.
CAMAC's paper raises the question whether the current regime regulating managed investment schemes should be adjusted to accommodate CSEF.
Australian Market Licence
Depending on the circumstances and the CSEF services offered by intermediaries or funding portal operators, under current Australian law a CSEF intermediary operating in Australia may be required to hold an Australian Market Licence (if the website operator offers or makes invitations to acquire financial products, such as a share, debt security or interest in a scheme) or an Australian Financial Services Licence (if the intermediary is carrying on a financial services business). There are specific compliance and resource requirements that apply in this regard.
A view has been expressed that any requirement that an operator of an Australian-based CSEF intermediary be licensed may diminish a key benefit of CSEF, namely quick and low cost access to funding for small business and start-up companies. CAMAC raises for discussion whether the current licensing requirements should be tailored to authorise CSEF intermediaries to operate. Specific requirements could address the level of risk disclosure required to be made by the intermediary to investors, the level of preliminary and ongoing due diligence, background or viability checks required to be made by the intermediary on the issuer before including them on their website and how funds are to be held prior to their being passed to the issuer.
CSEF is evolving globally and in doing so is by-passing
traditional debt and capital markets prospectus, venture capital
and angel investor fundraising structures.
The Australian Government's review of laws regarding CSEF will consider whether international models can provide guidance. A brief snapshot of some of the key legislative developments and proposals for reform in overseas jurisdictions concerning CSEF offers is set out below:
|Country||CSEF Approach/Proposals Under Consideration|
|United States of America (US) and Canada||
Specific legislation called Jumpstart our Business Start-ups Act (JOBS Act) was enacted in the US in April 2012. It applies only to US incorporated issuers. A company may raise no more than USD1 million in a 12 month period through CSEF. The JOBS Act provisions apply to equity or debt securities of the issuer. There are specific disclosure and financial reporting requirements on the issuer. The CSEF framework is not available for security holders to on-sell their securities.
CSEF legislative proposals are currently under consideration in Canada. The Canadian proposal includes that an issuer can't raise more than CAD1.5 million in a 12 month period under a CSEF exemption. The only securities that can be distributed are common shares, non-convertible preferred shares, non-convertible debt securities that are linked only to a fixed or floating rate and securities convertible into common shares or non-convertible preferred shares. Like the JOBS Act, the Canadian proposals include a concept of financial reporting (whether audited or management certified) based on the proposed aggregate of CSEF proceeds within a 12 month period.
Under both the US and Canadian approaches:
|United Kingdom||The Financial Conduct Authority has authorised (as an exemption from the United Kingdom prospectus provisions) some intermediaries to conduct crowdfunding to investors who self-certify that they come within prescribed tests of being high net worth or sophisticated investors.|
|Italy||Specific regulations have been issued by the Italian securities regulator in July 2013. CSEF is limited to 'innovative start-ups' with no more than 48 months in existence. The maximum funds raised by an eligible start-up through CSEF can't exceed EUR5 million per year. CSEF investments must be arranged through 'permitted managers'. Sophisticated and professional investors must own at least 5% of the equity of a crowdfunded firm after the crowdfunding exercise.|
New Zealand recently enacted the Financial Markets Conduct Act (the Act) which is designed to facilitate CSEF. The Act provides for applications to be made to the Financial Markets Authority to be licensed as a 'prescribed intermediary service'. Issuers making CSEF offers through licensed CSEF intermediaries will be exempt from the normal requirements to register a product disclosure document.
Issuers may only raise a total of NZD2 million (aggregated with any fundraising through the New Zealand equivalent of the small scale personal offers 20/12 exception) in each 12 month period through CSEF. There are no limitations on who may invest through CSEF.
Draft regulations to support the Act will be released for consultation later in 2013. The legislative provisions are due to come into operation in April 2014.
New Laws on the Horizon?
Members of the public are invited to make submissions on any aspect of CAMAC's review, including the series of questions raised by CAMAC in its paper, by Friday 29 November 2013. CAMAC's paper will be updated with developments in overseas jurisdictions, especially Canada, New Zealand, the United Kingdom and France.
CAMAC will consider industry submissions and consult with respondents in the first quarter of 2014 before settling its report to the Australian government.
It remains to be seen whether new laws or ASIC class order relief will be proposed to facilitate CSEF in Australia. Any such new laws and regulations will need to strike the appropriate balance between protecting investors from the risks of fraud and failure, supporting low cost and easier access to funding for start-ups and other businesses and ensuring a degree of regulatory and market scrutiny of crowdfunding platform operators and issuers.
Other CSEF situations may arise involving equity offers to Australian investors by overseas incorporated issuers which are intermediated on overseas-based websites. These are regulated under the laws of overseas jurisdictions.
Please contact us should you require any further information with respect to:
- Australian licensing, compliance and investment structuring (whether equity, debenture or managed investment scheme) legal and risk management issues for both an issuer and an online portal operator surrounding crowdsourced equity funding
- Australian legal issues regarding other forms of crowdfunding and business introduction and investment matching services,
or should you wish to make submissions in response to CAMAC's paper.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.