On 8 December 2014, the Australian Government Treasury (Government) released a Discussion Paper on crowd-sourced equity funding (crowdfunding).
Crowdfunding is an emerging global funding approach that allows smaller businesses and entrepreneurs to raise funds more easily from a larger number of small investors.
The Discussion Paper recognises that Government action is needed to overcome the current regulatory barriers to widespread use of crowdfunding in Australia.
The three policy options proposed by the Discussion Paper are:
- a regulatory framework based on the Corporations and Markets Advisory Committee (CAMAC) model proposed in June 2014 ie limited to certain small enterprises using an exempt public company structure and offering equity through licensed intermediaries
- a regulatory framework based on the New Zealand model which came into force in July 2014 ie not limited to small enterprises but requiring intermediaries to be licensed by the New Zealand Financial Markets Authority
- the status quo.
It is apparent from the Discussion Paper that the Government has not yet made a final decision on its preferred crowdfunding framework, and is not limiting itself to implementing either the CAMAC or New Zealand models in full.
The Current Position
There are currently a small number of online platform operators offering investment in Australian start ups. None of the platforms under the current legislation are able to make their services available to all investors. Instead, they offer their services either only to wholesale investors via a managed investment scheme, or utilise the small scale personal offer exemption and ASIC Class Order 02/273, Business Introduction or Matching Services.
The Discussion Paper recognises that such mechanisms do not comprehensively address the barriers to crowdfunding and do not allow offers to be made to the crowd. Nor does the current regime properly address any secondary market sale features that a crowdfunding business model may wish to offer or resolve with certainty when an Australian Market Licence (AML) is required to be obtained by an intermediary.
If the status quo is maintained, small businesses and start ups seeking to raise early stage capital would still need to comply with the existing prohibitions on making public offers of equity, subject to the limited exemptions currently available.
Currently, intermediaries are subject to a number of requirements, including:
- the need to hold an Australian Financial Services Licence (AFSL) and comply with AFSL licensing obligations if they meet the definition of carrying on a financial services business
- the need to hold an AML and comply with AML licensing obligations if they fall within the definition of conducting a financial market
- if a managed investment scheme (MIS) structure is used to facilitate an online equity offer, the need for the intermediary to comply with MIS requirements, including having a responsible entity that is a public company with disclosure and compliance obligations.
Key Elements of the CAMAC and New Zealand
The Discussion Paper contains a useful summary comparing a number of the key elements of the CAMAC and New Zealand models. Of particular note:
- Issuer Cap – Both models impose a cap for issuers of raising AUD2 million via crowdfunding in any 12 month period, excluding funds raised under existing prospectus exemptions for wholesale investors.
- Intermediary Remuneration – Under the CAMAC model intermediaries are prohibited from being remunerated according to the amount of funds raised by the issuer, or in the securities or other interest of the issuer. Under the New Zealand model there are no restrictions on fee structures, although fees paid by an issuer must be disclosed. The Discussion Paper suggests that a potential benefit of the New Zealand model may be the ability for an intermediary to charge a fee proportional to the funds raised. This is consistent with market practice for other equity capital raisings and provides an incentive for intermediaries to only list issuers they consider will successfully raise funds.
- Issuer Corporate Form – CAMAC's models involves the creation of a new category of public company which may add complexity to the corporate governance framework. The Discussion Paper seeks comment on whether the proposed corporate form may increase risks of regulatory arbitrage compared to the status quo, and whether these risks outweigh the benefits of the structure in facilitating crowdfunding.
- Investor Caps and Disclosure – The New Zealand model only imposes minimum disclosure requirements and investment caps for investors are voluntary. The CAMAC model sets mandatory caps and template disclosure requirements which may provide greater certainty around the level of disclosure required.
- Licensing Requirements – Both models impose licensing requirements and require limited due diligence checks on the issuer.
Interestingly, the Discussion Paper includes estimates of compliance costs for issuers and intermediaries associated with implementing either the CAMAC or the New Zealand model.
The Discussion Paper suggests that compliance costs for intermediaries are expected to increase per fundraising campaign under both models, with a marginal saving for an intermediary if operating under the CAMAC model.
For an issuer, the Discussion Paper assesses that there will be significantly larger cost savings under the CAMAC model, driven largely by temporary exemptions from audit and annual general meeting requirements and reductions in disclosure costs.
The Discussion Paper requests stakeholder feedback by 6 February 2015. Views are sought from a range of stakeholders, including intermediaries that offer equity and reward based crowdfunding platforms, investors in the venture capital sector, the small business sector and other government agencies.
Should the Government proceed with legislation to facilitate crowdfunding, it will seek to conduct further consultations on any draft legislative package to ensure the appropriate balance between reducing regulatory barriers and maintaining adequate investor protections.
Future of Crowdfunding
Exactly how the regulatory environment will change remains in a state of flux. There is substantial uncertainty surrounding the future direction of legislative change for regulating crowdfunding as well as other innovative forms of financing that have captured the attention of regulators, such as peer to peer lending and the growth of secondary market sales of 'crowd' acquired equity interests.
Various business models are emerging under the current Australian status quo and in the New Zealand market. However, all of these are still in their infancy and the financial and industry data available is limited to fully assess the benefits and risks for issuers and investors alike.
Equity crowdfunding is an emerging practice across global markets. It will not replace the many other forms of capital raising and investment structures for companies seeking to grow and build a wider shareholder base, but it may assist with the start up and incubation of new Australian businesses. However, legislative and regulatory certainty surrounding the issues involved in crowdfunding is a pre-requisite to a confident Australian and Trans-Tasman business community that truly fosters innovation and entrepreneurship.
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.