In April we reported on the CAMAC discussion paper on crowd sourced equity funding (CSEF) and considered how other countries had already undertaken law reform to enable this alternative method of equity funding. We now know CAMAC's proposal for Australia, and it may be the most important capital raising measure for small companies since the 1984 advent (and 1992 demise) of ASX's second board.
If enacted, it would give innovators and entrepreneurs the ability to raise funds from small investors. In return, a wide range of small investors will get access to new investment opportunities.
Early stage ventures are generally a high risk asset class. CAMAC proposes to limit the potential for damage to investors by what is effectively a stop order: there will be limits on both the amount of money that a company can crowd-source and the amount of money that individual investors will be able to invest.
Regardless of how enthusiastic entrepreneurs and investors are, the success of the proposed regime will ultimately depend upon a third party – the financial service intermediaries who will provide the platforms for making offers. Here, CAMAC is proposing some innovative measures.
The big picture
CAMAC has proposed that two types of company should be able to utilise crowd sourced equity funding:
- public companies; and
- a new class of company – "exempt public companies".
Exempt public companies would be exempt from various compliance requirements (see below) during their start-up phase. Thereafter, they would automatically become public companies, subject to all existing compliance requirements.
A CSEF fundraising document would follow a detailed boilerplate template prescribed by ASIC. The template would prescribe the information to be contained in the fundraising document, rather than the "all information reasonably required by investors" model for prospectuses. Among other things, it would cover:
- the offer size;
- the method of pricing the shares and the company's equity structure;
- the length of time the offer will be open (no more than three months);
- what skin the promoter has in the game;
- a generic risk warning about crowd-sourced equity funding;
- the potential for investors to be diluted;
- the company's business plan;
- any previous crowd-sourced fundraising by the company; and
- the intended use of the funds.
This standardised disclosure is intended to ensure that potential investors could readily compare offerings.
The amount of money that a company could raise through this method would be limited to $2 million per annum. The normal fundraising channels already provided for by the Corporations Act would also be available (eg. full prospectus, offers to sophisticated investors, the 20/12 small scale personal offer exemption, etc). However, CAMAC does not believe that a company should be able to use both the small scale personal offer exemption and crowd-sourced fundraising to raise more than $2 million. This would mean that:
- a company could not raise more than $2 million through a combination of crowd funding and small-scale personal offers;
- a company which raised more than $2 million through small-scale personal offers in a year would not be able to use crowd funding in that year.
For their part, investors could be limited to a $2500 investment per annum in any one company, with an annual cap on their investments of $10,000.
What kind of equity?
Under the CAMAC proposal, issuers raising funds through this method will not be limited as to the classes of shares (and rights attaching to those shares), provided that those matters are fully disclosed.
In arriving at this conclusion, CAMAC has tried to balance two competing concerns. The first is that investors are entitled to know what they are buying. The second is that many entrepreneurs and innovators are hesitant about issuing shares because they may lose control of their project. CAMAC's solution is to allow an exempt public company to make offers of shares that are not full voting shares or have limited dividend rights. The company could also issue different classes of shares, both to the crowd and to private investors (including the founder of the company). CAMAC believes the key is disclosure: the offer document would have to fully disclose the company's equity structure.
Limited compliance requirements for exempt public companies
As noted above, limited public companies would not have the same governance and other compliance requirements as public companies. The most significant of these would be exemptions from:
- continuous disclosure requirements;
- the requirement to hold an AGM;
- the Two Strikes Rule;
- the remuneration report;
- the requirement to appoint an auditor (but only until the company had raised $1m and had expended $500,000).
- These exemptions would fall away in four circumstances:
- the company's capital reaches $5m and remains there for six months;
- the company's annual turnover reaches $5m;
- the company has been an exempt public company for three years (although shareholders could vote to defer this by up to two years);
- the company voluntarily decides to become a public company.
The offer and acceptance process would be run through a platform run by an intermediary (who would require a licence from ASIC (although CAMAC has not outlined precisely what kind of licence this would be)).
The intermediary would be far more than just a web-based facilitator. CAMAC proposes that it would also be required to:
- conduct limited due diligence checks on issuers;
- provide a generic risk disclosure statement to CSEF investors;
- check compliance with investor caps in some instances;
- provide communication facilities between issuers and investors;
- disclose the fees they charge.
These due diligence requirements would not be particularly onerous, and it is important to note that the intermediary would only be required to do due diligence on the issuer – not the issuer's business and business plan.
CAMAC has put up for consideration a number of alternative approaches to business diligence. These range from template-based due diligence (which would ensure that all businesses are assessed by reference to the same criteria) to simple disclosure by the intermediary of whether it has done any due diligence on the business (and what that due diligence was). CAMAC appears to lean towards the latter approach (consistent with its "disclosure is key" perspective).
CAMAC's proposals for crowd sourced equity funding in Australia are encouraging. A bespoke regime is more likely to facilitate a new market which was not contemplated when the current fundraising laws were enacted. The regime is clearly designed to carefully balance the competing policy objectives by harnessing the power of the internet to create a new type of fundraising market while managing the heightened equity investment risk for unsophisticated investors.
While some may criticise the proposals for still being heavily reliant on disclosure for investor protection, it should be noted that licensed intermediaries will be inclined to provide an additional layer of "deal vetting" to encourage a continued flow of investor funds to their platforms.
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