20 Aug 2015

Crowd control: regulating crowd sourced equity funding in Australia, part 3

by Geoff Hoffman

Government commits to crowd-sourced equity funding by public companies, but crowd-sourced funding by proprietary companies is up for discussion, but with no guarantees that it will happen.

The Government has released a set of proposals for crowd-sourced equity funding (CSEF), replacing the draft regime originally proposed by CAMAC in May 2014.

This time, however, there may be light at the end of the tunnel. The Government appears to have definitely decided on its preferred model for crowd-funding by public companies. In a new development, it is also considering allowing proprietary companies to access crowd-funding.

It says that it intends to introduce crowd-funding legislation into Parliament in the Spring Sittings (which run until early December). That legislation will definitely cover public companies, but the Government gives no commitment that it will extend to proprietary companies.

Crowd-funding for public companies: who's eligible?

The Government's proposal would allow a limited range of public companies to crowd-source equity funding, with offers made through an intermediary which had an Australian Financial Services Licence.

The eligible public companies would be "certain small enterprises" which had not previously raised money from the public.

They would be able to raise up to $5m annually. This cap would include any raisings under the small scale offerings exception but exclude funds raised under existing prospectus exemptions for wholesale investors.

On the other side of the ledger, individual investors would be limited to investing up to $10,000 annually in any single company, with an overall annual cap of $25,000.

What would they have to disclose?

The model has a three-tiered disclosure/investor protection regime.

The companies themselves would be required to issue a tailored CSEF disclosure document. Required disclosures will relate to:

  • facts about the company and its structure, including financial statements;
  • facts about the CSEF raising; and
  • mandatory risk warnings.

The intermediaries through whom crowd-sourced equity funding was conducted would be required to run prescribed checks on the company and to provide generic risk warnings to investors.

For their part, investors would have to sign an acknowledgement that:

  • investing in early stage companies is risky and the investor might lose the entirety of their investment;
  • investors might not be able to sell their shares;
  • the value of the investment might be diluted over time; and
  • the investor had complied with the investor caps.

Reduced reporting requirements

As well as reduced disclosure requirements, CSEF companies which had an annual turnover and gross assets of less than $5m would enjoy:

  • exemption from the disclosing entity rules
  • the ability provide only online annual reports
  • no requirement to hold an AGM
  • provided they raise no more than $1m pa, no audit of their financial reports.

These exemptions would last for five years, apparently from the date on which the company was incorporated or converted from a proprietary company.

Proprietary company fundraising

While the proposal for fundraising by public companies appears to be well-advanced, the same cannot be said in relation to CSEF by proprietary companies. In recognition of the potential impracticality of expecting small start-ups to discharge the regulatory burden of public company governance, the Government seems open to the idea of extending a modified version of the public company CSEF regime to proprietary companies. However, it also recognises that there are potential problems with this approach.

For example, proprietary companies cannot have more than 50 non-employee shareholders. That imposes an inherent limitation on a proprietary's fundraising abilities. The Government has canvassed a number of ways of addressing this issue, including:

  • permanently raising the cap to 100 members for all proprietaries
  • permanently raising the cap to 100 for proprietaries that use crowd-funding
  • allowing the cap to be raised temporarily for proprietaries that use crowd-funding.

The last option illustrates the complexity of this issue. How would a temporary membership cap work? One suggested possibility is to allow a CSEF proprietary to have more than 50 shareholders for a maximum period of five years (provided that their annual turnover and gross assets did not exceed $5m). When they were no longer eligible for the increased membership cap, they would have to convert to a public company or reduce their number of members back to 50.

Other issues canvassed by the Government include:

  • should proprietaries that use crowd-funding have a lower annual $ cap than public companies (eg $1m)?
  • what additional requirements (such as annual reporting and auditing) should apply to CSEF proprietaries?

For those who think that this is starting to become a bit complicated, the Government does hold out the possibility of a simpler alternative. This would be a liberalisation of the current small-scale offers exception to the prohibition on raising funds without a prospectus. The current limit allows companies to raise up to $2m a year from no more than 20 investors. The Government is canvassing the possibility of:

  • lifting the number of investors and/or
  • lifting the $2m annual cap and/or
  • indexing the dollar cap.

Where to now?

As mentioned above, the Government hopes to have legislation for public company CSEF into Parliament before the end of this year. Since the Government has given no commitment to legalise proprietary company CSEF, there is no certainty that it will be introduced at the same time ‒ or ever.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.