10 Dec 2015

Crowd control: regulating crowd sourced equity funding, part 4

by Geoff Hoffman

The new crowd-funding regime will be a large step forward for Australian investment and will bring Australia into line with crowd-funding regimes in New Zealand, the United States and the United Kingdom.

The good news: crowd-sourced equity funding may soon be legal in Australia.

The not-so-good news: most small companies will not be able to use it.

After a long period of discussion and debate, a Bill to allow crowd-sourced equity funding is now before the Australian Parliament. The Bill will allow unlisted public companies to raise up to $5m pa through crowd-funding.

Significantly, crowd-funding will not be available to proprietary companies. Most start-ups currently begin life as proprietary companies and would, therefore, not be able to access crowd-funding. The Bill tries to compensate for this by allowing start-ups to incorporate as public companies with reduced corporate governance requirements (such as relief from the need to hold an AGM or appoint an auditor ‒ see below).

What will Australia's crowd-funding regime involve?

Eligible companies (see below) will be able to raise funds by making offers of securities to large numbers of investors using platforms run by "CSF intermediaries". Eligible companies will only be able to offer certain types of securities as set out in the regulations. Under the new regime, CSF offer documents will be subject to less onerous disclosure requirements than under Part 6D.2 of the Corporations Act.

The CSF offer will be published on the crowd-funding platform of a single CSF intermediary. CSF intermediaries will be required to hold an Australian Financial Services Licence which expressly authorises them to provide a crowd funding service. Investors can then make applications on the platform.

Crowd-funding by an eligible company will be capped at $5 million per year. The cap includes any raisings under the small scale offerings exception and offers made via an Australian financial services licensee where the person has previous experience in investing. The cap also includes the total amounts raised by related parties of the company in the 12 months prior to the new offer.

On the other side of the equation, retail investors will be subject to a $10,000 per company per year investment cap. Retail investors will also have a cooling off period of five days to withdraw their application under a CSF offer.

Significantly, the Bill does not contain a cap on the amount that a retail investor can invest in CSF each year. This is a substantial change from the $25,000 cap proposed by CAMAC. It is also different to the United Kingdom crowd-funding regime in which investors can only invest up to 10% of their total savings and the United States crowd-funding regime which places caps of 5-10% of total savings upon investors. Without a maximum cap, companies will have far greater access to funding. However, it increases the risk of investors losing large amounts of money through failed CSF investments.

What companies will be eligible?

A company must meet certain eligibility requirements in order to make a CSF offer:

  • the company must be a public company limited by shares;
  • the company's principal place of business must be Australia and the majority of its directors must ordinarily reside in Australia;
  • the company and its related parties must not be a listed corporation or have a substantial purpose of investing in securities or interests in other entities or schemes; and
  • the company and its related parties combined must have consolidated gross assets of less than $5 million and consolidated annual revenue of less than $5 million.

The Bill does not enable proprietary companies to engage in CSF. The difficulties involved in overcoming the issue of the 50 shareholder maximum limit for proprietary companies have been placed in the too-hard basket for now. This may restrict the use of CSF in Australia because of the reluctance of small companies and start-ups to become a public company and comply with the onerous reporting and disclosure requirements.

Exemptions from corporate governance requirements for new CSF public companies

A newly created public company which is an eligible CSF company and which indicates, on its application for registration, that it intends to make CSF offers will be eligible for exemptions from certain governance requirements for the first five years. In order to be eligible, the company must make a CSF offer within 12 months of registration. These requirements have been set out to ensure that only companies that genuinely wish to make CSF offers benefit from the exemptions.

An exempt public company will not be required to hold an annual general meeting or appoint an auditor. The company will not need to audit its annual financial report if it has raised less than $1 million from all CSF offers and offers of securities requiring disclosure combined in that financial year. The company is only required to provide its financial report and directors' report to shareholders online and does not have to send members a copy of the report if requested free of charge.

These reduced requirements may remove some of the disincentives for start-ups in becoming public companies. However, the companies will still be required to produce a directors' report and financial report each year, adopt and lodge their constitution with ASIC, have a minimum of three directors, and comply with additional requirements for the appointment, removal and remuneration of directors. There are also stricter rules for public companies in relation to material personal interests of directors and financial benefits to directors and their relatives. Proprietary companies looking to become public companies in order to make CSF offers will have to weigh the benefits of CSF against the disadvantages of stricter obligations for public companies.

Details of the process for making CSF offers

Eligible companies will be required to prepare a CSF offer document containing certain information required by the regulations in a clear and precise manner. A company and its related parties can only have one CSF offer open at a time. The maximum time for a CSF offer to remain open is three months.

CSF offers must only be for the issue, not sale, of securities and therefore only sets up a primary trading market. Schedule 3 of the Bill enables the Minister to reduce the requirements placed on financial market and settlement facility operators in order to enable secondary trading markets for CSF securities to be licenced.

Sanctions will apply where a company offers securities under a CSF offer document which is defective because it contains misleading or deceptive statements or omits information required by the Act. A company must immediately inform the intermediary if it becomes aware that the document is defective. The intermediary must then remove the document and either close or suspend the offer.

Criminal sanctions may apply to a company that offers securities under, or an intermediary that knowingly publishes, a defective CSF offer document if the defect is materially adverse from the point of view of an investor.

CSF intermediaries will be required to act as gatekeepers by conducting certain checks before publishing an offer. This is intended to safeguard the interests of investors. The intermediary must not publish or continue to publish an offer if:

  • it is not satisfied as to the identity of the company and its directors;
  • it is not satisfied as to the good fame or character of the directors before it publishes an offer;
  • it has reason to believe that the company or officers of the company have knowingly engaged in misleading or deceptive conduct; or
  • it has reason to believe the offer is not eligible to be made as a CSF offer.

Intermediaries must also ensure that a general CSF risk warning appears prominently on their offer platform, set up a communications facility, and deal with all applications and money in response to the CSF offer.

The Bill seeks to maintain a balance between giving companies flexibility to access funds from a large number of people and protecting retail investors from risky or fraudulent behaviour by companies.

Australia comes up to speed

The new crowd-funding regime will be a large step forward for Australian investment and will bring Australia into line with crowd-funding regimes in New Zealand, the United States and the United Kingdom.

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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.