Crowdfunding or crowdsourcing, the process of raising small amounts of finance from a large number of 'investors', has become an increasingly popular and rapidly evolving method for small to medium start-up ventures to raise funding. Some estimates have the value of the global crowdfunding industry at over USD 5 billion. The proposed changes to the regulatory framework in Australia with respect to crowdfunding may have an impact on insurers, particularly those that underwrite D&O and management liability insurance, and it is important that insurers start considering the implications of it.
There are two primary types of crowdfunding:
- Reward-based crowdfunding where entrepreneurs pre-sell a product or service to launch a business concept without incurring debt or sacrificing equity/shares.
- Equity-based crowdfunding or crowd sourced equity funding (CSEF) where the backer receives unlisted shares of a company, usually in its early stages, in exchange for the money pledged. The company's success is determined by how successfully it can demonstrate its viability.
Theoretically, CSEF is available in Australia, provided issuers operate within the existing regulations. However, unlike a number of international jurisdictions, including the US and New Zealand, there is no specific framework which facilitates CSEF. In light of these international developments, the Corporations and Markets Advisory Committee (CAMAC) considered CSEF in Australia and in June 2014 produced their report on CSEF (the Report). In considering the role and possible regulation of CSEF in Australia, the CAMAC has considered whether CSEF should be facilitated in Australia and the policy option that may need to be adopted to facilitate this type of equity funding.
Ultimately, CAMAC is of the view that CSEF should be facilitated in Australia, however that the current law presents fundamental difficulties for the use of CSEF by either proprietary or public companies. CAMAC suggests that changes would have to be made to the Corporations Act 2001 if CSEF is to be facilitated in Australia. One of the key issues is that a company looking to obtain crowdfunding could not be a proprietary company as the limit on shareholders would severely impact the crowdfunding model and such companies cannot make public offers of equity. Further, to be a public company would place compliance obligations (ie public fundraising obligations) that would be too onerous for a start-up venture.
Given the obstacles identified above, the Report considers the various policy options to facilitate CSEF in Australia. Ultimately CAMAC's view is that a new regulatory regime for CSEF would be the most appropriate, the basis of which is a new category of public company known as the 'exempt public company'.
Treasury Discussion Paper
Following the Report, the Treasury Department released a CSEF Discussion Paper in December 2014 which considers the policy options and respective impact analysis of three models: the model proposed by CAMAC; the regulatory framework that has been adopted by New Zealand; and maintaining the status quo.
The consultation period for the Discussion Paper closed on 6 February 2015.
What this may mean for insurers
While the submissions and outcomes of the Discussion Paper remain to be seen, the Minister for Small Business has recently been talking up the prospects of regulation for CSEF in Australia.
While such regulation is an issue that primarily affects the capital raising regulatory framework in Australia, regulation with respect to CSEF may have an impact on insurers. It is important for insurers that underwrite D&O and management liability insurance, to start considering the implications of CSEF, including:
- The traditional distinction between public and private companies in D&O policies that may be blurred by the emergence of the hybrid public-proprietary company. Such companies will have the status of a public company but will not be publicly traded, and will have less stringent compliance requirements than a public company. Policyholders will therefore need to ensure that their insurance coverage covers their form of company (whether proprietary, public or exempt-public). This is critical as some D&O policies for private companies contain exclusions pertaining to securities claims or “offerings”. Policyholders that may engage in crowdfunding activities will want to ensure that such activities are covered.
- Policyholders will also want to ensure that the pertinent definition of “loss” covers losses which might arise out of crowdfunding. For example, some policies contain exclusions pertaining to disgorgement or, as mentioned, securities claims. While policy language can vary widely, it is important for those engaged in crowdfunding to have coverage in the event of a suit by investors which could necessarily entail the reimbursement of invested capital.
- Policyholders should closely analyse any fraud or dishonesty exclusions, if present in any pertinent policies, to ensure that the insurance company will not seek to bar coverage in the event that investors assert fraud claims in connection with crowdfunding.