With the federal Government recently affirming its commitment to the development of crowdfunding in Australia, it is timely to consider whether crowdfunding is a viable source of capital for SMEs and start-ups. While crowdfunding has been acknowledged as a genuine source of finance in a number of developed markets, Australia has not yet enacted legislation dealing with this relatively new phenomenon where existing regulatory frameworks are still being applied to crowdfunding models.
Read on for Erin Brown and James Stevenson’s discussion of the legal implications of crowdfunding in Australia, with a focus on equity-based crowdfunding.
What is crowdfunding?
“Crowdfunding” refers to the practice of raising funds from a large number of individuals to finance a new or existing business venture. Generally facilitated via an online platform, crowdfunding taps into easily accessible networks of friends, family and colleagues (through social media websites like Facebook, Twitter and LinkedIn) to spread the word about a business’ fundraising goals and to attract investors.
There are four key crowdfunding models currently in the marketplace:
- donation-based crowdfunding, where donations are made in support of a social cause with no expectation of donors receiving anything in return;
- reward-based crowdfunding, where donations are made for reward or benefit (for example, merchandise, future goods or future discounts);
- debt-based crowdfunding, where donations are made by way of a loan repayable with interest; and
- equity-based crowdfunding, where donations are made in return for an interest (or share) in the equity of the promoter.
Regulation of equity-based crowdfunding in Australia
There is currently no specific legislation governing crowdfunding in Australia and existing regulatory frameworks are currently being applied to crowdfunding models. In 2012, the Australian Investments and Securities Commission (ASIC) issued guidance on the legal implications of crowdfunding. ASIC stated that, depending on the rewards offered to investors, crowdfunding may be seen as either a managed investment scheme, the provision of financial services requiring an Australian financial services licence or fundraising requiring disclosure under Chapter 6D of the Corporations Act 2001 (Cth) (Corporations Act).
Managed Investment Schemes
ASIC has indicated that a crowdfunding scheme offering a reward or incentive for investing in a company may constitute a managed investment scheme where ‘funds contributed are pooled or used in a common enterprise to produce financial benefits or benefits consisting of interests in property for the contributors’. Under the Corporations Act, a managed investment scheme could occur where funds are pooled to acquire rights to a prospective benefit produced by the scheme (for example, a reward or discount on future products or a loan) if all of the elements of a managed investment scheme are met and no legislative exemptions are available.
Onerous regulatory and compliance obligations apply to managed investment schemes including registration of the scheme with ASIC and operation of the scheme through a responsible entity (being a public company that holds an Australian Financial Services Licence). These obligations are likely to deter many SMEs and start-ups from sourcing funds via crowdfunding.
Financial services licensing
ASIC has further indicated that online intermediary platforms may be considered as issuers of a financial product. This would require these online platforms to hold an Australian Financial Services Licence and provide investors with disclosure documents such as a financial services guide or product disclosure statement. ASIC have recognised that while reward-based crowdfunding may involve the provision of financial services, the Corporations Act may not apply to contributions in exchange for possible returns of nominal value.
Under Chapter 6D of the Corporations Act, a company is prohibited from offering securities to investors without disclosure unless an exemption applies. Where disclosure to investors is required, a disclosure document (for example, a prospectus, short form prospectus, profile statement or offer information statement) must be prepared.
The most common exemption relied on by SMEs and start-ups is the “20/2/12 rule” for small scale fundraisings. This exemption allows companies to raise up to $2 million over a 12 month period from less than 20 investors without having to lodge a disclosure document with ASIC. Obviously, this exemption is incompatible with the concept of equity-based crowdfunding which relies on donations from a large number of investors.
Proprietary company limitation
Another major issues facing private company SMEs and start-ups is the limitation in the Corporations Act that a proprietary company must not have more than 50 non-employee shareholders. Crowdfunding may therefore not be an attractive option for private companies that do not wish to convert to a public company with additional governance, disclosure and reporting requirements.
The future regulation of crowdfunding
Given the restrictions the Corporations Act imposes on the availability of equity-based crowdfunding, there has been a call for Australia to follow the lead of other developed markets (for example, the United States, Italy and New Zealand) and ease securities regulation regarding crowdfunding in Australia.
Australia’s Corporations and Markets Advisory Committee (CAMAC) released its report on crowd-sourced equity funding in May 2014 recommending that a specific regulatory regime be established in Australia. In particular, CAMAC recommended:
- a new type of company be created, the "exempt public company", specifically for use by equity crowdfunding issuers;
- the licensing by ASIC of online intermediaries to operate an equity crowdfunding portal, which will conduct due diligence checks on the issuer, provide risk warnings to investors, and provide a means of communication between the issuer and potential investors;
- an "investor cap" for individual investors of no more than $2500 to any particular issuer in any 12 months and no more than $10,000 in total during any 12 month period; and
- an "issuer cap" on total capital raised through equity crowdfunding of no more than $2 million during any 12 month period.
In response to the CAMAC report, the federal Government introduced the Corporations Amendment (Crowd-sourced Funding) Bill 2015 (Crowdfunding Bill) on 3 December 2015. The Crowdfunding Bill, which adopted only some of the recommendations in the CAMAC, provided for:
- crowdfunding to be available to unlisted public companies with less than $5 million in assets and less than $5 million in annual turnover;
- an “investor cap” of $10,000 per investor over a 12-month period;
- the exemption of public companies from some reporting and governance requirements for a five-year period; and
- the protection of investors with a five-day cooling-off period during which they can reclaim their investment.
The Crowdfunding Bill has now lapsed given the dissolution of the federal Government announced on 9 May 2016. It will be interesting to see where the next Government drives crowdfunding going forward.