Legislation aimed at providing Australian innovators with alternative funding means was reintroduced to Parliament in late November. The Corporations Amendment (Crowd-sourced Funding) Bill 2016 forms part of the Australian Government’s Innovation and Science Agenda.
The bill is designed to make it easier for innovators to access equity-based crowd-sourced funding (CSF).
Key features of the proposed CSF regime include: a new class of Financial Services License for crowdfunding platforms (CSF intermediaries); retail investor protection measures, such as a cooling-off period; investment caps; and obligations of the platforms to provide and monitor communication between retail investors and CSF offer issuers.
The bill proposes improved access to the CSF scheme (in contrast to a similar bill presented in 2015) by enabling businesses that incorporate or convert to a public company structure for the purposes of CSF to forego annual general meetings, audited financial reports and requiring only online financial reporting to shareholders.
If and when the regime is enacted in Australia, it is sure to provide a healthy boost to the start-up and small business community. In this article, we provide more detail on the proposed changes and IP considerations.
The Crowd Funding Landscape in Australia
Crowdfunding is a rapidly growing source of capital for start-ups and small business. Globally, CSF equity funding makes up 2.56bn of all funding as illustrated below.
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The Australian Tax Office divides crowd sourced funding into four broad categories:
- Donation-based crowdfunding, usually to a charitable project;
- reward-based crowdfunding, providing merchandise, products or other incentives to funders;
- debt-based crowdfunding, wherein a large number of creditors collectively receive interest and principal repayments from a single debtor; and
- equity-based crowdfunding, distributing shares or equity interest in the commercial venture.
The legislation reintroduced to Parliament solely addresses equity-based crowdfunding. Donation and reward-based crowdfunding are in little need of further regulation, as no return is expected in the former and successful action against misrepresentations in the latter may be brought under the Australian Consumer Law. Debt-based crowdfunding platforms already exist in many jurisdictions, including Australia, and appear to be operating without the need for further dedicated regulatory schemes.
In contrast, equity-based crowdfunding currently requires an onerous level of disclosure and reporting requirements of fund-seekers and is limited to sophisticated or wholesale investors.
New requirements proposed
The proposed regime requires that a company seeking CSF (the issuer) must be a (non-listed) public company having gross assets and annual turnover of less than $25 million. The company may not be an investment company and both the company, as well as the majority of directors, must have their principal place of business and residence, respectively, in Australia.
The issuer may make an offer via a CSF intermediary (the platform). There is an offer cap of $5 million over a 12-month period. The platform must satisfy itself of the identity of the directors and company making the offer, provide a communication platform between investors and issuers, handle funds on trust, and ensure the rights of retail investors are enforced. These responsibilities are regulated using a new ‘crowd-funding service’ class of Australian Financial Services License.
Retail investors, on the other hand, have been defined as persons with net assets under $2.5 million, gross annual income under $250,000, businesses with less than 20 employees or any entity with a total investment of under $500,000. They are afforded special protection such as a 48 hour cooling-off period, an investment cap of $10,000 per issuer per year and a restriction on providing financial assistance to retail investors for the purposes of participating in CSF.
Reduced disclosure and reporting requirements
To improve access to the scheme, which is only available to a public company, the bill proposes exemptions to soften the impact of disclosure and reporting burdens associated with public company incorporation. The exemptions, which would be available for the first five years after registration/conversion of the public company include:
- Waiving the requirement of an annual general meeting (AGM), though a general meeting must still be held upon request of a members representing 5% of votes;
- financial reporting to shareholders may be performed exclusively online;
- no requirement to appoint an auditor or provide audited financial reports until more than $1 million has been raised using CSF.
In order to be eligible for the above exemptions, the issuer must be eligible to make CSF offers (see above) and intend to do so at the time they are registered. The company must successfully complete a CSF offer within 12 months of registration/conversion. The company must also not undertake fundraising offers requiring disclosure (the classic type of public fundraising).
CSF regimes globally
As a whole, the proposed regime appears to be a bold step to provide a robust regulatory framework. Inspiration for the changes was drawn from the efforts to foster and regulate equity-based crowdfunding globally.
Federal regulation in the United States, for example, limits retail investment to US$ 2,000 or 5-10% of annual income, while mandating an issue cap of US$ 1 million per year. However, individual US states have now begun creating exemptions to facilitate localised crowdfunding.
The framework enacted in New Zealand in 2013 provides an issue cap of NZ$ 2 million per year and waives the requirement to prepare a prospectus or investment statement before raising capital from the public. Similarly to the Australian proposal, the New Zealand framework utilises licensed intermediaries, though there are no investment caps for retail investors at present.
If and when the regime is enacted in Australia, it is sure to provide a healthy boost to the start-up and small business community, where funding is a perpetual problem.
Enabling retail investors to hedge risk by investing small parcels of funds across a variety of companies in a variety of fields or Australian markets could prove to be a powerful innovation motor.
From an intellectual property perspective, the increased motivation to disclose the invention at an early stage to gain funding may have significant effects on the ability of entrepreneurs to protect their intangible assets with registered intellectual property. While disclosures to traditional funding sources, such as venture capital or angel funding, may have been tolerable using non-disclosure agreements, it is difficult to see how a non-disclosure agreement with 10,000 shareholders is enforceable.
This means it is absolutely crucial for inventors seeking CSF to develop a robust disclosure strategy and ideally file a provisional patent application or a design application for any “secret sauce ingredients” they may have to disclose to attract retail investment.
In any case, if the proposed legislation is adopted, it will provide a healthy funding boost to Australian innovation and accelerate the growth of start-up ecosystems.