Crowd sourced equity funding
A brief on what you need to know
In September 2013, the Corporations and Markets Advisory Committee (CAMAC) released a discussion paper outlining details of, and inviting submissions on, its review of crowd sourced equity funding (CSEF). This followed the Australian Securities & Investments Commission (ASIC) releasing guidance back in August 2012 to promoters of crowd funding (in its broader forms) clarifying those arrangements which may be subject to regulation under the Corporations Act 2001 (Cth) (Act).
What is CSEF?
CSEF is a specific form of crowd funding. It is a relatively new and evolving type of capital raising whereby companies raise early stage funding by offering online small debt or equity interests to a large number of investors. Broadly, CSEF involves the pooling together of small financial contributions made predominantly by retail investors through an online investment website in support of a specific project or business idea that has typically been promoted using social media.
Why is CAMAC focused on CSEF?
CSEF is receiving increasing attention internationally as an alternate form of corporate fundraising, with a number of countries having already enacted legislation (namely the United States, Italy and New Zealand) or considering enacting legislation (namely Canada, France and the United Kingdom). This global interest stems from the perceived potential for CSEF to promote investment activity to aid economic recovery from the global financial crisis.
Historically, crowd funding has not involved the issue of securities. However, in some jurisdictions, CSEF is emerging as a way for businesses - particularly small to medium sized enterprises - to raise capital by issuing securities.
CAMAC considers that this form of fundraising carries a series of risks for investors, including fraud or misappropriation of investors' funds by the CSEF promoter or website operator and failure to receive a return on investment due to a project being unsuccessful or not completed.
What is the focus of CAMAC's review of CSEF?
CAMAC's review of CSEF is centred on whether it should be regulated in a manner different to traditional capital raisings.
Although CSEF is theoretically available in Australia, it would be subject to compliance with the fundraising, licensing and other requirements of the Act. Depending on the arrangements, CSEF could potentially involve:
• an offer of securities requiring a disclosure document in accordance with Chapter 6D of the Act; and/or
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1. Existing regulation theoretically accommodates but does not adequately deal with the CSEF phenomenon.
2. Regulatory change is required to facilitate active use of this form of fundraising in Australia, and to ensure that Australia and its entrepreneurial community are well placed to reap the benefits of CSEF.
3. A bespoke regulatory system is required to deal with the very unique aspects of CSEF so as not to tamper with the well established and understood principles for traditional fundraising.
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• the carrying on of a financial services business for which a licence is required under Chapter 7 of the Act.
Accordingly, the applicable regulatory requirements for corporate fundraising in Australia are not well suited for CSEF.
What options are being considered by CAMAC in respect of CSEF?
The key objective of CAMAC's review is to ensure an appropriate balance is reached between facilitation and regulation of this form of fundraising. In considering the appropriate regulatory response to the increasing prevalence of CSEF, CAMAC has identified the following five policy options:
1. No change to existing regulation
2. Liberalising the small scale personal offers exemption from the fundraising provisions
3. Confining CSEF exemptions to offers to sophisticated, experienced or professional investors
4. Making targeted amendments to the existing regulatory structure for CSEF open to all investors
5. Creating a self-contained statutory and compliance structure for CSEF open to all investors.
Although each of these options have a number of pros and cons which need to be carefully evaluated, we consider that the enactment of standalone regulation for CSEF will most effectively accommodate the unique digital aspects of this form of fundraising.
What are the arguments in favour of regulatory reform in respect of CSEF?
As yet there has been no discernible move by start-up companies in Australia to seek capital through CSEF notwithstanding the existence of online CSEF websites. This reticence on the part of companies to seek CSEF is likely due to the restrictiveness of the current regulations, which would largely be eliminated by facilitative regulatory intervention. Even if CSEF would only ever be applicable to a small part of the Australian economy, it may still play a valuable role in our country's economic performance and growth in that CSEF:
• provides necessary seed capital for start-up companies that may ultimately prove successful but which have limited capital and are unable to secure alternative forms of financing;
• gives potential investors access to a broader range of investment opportunities and issuers access to investors that they previously would have been unable to reach;
• promotes entrepreneurism and innovation, which in turn foster Australian ownership of valuable intellectual property;
• reflects a new business model that is aimed at identifying the viability of a project earlier than traditional business models; and
• when combined with the proposed taxation changes to employee share plans*, could aid in the building and retaining of a skilled workforce for start-up companies.
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However, given the risks associated with CSEF, the key to harnessing these potential benefits will be to ensure that any regulatory developments in respect of CSEF:
• for investors: minimise the possibility of them funding high risk and illiquid investments without a full understanding of the potential business outcomes and limited recovery rights available (e.g. by imposing a minimum disclosure standard); and
• for issuers: limit the ongoing reporting and compliance obligations of start-up companies, to ensure funds are used for intended purposes by lowering overall operational costs.
In an ever advancing technological world, CSEF is rapidly developing and likely to become an increasingly popular form of fundraising. Australia will need to keep pace with international regulatory developments if it wishes to compete with foreign countries in attracting and cultivating entrepreneurial activity. In the absence of any amendment to the existing regulations applicable to CSEF, this is likely to prove challenging as start-up companies will look to other jurisdictions with less onerous regulations.
Submissions on CAMAC's discussion paper on CSEF are due by Friday, 29 November 2013, after which CAMAC will hold roundtable consultation in early 2014 before settling its report.
* Employee Share Scheme and Start-Up Companies: Administrative and Taxation Arrangements Discussion Paper August 2013, The Australian Government the Treasury
For further information please contact
Partner +61 2 8922 5181 julie.hutton @bakermckenzie.com
Partner +61 2 8922 5302 kate.jefferson @bakermckenzie.com
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