Country after country, state after state are introducing regulations to facilitate equity crowdfunding for entrepreneurs and investors. This is normally sold by the implementers as a combination of ways to create more jobs and fund businesses that are finding it more difficult in the post GFC era to get funding.
Unfortunately Australia isn’t even yet at the starting gate for more broadly permitting equity crowdfunding except for ASSOB. ($138 million raised for StartUps and SME’s facilitated to date for around 300 companies)
ASSOB operates under existing legislation to match entrepreneurs and investors for startup and early stage companies. It has managed to carve a position as the oldest and longest running equity crowdfunding platform in the world.
Conversations I’ve had with regulators around the world have enabled me to share with them the benefits and learnings from data gathered during ASSOB’s 8 years operation as an equity crowdfunding platform. Regulators appreciated the practicality of the data and I believe some of it has shaped better options in other countries around the world than just relying on taking a shot at what might work. Universities and the World Bank have written about the ASSOB journey and findings from data.
Over the last three years I’ve spoken at a score of international events on equity crowdfunding and I thought it was about time I focussed my expertise on changes that would enable Australia to embrace the evolving equity crowdfunding space better. Some were included in ASSOB’s submission to CAMAC but there have been a number of countries come on stream, and a number of new learnings since the submission date of Friday 29 November 2013. For a further look into the future see my previous post “what can we expect crowdfunding to be in 2020″.
My suggested ‘best practice’ pathway is outlined below as a A) “quick summary“, as a B) “graphic summary” and C) “in detail“.
I hope that you will be on board with my suggestions for embracing the concept of equity crowdfunding in Australia and the regulatory changes needed. I’ve tried to blend my extensive practical experience in this area with a holistic approach to implementation. At the end of the day most of this is about legitimising transactions that take place every day but are often not properly done or clearly defined. By far the most money invested into the early stage space comes from friends, family, fans and followers. They deserve better recognition and legitimacy for their transactions. Equity Crowdfunding can reduce family and friend tension.
A) QUICK SUMMARY
Australian regulators are able to modify the fundraising provisions of the Act for ‘minor and technical relief’ without the need of a full parliamentary enquiry. Here are some of the changes that would enable Australia to embrace two huge trends that are driving crowdfunding. “Technological Disruption” and “Meaningful Investing”.
- Broaden the definition of Associates. This group is not fully handled sufficiently in existing legislation.
- Add category of “Experienced” investors. These could be for example people that have reached a certain level in Angel and Director organisations
- Recognise that consultants can accept shares for services rendered but cannot invest funds. This will assist cash-strapped companies in obtaining the corporate advice they need, without burdening operational cashflow requirements.
- Portals cannot give advice or have a pecuniary interest but can curate offerings.
- Small Scale Offerings 20 retail investors in a twelve month period should be lifted to 100 but there should be a cap of $25,000 per investor per annum. A maximum of $2 million can be raised per annum including the “CSEF” exclusion.
- A new category of Equity Funding Portal be established for “Crowd Sourced Equity Funding” CSEF. Maximum $1 million per company per annum with a $2,500 max per investor.
- Registered Portals can disclose summaries of the offer information to the public but prospective investors need to log in to see full deal details
B) GRAPHIC SUMMARY
1. Types of investors
2. Limitations by Investor Type
3. Promotion of Offers
4. Changes needed
C) IN DETAIL
1) Types of investors
In an entrepreneurial journey many people contribute. Many prospective investors want to contribute, but with existing Australian regulations it is a challenge.
If we consider first degree connections to a company – say a startup or growth company that needs to raise $800,000 to grow – maybe there are a few mates that would like to contribute a couple of thousand each. However with the existing 20 retail investors in a 12 month period they would have to stump up with around $40k each to actually make it work for their entrepreneurial mate.
Strange though when this is a “small scale offering” exemption at an average investment of $40,000 when the average ASX share transaction is heading for $5,000 a trade! This seems counter to the idea of risk aversion, when a fully disclosed company can accept small amounts, but an undisclosed company has no choice but to ask for large investments.
So what is this worldwide equity crowdfunding trend really about? Well, its basically people that are passionate about a “friend’s” opportunity who want to be able to easily invest and be involved.
Let’s now look closer at the various types of people who really want to support an entrepreneurial endeavor:
After the Founders, early staff are often next to invest. In Australia this is not easy to do due to the tax effect on employee share schemes and consequently seldom happens. The tip of the triangle above is really, really important and we hope that before year’s end the Australian government recognises this with legislation changes to Employee Share Schemes.
This group is not fully handled sufficiently in existing legislation. Many people have direct experience and knowledge of an investment offering that doesn’t usually make it into an investment document.
The types of people in this category should include the full gambit of associates. These are normally executive officers of a company, spouse, parent, child, brother, sister, uncle, auntie, grandfather, grandmother, accountant, lawyer, engaged business consultant and a shareholder for at least a year. You could say, those having genuine knowledge about the people responsible for running the company.
This category is already provided for in legislation. The one type that is not covered adequately is people like Angel or Experienced Investors that are informed and competent enough, but may not meet the monetary cut-offs. Just because someone has a lot of money doesn’t make them a “sophisticated” investor!
Angel investors have often learnt the hard way, as have Company Directors. Two examples of Experienced Investors are Fellows of the AAAI (Australian Association of Angel Investors) and Fellows of the Australian Institute of Company Directors. For this reason I believe Fellows of the AAAI and Fellows of the Australian Institute of Company Directors, and any other equally qualified people should be added to the professional investor category.
A Startup entity and growth company has lots of contacts and connections. Many would like to invest but are prevented by existing regulation. At the moment 20 can invest in 12 months, but these concessions would all be used up if 20 people invested $2,000 giving $40,000 in total. This would be OK if the entity only needed $40,000 but this is mostly not the case.
Connections are people known to the capital raising entity, know its product, and/or those directly assisting the Company to raise capital. In my experience through ASSOB, around 80% of investment comes from this group, but many who wish to invest (and be involved) miss out due to present regulations. They have some connection with the entity, its location, its people, its technology or the business to make an informed investment decision. As regulations stand, these investor types, having knowledge of the company, its people and the opportunity, are often not acceptable as investors due to the often smaller size of the investment they can afford.
Not everyone has $20,000 to invest. Some people may be passionate about supporting an activity but may only have hundreds or a few thousand dollars to contribute. Thus, the notion of equity crowdfunding is evolving to include these people that want to take a small punt on an investment of their choosing and hope it will one day come to fruition – having been part of something from the ground up.
2) Limitations by Investor Type
Most jurisdictions have introduced investor categories and included limitations of investment primarily to prevent fraud. Some though have adjusted or are in the process of adjusting limitations for practicality. Title III of the Jobs Act in the U.S.A. is weighed down with so many limitations that new Acts are being introduced to lighten the legislation.
I believe the following limitations are workable in the Australian environment and ASSOB’s 8 years of operation give me the sense that they are sufficient to prevent fraud.
The main limitation at present is that it is not attractive, nor affordable for staff to take shares in startup and growth entities. Our present government has stated that it is going to address this. When this is changed there need not be any limitation as to how many shares a staff member can have in the entity they work for.
There should be no limits here as those at this level of contact, and are known to the directors personally, should have the actual knowledge to know whether the investment opportunity is real or otherwise.
There should be no limits here as investors have assumed knowledge through their experience, professional advisors and bank balance to afford to take a hit (if the unfortunate situation arises).
The existing small scale offering legislation allows 20 investors per annum. Lifting this to 100 new investors per annum will allow the average investment in this category to move from $30,000 to $40,000 per investor to a lesser amount, still attaining the overall target funding goal needed for the company to grow and deliver its promises to investors.
To ensure that individuals, who are not professional investors, do not over stretch themselves by investing in this ‘connected’ company, prudence suggests that the individual investment per annum should be capped at $25,000 for this investor type, per annum.
Under this category a maximum $2 million (retail) per annum can be raised for the 12 month period (as it is today). This amount also includes any “crowd”investment raised (as noted below) but not the investment amounts from those stated above from other excluded investors.
For each crowd raise there is a maximum of $1 million per annum per company with a maximum of $2,500 per investor per annum. This is sufficient to assuage any financial risk that a random investor may take without knowing the company or its directors to the same extent as the other investor categories.
3) Permitted Promotion
Time has shown that the present promotion restrictions in Australia have functioned well to avoid fraudulent activities, taking into account the needs of consumer protection legislation.
In general we see no reason to change these significantly other than allowing the funding portal to show an “offering summary” on its primary pages without the need for the visitor to be logged in.
An example from Crowdcube is below. If the person wants to know more about the investment opportunity they would have to subscribe / log into the portal, acknowledge the investor warnings, to then have access to the full offering details. There can be no harm from reading an “offering summary” to those who do not go the distance.
Shares in this category would not be promoted outside of the organisation but would be handled by face-to-face presentation and negotiation and usually tied to an employment contract or ESS.
Shares in this category would not be promoted outside of the organisation but would be handled by face-to-face presentation and negotiation at the directorship level.
Any promotions must specify that the offering is for sophisticated, professional or wholesale investors only and the investor must be qualified prior to receiving details in relation to the investment opportunity. This would be no different than the legislation now.
Promotion in this category will be covered by the existing regulation in Section 708 for ‘personal offers’, which is as follows:
A personal offer is one that:
For Promotional purposes Registered Portals can disclose summaries of the offer information to the public but prospective investors, who are the connections and other investor types, still need to log in to see full deal details.
Registered Portals can disclose summaries of the offer information to the public but prospective investors need to log in to see full deal details, as noted above. Their investment is limited to $2,500 as a “crowd” investor type, and promotion is only by the registered portal which is a controlled environment.
4) Changes needed
This is not an exhaustive list of changes but provides a guide as to what needs to be done to improve the startup and early stage investment environment for investor types that need changing now:
Associates > change the offers of securities to peoples associated with the company legislation at s708(12) to include ‘family, friends and business associates’, as follows:
Family have a pre‐existing relationship with the issuer which would provide them with access to information about the issuer to be able to assess that person’s capabilities and trustworthiness.
A close business associate is someone who has had sufficient prior business dealings with the founder, director, executive officer or control person of the issuer to be able to assess that person’s capabilities and trustworthiness.
Connections > change the small scale offerings legislation at s708(1)(a) from 20 persons to 100 persons remembering the directors are to advise the capacity the Associate is known for their own company records.
A close personal friend is someone who has known the founder, director, executive officer or control person of the issuer for a sufficient period of time to be able to assess that person’s capabilities and trustworthiness. The directors are to advise the company and anyone assisting in the capital raise that the investor is a close personal friend.
Crowd > crowdfunding offerings must be conducted through an intermediary funding portal, like the ASSOB Platform. Their investment is limited to $2,500 as a “crowd” investor type with maximum $1 million per year. The funding portal is to advise the crowd investor type.
Permitted promotion> Registered portals can display investment summaries without the visitor logging in
Intermediaries> Consultants can accept shares for services rendered but cannot invest funds. This will assist cash-strapped companies in obtaining the corporate advice they need, without burdening operational cashflow requirements.
Corporate structure> An existing Pty Ltd company is usually not in a form to be investor ready. With crowdfunding they are very likely to get over 50 shareholders. If a Pty company through crowd sourced equity funding attracts over 50 investors then for the larger number they need have at least 2 Directors, one of which is independent of the Founders and adopt a governance charter to ensure their company is more investor friendly. A suggested governance policy is as follows:
- recognise that their primary responsibility is to [Company] Pty Ltd and all of its shareholders. However, directors must also be aware of legal responsibilities to other stakeholders, including creditors and employees and ensure that they and the company meet these responsibilities.
- act honestly, in good faith and in the best interests of [Company] Pty Ltd.
- use due care and diligence in fulfilling the functions and exercising the powers of directors. All director actions are to be for a proper purpose, in the best interests of the company.
- notify the board of directors of any conflict of interest that arises and not allow personal interests or those of any associated person, to conflict with the interests of the company.
- not take any improper advantage of their position as a director and not make improper use of information acquired as a director. Confidential information received as a director regarding the company remains the property of the company and directors must not disclose, or allow to be disclosed, such information unless the disclosure is authorised by the company or required by law.
- be independent in judgment and actions and to take all reasonable steps to be satisfied as to the soundness of all decisions made by the board. This includes reading all information provided to directors for board meetings and attending all board meetings where possible.
- ensure all [Company] Pty Ltd’s registers and financial records are properly maintained.
- read [Company] Pty Ltd’s financial reports regularly enough to satisfy themselves that the company is not trading insolvently or likely to become insolvent.
- produce an annual financial report within five (5) months of the financial year end and provide this to all shareholders.
- hold an annual shareholder meeting within six (6) months of the financial year end.
- not engage in conduct likely to bring discredit upon the company.
- comply at all times with the spirit, as well as the letter of the law and with the principles of this Code of Conduct.
All the changes above can be implemented by the granting of relief from the relevant provisions of the Corporations Act, consistent with ASICs power under s741 (ASIC’s power to exempt and modify) and 1020F (Exemptions and modifications by ASIC) to modify the fundraising provisions of the Act for ‘minor and technical relief’ without the need of a full parliamentary enquiry.
For those wondering about the type of learnings ASSOB has gained in the startup / early stage investment space to support the recommendations we have made I list the following:
1) 63% of investors on the ASSOB platform are retail. It is only in the later rounds that sophisticated (accredited) investors join the raise. The “smart money” needs to see that those near and dear to the founders, IP, location and technology have backed them. ASSOB has always been a mixed accredited / unaccredited investor platform.
2) Each of our raises has on average a crowd of around 1000 followers that are gathered and congregated around each offering. Each offering draws its own crowd including some from the 26,000 subscribers ASSOB has. From the fund raising entities 1000 person crowd around 200 followers on average download the offer document resulting in about 20 investors.
3) Small scale offerings is just a legislative term. In reality it is companies offering their shares to their friends, fans, families and followers (Their Crowd). It is in reality their platform for the raise and it is only “private” to the degree that people have to log in which they have to do with most crowdfunding platforms in the world.
4) ASSOB’s average raise size is around $500k. Nearly all raises are between $500k and $1.5 million. We seldom have raises over $2 million.
5) Of the 300 companies that have raised money on the ASSOB platform around 70% are startups. You just need to look at recent raises to see this. Opmantek an open source startup raised around $700k. Selfwealth that raised $1.65 million is a superannuation portal that hadnt written a line of code when they started their raise. Cocoon data that are listing on the ASX shortly were a startup when they raised funds on ASSOB.
6) Over the past eight years over $138 million has been raised for just over 300 companies.
7) Around 60% of investors are in the same state as the company raising capital.
8) Raises normally take between four month and eight months to raise the majority of the funds.
9) ASSOB operates with a high bar for offering compliance. Through our many years of experience and monitoring compliance in the area of small scale offers and excluded investment opportunities, we have first-hand knowledge of issues that directly affect crowdfunding in any form. These include:
- Failure to adequately reflect or substantiate Founder cash investment or conversely overstate unsubstantiated Founder investment.
- Failure to transfer intellectual property into capital raising entity or subsidiary holding.
- Failure to monitor registered intellectual property (e.g. TM expired, patents lapsed).
- Failure to enter into any contractual agreements to transfer intellectual property (or stamp contracts at all).
- Failure to properly disclosure contracts not at arms-length (i.e. Founder owns intellectual property, sells property, etc.).
- Material changes which occur to the business not reflected properly or conversely, replacement documents needed but not done properly to ensure adequate investor disclosure of material changes.
- Issuing equity during a capital raising which comes from the shares allocated for the raising.
- Failure to observe basic corporate governance obligations – lodging share notifications, holding AGM, preparing audited financials – some even change the name at their own desire.
- Failure to send share certificates to investors.
- Material events occurring and directors not keeping investors updated, e.g. intellectual property expired, material contracts fallen through.
- Manipulation of share allocation through undisclosed debt for equity transactions, equity for services.
- ￼Non-disclosure of heavy leverage by Founders in which money is being repaid from capital raised which includes debt for equity conversions during the capital raising.