Sometimes regulators can’t see the trees for the forest.
“Equity Crowdfunding” or CSEF is the forest. It is a new area, countries worldwide are contriving regulations that are yet to be proven and have no track record of success as legislation or as a “forest”. Australia, by copying something unproven and bettering it is a high risk approach for an area by investing millions in new regulations. (NB: CSEF = Crowd Sourced Equity Funding)
Here are three reasons why the new Australian regulatory framework for equity crowdfunding is the wrong approach for startups and millennials will leave it in the dust.
- Traction and lower costs doubtful. AFSL holders in the capital raising area don’t get out of bed for under $20k per raise or a retainer of 5k a month. Equity crowdfunding raises worldwide with retail investors are around $100k to $300k a raise. Not good economics here. A regulatory mismatch is evident here as few startups have the $20k to get a raise started. If the intermediaries are not charging the $20k as they build deal flow then it’s not a long term viable business model (NB: AFSL = Australian Financial Services License)
- Its about Small business funding not a new asset class. CSEF is primarily a small business financing opportunity not a reason to create a new regulatory framework for a new type of security. There is a mismatch here as businesses need finance not the burden of regulatory responsibilities and record keeping and the need to become familiar with securities and corporation law while building an innovative business.
- Jobs growth unlikely. The combination of an AFSL, a new regulatory framework, “public companies” and investor caps will result in cherry picked raises that would have mostly been funded anyway and thus no new jobs growth. Worldwide equity crowdfunding is being trumpeted for job growth opportunities but jobs only come with traction. Traction only comes with volumes of deals (hundreds) not 3 or 4 per platform per year.
ONE: Traction and lower costs doubtful
After personally handling around 200 crowdfinance raises in Australia two things are apparent.
- Intermediaries need to be paid up front to survive and if they are regulated they are not cheap. If they are not paid up front they will create special shareholding structures, exit fees, carry terms etc to get their “share” that runs counter to the democratisation of finance.
- If the raise cost is high capital seekers (issuers) will find another way OR not bother.
TWO: Its about Small business funding not a new asset class
The word “crowdfunding” will disappear just like”cyberspace”, “ecommerce” and “internet marketing” has. It is not a new way of doing things it is just an evolutionary development driven by internet adoption. eBay (auctions), Lending Club (small loans), Kickstarter (pre-sales) and similar entities didn’t need a new regulatory framework as like CSEF they are just an internet fuelled evolution of a traditional way of managing transactions.
Building a new regulatory framework based on empowering intermediaries rather than developing smart approaches to peer to peer transactions is going against the tide and is short sighted. Millennials will create pathways around this by using blockchains, coloured bitcoins and other peer to peer methods that will render this legislation unnecessary, unusable and a total waste of time and money.
Equity Crowdfunding as expressed in Title III in the Unites States and CSEF in Australia is about funding small businesses. It is already legal for Title II and Sophisticated Investor Crowdfunding in Australia.
It is not about creating a new securities asset class. Maybe only 1% of all retail funded crowdfunded businesses will ever list on a stock exchange. The focus should be on ways to seamlessly allow friends, fans, family and followers to participate in funding an entities growth as easily as contributing to a Kickstarter campaign.
If equity sourced crowd funding is going to work in Australia it needs to:
- Assign the responsibility on the issuer NOT the publisher (intermediary) as it is with eBay, Kickstarter and a plethora of matchmaking sites.
- Accept that innovation to make Australia a world leader in the area of crowdfunding will not come from AFSL holders and regulators. It will come from millennials focussed on building systems they want to use to invest. It should no longer be the premise of regulators to protect grandma but to work collaboratively with those smarter than them to build future proofed systems.
- Recognise that the crowd will “out” bad actors long before the regulator does and allow systems to develop that do this.
- Share registry costs should be reduced to zero by one central SME registry, preferably, block chain driven, used by all stake holders including ASIC and individual shareholders
- Accept that it is a high risk gamble investors are involved with and construct and amend the corps act to accommodate this instead of turning this into a securities play managed by a regulator and their incumbent AFSL network
- Small Business Minister The Hon Bruce Billson MP to recognise it is a funding issue not a securities one. Perhaps a new instrument like “Enabler Bonds” or “Startup Bonds” or “SMEBonds” or another form like Y Combinators SAFE instrument could be used rather than securities treated like they are listing on a stock exchange. Put the $7.8 million into this area.
THREE: Jobs growth unlikely
To get new jobs thousands of businesses need to efficiently use equity crowdfunding. If we look to the licensed platforms approach in New Zealand, which includes one Australian platform, there is strong evidence that curation, filtering and cherry picking is just letting through the ones that probably would have been funded anyway. Under 20 raises in a year are not even statistically significant when it comes to jobs growth.
The tweet below shows that two raises for five platforms in a month is two narrow.
Tweet: NZ Crowdfunding in August got difficult. Only two of four offers succeeded. One would have made the promoter happy. interest.co.nz/news/77398/rai…
Other Pathways
As I said above “The focus should be on ways to seamlessly allow friends, fans, family and followers to participate in funding a small businesses growth as easily as contributing in a Kickstarter campaign. Irrespective of the type of instrument used.
The Small Business Minister The Hon Bruce Billson MP should focus resources here rather than on building a new regulatory framework for an asset class that will never fire. The task for Mr Billson is to shift the Australia circle below towards small business funding by using data driven solutions.
Some alternative thoughts are as follows:
- Crowdfunding shares should be viewed and treated as a backers punt not as an IPO share issue. Upfront an investor has no doubt, and is warned and evidences their understanding that they understand they will probably lose their money. There is a transparent evidential record in the blockchain, or the on-line backers share register, or the Enabler Bond or SME Bond in case the entity grows up and has a serious share raise and structure when they enter into Series A funding round or similar.
- Take the $7.5 million allocated to ASIC to build a regulatory framework and engage say 10 bright millennials in the financial transactions area and task them and pay them to come up with a method to record financial contribution into startups and growth companies that is an acceptable precursor that can be switched to share capital if the business succeeds and requires a traditional equity structure. Block chains and all emerging technology should be canvassed to become a world leader in the space. (NB: The budget includes $7.8 million in funding over four years to enable ASIC to implement and monitor a regulatory framework which will facilitate the use of crowdsourced equity funding (CSEF).
