CAMAC releases report on crowd sourced equity funding
In September 2013, the Corporations and Markets Advisory Committee (CAMAC) published a discussion paper on crowd sourced equity funding (CSEF) inviting submissions on whether CSEF should be introduced in Australia, and if so, how it should be implemented. On 5 June 2014, CAMAC released the long awaited report on its findings and, in reviewing various frameworks within other countries and considering the submissions from stakeholders, supported the view that CSEF should be facilitated in Australia. This article provides a high level overview of CSEF and the recommendations made by CAMAC.
What is CSEF?
Crowd funding has been a global phenomenon facilitated by the internet that has enabled many entrepreneurs and start-ups to turn their ideas into reality. Traditional funding channels (such as banks and venture capital funds) have typically been inaccessible to early-stage businesses due to their inherent risk profiles and lack of revenue. This is particularly true in Australia, where venture capital funds tend to take a more conservative approach than their American counterparts.
Unlike the crowd funding campaigns you may be familiar with (such as involving a donation or a pre-purchase of goods/services), people who support a CSEF campaign actually take an equity stake in the business entity in return for the funds they provide. CAMAC in its report supported CSEF due to its “potential to provide meaningful returns to … crowd investors, as well as creating employment and other consequential economic benefits”.1
Although a number of countries, including Canada, UK, USA and New Zealand, have introduced various forms of legislation to facilitate CSEF, it should be noted that CSEF is only in its infancy world-wide. It is difficult to gauge the level of interest in CSEF at this point since most of the push has been supply-side driven (by companies wanting to use CSEF and by crowd funding platform operators). Nonetheless, the potential for CSEF to bridge the capital needs “gap” in Australia could be crucial for early stage businesses and help keep Australia “on the map” as a viable place for start-ups.
Barriers to CSEF
There are fundamental barriers in current Australian law that make CSEF very difficult to use. Start-up businesses often take the form of proprietary companies. However, due to the general fund raising prohibitions2, advertising restrictions3 and other constraints4 under the Corporations Act 2001 (Cth) (Act), it is currently not possible to implement CSEF for proprietary companies in Australia without changes to the law. Public companies would arguably be able to undertake a form of CSEF, but any offers of equity would require compliance with requirements under Chapter 6D of the Act, including the issue of a disclosure document.5 There are also many compliance requirements for public companies. Altogether, these costs are understandably prohibitive for start-up companies.
The CAMAC report
As mentioned above, CAMAC has on balance considered that CSEF should be supported to encourage the Australian start-up sector. This should be applauded as a step in the right direction. Australia has often, due to our tax regime and lower government grants and other incentives, been low on the list of desirable start-up destinations. The recent Federal budget has also fuelled criticism that Australia does not support entrepreneurs. Failing to implement CSEF would likely cause many more worthwhile Australian entrepreneurs would consider moving offshore to enable their ideas to be funded.
CAMAC recommends that a new regulatory regime should be introduced specifically for CSEF. As with the introduction of any new laws, there are many other considerations which the law makers must take into account. For CSEF, the primary concerns are around the potential financial risks, possibility of fraud as well as checks on corporate governance and responsibility. In the report, CAMAC provides recommendations for a large number of issues pertinent to the implementation of this new regime, which are based upon comparisons of CSEF laws in different countries and on submissions received from stakeholders.
We highlight the main recommendations below.
- Only public companies may use CSEF.
- Recommended a new “public exempt company” class of companies:
– this type of company will have reduced compliance requirements. Suggestions include removing the need to appoint auditors or have annual general meetings; and
– suggested that the exempt status should expire automatically:
– if a turnover cap or market cap reaches a threshold ($5 million used as example); and
– upon reaching a certain period of time (3 years used as an example).
- Recommended that only one class of shares may be offered excluding options and convertible securities (preferably an ordinary share).
- CAMAC suggests a capital raising limit of $2 million per 12 month period – this includes any funds raised through the small scale offer exception under s. 708(1) of the Act.
- CAMAC considered the disclosure of the offer is important, but a balance needs to be found between providing sufficient information while not being unduly burdensome on issuers. CAMAC suggested that ASIC should develop a disclosure template and a policy document. This document should not need to be lodged with ASIC before publication.
- Recommended that there still needs to be controls on advertising, suggesting that the current model in s. 734 of the Act as being a possible approach (which provides for relaxation of restrictions after lodgement of a disclosure document). However, given that the disclosure document does not need to be lodged it is unclear how this would operate.
- CAMAC suggests that it may be prudent to have directors and other persons controlling the issuer should sign a certificate and be subject to civil liability in respect of misrepresentations in the offer documentation.
- CAMAC Suggested that anyone with legal capacity may invest in CSEF but there will be a cap on investments:
– cap based on investment in CSEF (any company) of e.g. $10,000 per 12 month period; and
– cap based on per issuer ($2,500 was used based on Canada’s system, but CAMAC suggested this cap may be higher).
- Investor caps do not affect investors that fall within s. 708 exceptions (such as sophisticated investors).
- Investors must acknowledge risk disclaimers etc. before accessing platforms.
- Investors should have a short period (e.g. 5 working days) to withdraw their acceptance. CAMAC considered that other withdrawal rights such as “tag along” rights were not suitable for CSEF.
For intermediaries (online platforms)
- Recommended a separate licensing system be put in place (i.e. platforms will need to obtain a licence from ASIC).
- There will be checks in place to obtain a licence, including full disclosure of the directors.
- If the platform intends to have a secondary market it will still need to have a separate Australian Markets Licence.
- Intermediaries should be required to monitor caps on individual campaigns, but not on annual investment limits (as investors may invest on more than one platform).
- Investors should self-certify regarding the annual investment cap.
- Intermediaries should be prohibited from publishing campaigns in which the intermediary (or its associate) has a material interest, or where the issuer does not qualify for CSEF.
- Suggested that each campaign may only be run through a sole online intermediary (i.e. a company can only use 1 platform at a time).
- CAMAC believes that it is important for intermediaries to undertake a degree of due diligence on issuers to avoid abuse by individuals seeking to manipulate CSEF for fraudulent purposes. These checks may be outsourced to third party service providers.
- Intermediaries should be allowed to rely on the information provided to them by issuers as being true. Liability should only be imposed where the intermediary had actual knowledge that the information was misleading or information had been omitted and the intermediary failed to act.
- Suggested that ASIC may provide a limited due diligence template.
- CAMAC had reservations about requiring business due diligence beyond basic checks as it is a far more complex and technical exercise.
- CAMAC did not support a “know your client” or similar screening requirement.
- CAMAC also did not support a central registry of CSEF information due to privacy concerns.
The full report is available here to download. CSEF_Report_21May2014
We will be keenly following the response of the Federal Government to CAMAC’s report and will continue to provide updates as they become available. In the meantime, should you wish to discuss the above in detail please contact us.
1 CAMAC, ‘Crowd Sourced Equity Funding Report’, (2014) p. 12.
2 Section 113(3) of the Act prohibits proprietary companies from engaging in any activity that requires disclosure under Chapter 6D. While the company may still rely upon s. 708 exceptions and ASIC Class Order 02/273, these are not sufficient to facilitate CSEF.
3 See s. 734 of the Act which restricts advertising or publishing a statement referring to equity offers unless certain circumstances are met.
4 A proprietary company may not have more than 50 non-employee shareholders, see s. 113(1) of the Act.
5 An Offer Information Statement or Prospectus is required under Chapter 6D, unless an exception under s. 708 of the Act applies.
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