Recently, the Australian Government legislated a new way for the average Australian investor to support start-ups and small businesses: Crowd-Sourced Equity Funding (CSEF/CSF). Prior to this, if you wanted to invest in a company, you found a broker, paid a fee, then bought shares. What if you wanted to help a business grow, yet they weren’t listed? You’re no angel investor, swooping in and supplying millions of dollars in funding (if you are, welcome… but I’m not sure what value you’ll derive from this blog!)
The Government passed legislation to enable this form of investment on 29th September 2017, but it’s only from January 11th 2018 that ASIC approved a first round of providers, which allowed the process to begin. Australia has become part of a group of 23 countries to offer this form of investment.
What is Crowd-Sourced Equity Funding?
On a simplistic level, CSF can be thought of as the Kickstarter or Indiegogo of the investing world. Investors pay a small amount of money in exchange for some shares in a company.
“The CSF regime aims to facilitate flexible and low-cost access to capital for small to medium-sized unlisted public companies by reducing the regulatory requirements for making public offers, while ensuring adequate protections for retail investors.”
While it is highly regulated, it is not the new Vanguard. The Australian Securities and Investment Commission (ASIC) mandates including the following statement in all offers (highlighting my own):
Crowd-sourced funding is risky. Issuers using this facility include new or rapidly growing ventures. Investment in these types of ventures is speculative and carries high risks. You may lose your entire investment, and you should be in a position to bear this risk without undue hardship. Even if the company is successful, the value of your investment and any return on the investment could be reduced if the company issues more shares. Your investment is unlikely to be liquid. This means you are unlikely to be able to sell your shares quickly or at all if you need the money or decide that this investment is not right for you. — Crowd-sourced funding: Guide for public companies
In our overall investing philosophy, I see this as a “play” investment, almost the equivalent of Bitcoin (although far more highly regulated). At this point, I’m not even sure whether I’ll have a go… just like Bitcoin!
Who Are The Players in Equity Crowdfunding?
1/ The Company
You own start-up or a small to medium company that needs funding to grow or implement a great idea. You may be unable to raise money through traditional avenues, such as loans, so you decide to try raising funds through equity crowdfunding. This form of funding isn’t open to all small businesses—there are restrictions on qualification. You must be:
There are many ways to trade as a business, including sole trader, partnership, trust or company. Companies are different to sole traders or partnerships in that they are considered to be a separate legal entity. That means the company owns debt and can be sued, not the individual.
An Australian Company
Your principal place of business is in Australia, and most of your directors live in Australia.
A Small Australian Company
Your business owns less than $25 million in combined gross assets and earns less than $25 million in revenue, on an annual basis.
A Small Australian Public Company
Companies can further be divided into public or proprietary (private). Public companies must have at least three directors; at least one company secretary; keep a registered office open to the public during certain hours; appoint an auditor; and disclose their constitution to shareholders. Public companies are not restricted in the number of shareholders.
A Small Australian Unlisted Public Company
Public companies may choose to list on an Australian financial market, such as the Australian Stock Exchange, or stay unlisted.
A Small Australian Unlisted Public Company Limited by Shares
Companies have sub-categories of liability (because a company can be sued as an entity in itself). When limited by shares, the most a shareholder can be held responsible for is the value of those shares. This is opposed to limited by guarantee (which restricts liability to an amount set out in the constitution) or unlimited with share capital (no limits to liability—personal assets may be at risk).
(Not) An Investment Company
Your company must not use the money to invest in other companies, nor loan to related parties.
It should be noted that the requirement to be a public company restricts eligibility for the vast majority of companies. There are some concessions that will help reduce the regulatory burden on private companies becoming public under this scheme. There is also a plan to open it up to private companies in the future.
2/ The Intermediary
The role of the CSF intermediary is two-fold. They are required to provide an online platform to enable investors to engage with a CSF offer. They are also responsible for ensuring the CSF offers and companies meet minimum eligibility requirements and conform to the legislation.
In order to be considered a CSF intermediary, a company must hold an Australian Financial Services licence authorising it to provide services under the CSF scheme. It is very important to note that there are some crowd-funding platforms that do not fall under the regulations for CSF.
Currently there are only seven companies that have successfully obtained a licence to act as a CSF intermediary: Big Start*, Billfolda, Birchal Financial Services, Equitise, Global Funding Partners, IQX Investment Services and On-Market Bookbuilds. The government plans to batch-issue new licences in the future.
*I can’t find a website for Big Start. I did find: “Sharequity Pty Ltd is an authorised representative of Big Start Pty Ltd”, but I can’t tell if the Sharequity platform is able to make CSF offers. If it’s not clear to me as a retail investor, I’m not including a link.
These intermediaries publish the CSF offer on their website, receive applications from investors, collect, hold and possibly refund investor money, and provide a means of communication between investors and the company placing the offer. There is a strict one-to-one relationship between a company’s CSF offer and the intermediary. A company is not allowed to publish the same offer with more than one intermediary.
3/ The Investor
Before this legislation passed, the ability to invest in start-ups or unlisted public companies was largely restricted to those with a lot of money—sophisticated investors, angel investors, venture capitalists, or institutional investors. The purpose of CSEF is to allow companies to raise money by offering ordinary shares to multiple investors, each investing a relatively small amount of money.
Retail investors are also known as personal investors, or small investors. They are people like you and I who generally have less than $2,500,000 dollars in assets, with incomes of less than $250,000 for the past 2 years (requirements to be deemed a “sophisticated” investor). Crowdsourced funding is directed at the general public.
Invest for the Medium Term
As per the mandatory warning, investing via crowd-sourced equity funding is likely to be illiquid. There are a limited number of shares issued, and those shares can’t be sold for at least 12 months. “Investors are not able to sell shares acquired under a CSF offer within 12 months of their issue without a prospectus or other disclosure document, unless an exemption in s708 applies (e.g. sales to sophisticated or professional investors) or unless ASIC gives relief”. In the UK, the first secondary market (haha) for equity crowdfunding was opened in 2017—five years after crowdsourced funding began.
High Risk Tolerance & Risk Capacity
It may be harsh, but most start-ups or early stage businesses fail. You must be willing to lose the entirety of your investment. This also means you must be able to afford to lose the amount of money you’ve chosen to invest.
People may invest up to $10,000 per company per year (probably as protection for we unsophisticated investors). If you are investing in joint names, each person is deemed to have invested the full amount for the purpose of the cap. That is, the limit does not become $20,000 for Mr. ETT and I together.
Let’s assume one company runs three CSF offers in a year. In the illustration below, both of us reached the investor cap, because the entirety of our joint investment is attributed to each of us.
If you decide to invest in a crowd-sourced funding offer, you have a 5-day unconditional cooling-off period to change your mind. If you choose to do so, you must follow the process on the intermediary’s website. The intermediary will return your money “as soon as practicable”.
In addition, if the original offer document is determined to be defective, and is replaced or supplemented, you then have a month to withdraw your application based on the revised information at hand.
Investors must acknowledge that they have read and understand the general risk warning. If you apply to participate in a CSF offer without doing so, your application will not be accepted.
4/ The Offer
The official CSF Guide for Public Companies emphasises clarity as an essential feature of the offer, with multiple references to this concept throughout. In fact a key requirement, given equal standing to “not be misleading or deceptive”, is “be worded and presented in a ‘clear, concise and effective’ manner”. Although the structure of the document is prescribed by law, ASIC encourages the use of graphics, tables, charts, and even video or audio presentations if it will help investors understand information. (They also specify that the document shouldn’t be too long. Clearly I have no future in producing CSF offers!)
There are strict rules on how companies may publicise their offer as well. Every advertisement in any form (including social media) must contain the risk warning and direct people to the actual offer document.
Companies may only have one CSF offer open at a time. They are prohibited from offering financial assistance to investors to take part. I had no idea this was a possibility. It seems counter-intuitive that the company hoping to raise money would lend me money to participate. It must happen though, because it is specifically forbidden. Companies are also not allowed to provide personal financial advice regarding their CSF offer. If they provide general advice, they must reference the cooling-off period, and let people know they are not licensed to provide financial advice.
Another rule I found interesting is that companies may not offer shares during an unsolicited meeting or telephone call. This means they cannot invite you to purchase shares in their company if you are speaking to them for any other reason.
Offers may be opened for a maximum of 3 months, although the offer document itself might specify a shorter time frame. Companies can withdraw a CSF offer at any time before it is completed.
This table lists the minimum requirements of a CSF offer document. Companies are able to provide more information only if it is relevant and helps investors make an informed judgement before purchase.
Well, I think that’s enough to start. In Part 2, I describe the process of bringing an offer to the public.
Have you heard of crowd-sourced equity funding? What do you think?