Company capital access for the future
Australian financial services laws do not foster crowd-sourced equity funding, where investors contributing to companies become entitled to equity, but market pressures might change this in 2016, David Court and Megan McMullan write.
New innovations in technology have led to a desire for innovation in capital raisings.
Companies want to use new platform technology that makes accessing small investments from large numbers of investors practical.
Thanks to the internet, investors have greater access to information about start-ups than ever before.
Some are demanding access to equity in early-stage companies but do not wish to invest large amounts or exercise significant control (both of which are hallmarks of more traditional venture capital investing).
Treasury has released the latest in a set of consultation papers that will allow new ways of sourcing equity. So what does it mean for you and your clients?
Crowd-funding
There has been a lot of talk recently about crowd-funding — whether it is equity fundraising, property finance or your favourite band's new album.
Crowd-funding is generally understood as meaning using the internet to raise funds for particular ventures.
Sometimes this is done for charitable purposes or to provide assistance to community groups and does not result in any reward or equity for the individuals contributing the funds.
Other times, say, when there is a project in the arts, contributors will be rewarded with a copy of the resultant music album or book.
The rising popularity of crowd-funding stems from the ability to reach large numbers of potential contributors or investors relatively cheaply and simply.
Crowd-sourced equity funding (CSEF) refers to a particular kind of crowd-funding, where investors become entitled to equity in a company, or other entity, upon contributing funds to it.
Unfortunately, Australia's financial services regulation is quite unfriendly to CSEF — it is not practical or economic to raise CSEF under the existing corporate and managed investment scheme regulatory structure.
This is the type of crowd-funding that is subject to the financial services laws and which Treasury is currently considering. Despite interest from industry, the Government has declined to make any moves to facilitate crowd-funding into property investment.
Treasury's consultation paper sets out how it views the CSEF regime in the future.
Although this is still subject to consultation, the key features of the regime appear reasonably settled.
How will it work?
CSEF involves three distinct groups. First, there is the company looking to raise the capital — often for a particular venture.
Secondly, there is generally an intermediary which runs an online portal facilitating the investment of funds by investors in a range of companies looking to raise capital in this way.
Thirdly, there are the individual investors, which contribute funds in return for equity.
Companies seeking funds
Companies can only take advantage of the new rules if they are a public company and have not raised funds under existing public offer arrangements.
These restrictions make the potential universe of companies raising funds using CSEF quite small — but more on that later.
Companies will be able to raise up to $5 million in any 12-month period from any number of investors under the CSEF rules, provided the issue is for a single class of fully-paid ordinary shares.
The offer can proceed under reduced disclosure requirements, including exemptions from disclosing entity rules, holding an AGM, and in some cases, without the need to be audited.
Most of these exemptions are only available up to a $5 million gross asset threshold or for a maximum of five years.
Companies will also be able to provide investors with a specialised CSEF disclosure document, rather than a full prospectus.
Investors
Investors will be able to invest in CSEF offers subject to caps of $10,000 per offer per year, and $25,000 in aggregate CSEF investments in any year.
Investors will also be granted an unconditional right to withdraw their investment within five days, as well as additional withdrawal rights where material adverse changes occur during the offer period.
They will be required to sign certain documents prior to investment that acknowledge the increased risks in CSEF investments.
Intermediary platforms
Practically, we expect almost all CSEF to occur via platforms operated by intermediary parties.
There are similar platforms already running under the existing rules and under special relief from the Australian Securities and Investments Commission (ASIC), such as the Australian Small Scale Offerings Board.
Under a CSEF regime, these intermediaries will be required to hold an Australian Financial Services Licence (AFSL), and must monitor compliance with the other obligations as best as possible, including conducting checks on offering companies, providing warnings to investors and monitoring compliance with investor caps for investments made via their platform.
There are no restrictions on the fees that these intermediaries can charge, but they must disclose any fees they receive from offering companies.
Expanding capital access for proprietary companies
As we noted above, the proposed regime is going to be quite limited in applicability, as a company can only qualify if they are a public company that has not previously raised funds from the public.
Many companies that may wish to access CSEF may be put off by the increased obligations and reporting required if they convert to a public company.
With these criticisms in mind, Treasury has laid out some proposals for increasing access to capital for smaller proprietary companies.
Enabling proprietary companies to access CSEF
Treasury has raised the option of allowing proprietary companies to access CSEF in the future, subject to meeting similar obligations to either large proprietary or public companies.
The problem with this approach is that it will impose significantly more obligations on small proprietary companies, which may act as a significant disincentive to those considering using the platform.
Understanding the issues at play, Treasury has outlined some additional approaches that may be considered, either in isolation or in conjunction with a CSEF regime.
More shareholders
A key change being discussed is raising the current limit on non-employee shareholders in proprietary companies above 50.
Currently, proprietary companies have a limited ability to raise funds from up to 50 non-employee shareholders before they have to issue a prospectus.
A Parliamentary Joint Committee in 2008 recommended raising this limit to 100, but no changes have yet been made to the law.
It is difficult to see how small proprietary companies could make effective use of CSEF unless this limit was raised as part of any regulatory solution.
Changes to small scale offerings
Treasury has also discussed amending the current rules providing prospectus relief to small scale offerings, to increase either the cap on investors (currently limited to 20) or the cap on capital raised (currently limited to $2 million).
This would seem to be the simplest solution in the short-term, as it would enable small proprietary companies to access a wider pool of capital while still maintaining their current exemptions under other areas of the law.
However, any capital raising ability under this option is likely to be more restricted than under a CSEF model, so may not meet the needs of small companies.
Where to from here?
Treasury will finish consulting on these changes at the end of August. We expect that any new CSEF regime will take some time to be implemented, especially as it will take some time for intermediaries to get their technology in place and meet their regulatory requirements (including, in many cases, obtaining an AFSL).
However, market pressures mean that increasing access to capital is currently a political priority and we are expecting to see changes in the landscape in 2016.
David Court is a partner at Holley Nethercote, while Megan McMullan is a law graduate.
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