Crowd-Sourced Equity Funding (CSEF) Approaches

In our experience, the efficient and cost-effective access to capital is at the forefront of the minds of small business owners who are looking to expand. Under the current regulatory framework, if a company intended to raise funds other than from wholesale investors, a lengthy disclosure process is required including the preparation of a prospectus (or similar disclosure document) and, more than likely, an audit of their financial statements. This is an expensive proposition for any small business, however this is set to change.

In December 2015, the Turnbull Government introduced a bill into Parliament and released an Exposure Draft of proposed regulations which, if passed into law, will allow certain small businesses the ability to raise funds from “the crowd” with reduced disclosure obligations. A component of the Turnbull Government’s National Innovation and Science Agenda, the aim of this Bill is to provide a framework for crowd-sourced equity funding to encourage Australians to innovate and invest.

The Crowd – What is it?

The crowd is a term which refers to raising funds over the internet from both wholesale and retail investors. Under the proposed legislation, companies will be able to raise investment capital with a reduced disclosure document in an online format. Accessing these investors via the internet will allow a company raising funds quick and efficient access to a large pool of potential investors.

Eligibility Criteria to Raise Capital

In order to raise funds through the proposed CSEF measures, a company must first meet certain criteria. These include:

• The company raising capital must be an unlisted public company (and cannot be a private company).

• Gross assets not in excess of $5 million

• Revenue not in excess of $5 million

• The company may only raise $5 million via CSEF in any 12 month period. We note funds raised via other means (such as directly from sophisticated investors) will not count towards the cap.

• An offer document must be prepared and circulated (via the internet) to investors. We note the exact requirements of this offer document have not yet been released.

• The equity must be raised through an intermediary

Process for Making the Offer

For a company to make an offer under the crowd-sourced equity funding framework, it must:

• Ensure it is eligible to make the offer including conversion to a public company, if necessary

• Publish an offer document compliant with CSEF requirement via a single intermediary. We note a company may only have one offer document published at a time

• Obtain consents from any persons named or associated with the offer document

• The CSF offer is open from the time the offer document is first published and may be open for no longer than three months.

• The offer will be closed once the offer is fully subscribed

• Once the offer is complete and the minimum subscription amount reached, the intermediary can liaise with the company to transfer the funds

The Offer Document

An Exposure Draft of the proposed content requirements for the offer document has been released for comment which shows the Government’s intentions for the CSEF offer document. This Exposure Draft reveals that the offer document may require sections laid out as follows:

1. Risk Warnings including a warning matching the wording prescribed in the regulations

2. Information about the Offering Company including:

• Names of directors and other Key Persons;

• A description of the capital structure of the company;

• The most recent statement of financial position

1. Information about the Offer; including:

• The minimum and maximum subscription amounts

• The offer period

• The intended use of funds

• Disclosure of what portion of funds raised, if any, will be paid to certain persons listed in the regulations

• A description of previous crowd-sourced equity funding offers

1. Information about the Investor Rights including a description of the reduced disclosure requirements available to the Company and the cooling off rights available to retail investors.

The Gatekeeper

In order for a company to raise funds through the proposed CSEF regulatory framework, it must go through an appropriately licenced intermediary operating a crowd-funding platform. This intermediary will act as a ‘gatekeeper’, whereby they will be required to undertake checks on companies and their disclosure documents prior to marketing their offer.

When accepting an offer from retail investors, the Gatekeeper must ensure that whilst not having a cap on the total amount of investment they can make via CSEF, they are limited to only $10,000 per company per 12 month period. Retail investors must also be made aware of their 5-day cooling off right during which they can cancel their investment

Reduced Disclosure Requirements

Private companies which convert to a public company for the purposes of raising capital through CSEF will be entitled to reduced disclosure requirements for the first five years, including:

• Exemption from an audit until after $1 million has been raised via CSEF

• Exemption from the requirement to hold an Annual General Meeting (AGM)

• Financial reports will only be required to be provided electronically and not via paper.

Review

The proposed changes to the Corporations Act will provide companies seeking to grow, expand and innovate, a cost-effective way to tap in to both wholesale and retail investors. We see the pros and cons of the crowd-sourced equity funding framework for growing companies as:

Pros:

• Open access to a wider distribution network by leveraging the internet.

• Capital can be sought from wide pool of retail investors without the added disclosure requirements of a listing and/or full prospectus.

• Growth can be funded more efficiently than via prospectus marketed to retail investors

• Reduced requirements to disclosure historical financial information than via a prospectus

• Business can operate as a public company but with reduced overhead and disclosure for five years.

• Should the company seek a listing on the stock exchange in the future, operating as an audited public company may provide the market with more confidence in the financials of the business.

• Investment and funding from other means does not inhibit the cap on CSEF raises.

Cons:

• If required, the conversion process to a public company generally includes a conversion waiting period.

• Some small companies may already be above the $5 million gross assets threshold. In the future we may see the cap lifted to encompass the full range of non-large companies.

• Requirement for an audit after raising $1 million may decrease efficiency to businesses seeking growth.

• The commercial and practical implications of this framework has not be tested in Australia as yet.

Chessboard is enthusiastic about the proposed changes which may allow small businesses to access capital more efficiently. We wait in anticipation for this legislation and associated regulations to be implemented.

This article is not intended to be advice and is solely Chessboard’s summary of recent announcements. The reader should seek appropriate advice on the full effects of this Bill before taking any action.