Doors to open on equity crowdfunding

Just because Australia's equity crowdfunding laws are changing for retail investors, proceed with caution before putting all your money behind the next Facebook or Amazon.

From September 29, retail investors will be able to invest in startups and scale-ups alongside institutional investors through crowdfunding platforms. These have previously only been accessible to those with more than $2.5 million of assets outside the family home or income above $250,000 a year, unless they were operating syndicates to get around the rules.

Considering companies require a minimum market capitalisation of $15 million to list on the ASX — but more often than not list with market capitalisations of between $50 and $100 million for real feasibility — there does look to be an underserved market at the smaller end.

A company with gross assets of up to $25 million will be able to tap into the crowd for equity. However, proprietary limited companies, which are more commonly early stage startups, will be excluded.

The new laws only open the gates to unlisted public companies, ruling out more than 99 per cent of Australian business.

Unlisted public companies will be able to raise up to $5 million a year through a crowd of investors. An individual investor, regardless of their level of wealth, can soon invest up to $10,000 per company per year.

Dancing in the dark

By and large, it's perceived as a positive development by Australian crowdfunding platforms — InvestSMART spoke with VentureCrowd, Pozible and ASSOB, who've been watching their overseas counterparts with envy. But there are a few points of concern, for both these crowdfunders and the crowd.

Unlisted public companies created after September 29 can take a reporting holiday for five years. During this time, they're not required to hold shareholder meetings, distribute annual reports to shareholders, or even be audited if they are raising less than $1 million.

Basically, disclosure can be kept to a bare minimum, which could leave some shareholders searching for answers in the dark. Perhaps more obviously, the laws don't guarantee a return on investment either.

A positive for half the party — retail investors will be afforded a lengthy cooling off period of five business days, which is more protective than the stock market and compares to the cooling off after purchasing a property.

Not a “get rich quick scheme”

Marina Nehme (pictured below), a senior lecturer in the Faculty of Law at the University of New South Wales, gave evidence to the Senate last year and has been closely following the changing proposals.

She said these businesses are long-term investments, and shouldn't be looked at as “get rich quick schemes”.

Of the three types of companies in Australia — private, publicly listed and publicly unlisted — the latter is most likely to fail in its early days (although, those that make it through actually end up having a better shelf life than private companies).

Nehme believes that because it's a relatively new and nuanced market, many investors don't have the financial literacy to understand what they're getting into. In Italy, for example, retail investors must pass a test to prove they understand business red flags and indicators of financial health before they can invest through a similar scheme.

“Even if these startups succeed, the chances of getting your money back are small in the first few years. It's only down the track. It's basically a long-term investment, not a get rich quick scheme,” said Nehme.

“Financial literacy is very important, and not onerous from the perspective of intermediaries or businesses, but from the perspective of ASIC educating investors.

“You will essentially be buying shares, but you will find it very hard to sell the shares, as they are quite illiquid, especially when you're dealing with companies that receive concession. You have to find someone willing to buy your shares and get it through the board approval. It's very unlikely for these companies to list on the ASX, so there's potential of being locked in.”

In saying that, she's concerned the legislation coming into effect in September is too restrictive, and could potentially hinder the success of the companies that take advantage of it. It's costly to appoint an auditor if you're raising more than $1 million.

“It's restrictive because it excludes proprietary companies completely. The regulation encourages them to become public companies, but the minimum obligation that would be imposed on them might not give them the incentive to change from a proprietary to a public company,” explained Nehme.

“The bigger restriction though is that the legislation targets unlisted public companies with share capital and, in addition to that, assets of no more than $5 million. So these companies might end up feeling restricted when it comes to capital and revenue.”

An innovation nation?

In Canada, any company besides financial advisory firms can access crowdfunded capital, and in the US, only companies without business plans are excluded, said Nehme.

As VentureCrowd CEO Vivian Stewart (pictured left) put it: “It's been a lost opportunity for so long”.

“The government has been incredibly slow to deliver the same level playing field that's in place in Canada, US, the UK and New Zealand already, but it does seem to be moving in the right direction.”

Nehme, and ASIC too, have proposed changing the Corporations Act to be less restrictive on private companies, which under the current structure, can only have 50 non-employee investors.

ASIC noted the legislation “is just a first step to closing the funding gap for SMEs”. Last month, there were moves in Treasury to extend the legislation to private companies, but those in the game suspect an iteration of this bill won't pass until the middle of next year at the earliest.

VentureCrowd's Stewart said this was important because it was probably overlooked early on that companies most likely to use crowdfunding couldn't actually bear the cost of it.

“It's true that those who can afford to become public companies and raise the capital probably need crowdfunding less,” he said.

Will Leitch, the CEO of the Australian Small Scale Offerings Board (ASSOB), thinks one of the biggest positives is the laws are changing so companies can have an unlimited number of investors, up from 20 in a 12-month period.

He is obviously optimistic about the outlook for Australian startups, with 30,000 potential investors on the ASSOB database, but he also stressed just how important it was to get the regulation right.

“When I look around the globe at where the business models of tomorrow will come from, over the next 10-20 years, it's from this part of the market, not the institutional long-term businesses,” said Leitch.

“If we don't get this right in Australia we really do risk falling behind the rest of the world. And these businesses aren't ideas on a whiteboard; they have established themselves with a minimum viable product with maximum global opportunity.”

Finally catching a break

These types of investments might be appealing to some investors because of the tax breaks.

Alan Crabbe, the CEO and co-founder of the crowdfunding platform Pozible, believes tax incentives helped raise the bar for equity crowdfunding in the UK, where in the past year, he said £80 million passed through the space.

There have been a handful of high-profile success stories in the UK which have helped equity crowdfunding get traction in the mainstream. Crabbe refers to the craft beer company Brewdog, which has done five subsequent raises since its first in 2009. It has 50,000 retail investors and just took institutional money a few months back at a £1 billion valuation.

“When it's very early stage capital, going into seed enterprise investment schemes (SEIS) in the UK, you get a 45 per cent rebate on your investment, and you still get rebates, although lesser, when investing in later stage companies,” he said.

“A tax incentive was introduced in Australia for early stage companies in July last year, so retail investors might look into these opportunities where there's a 20 per cent tax incentive.”

The problem with mainstream audiences

Like with any investment, hype can be good for those in the game, but not when it draws people in for the wrong reasons — that's when it becomes a bubble.

UNSW's Nehme believes it's important to be conscious that “crowdfunding isn't attracting your traditional investor”.

“It's more so attracting those on social media interested in the startup scene who may not have invested in securities before — they will go with the hype of the business, but it's important to be across all the disclosures,” said Nehme.

“Check how many warnings they have put in their documents that signal they aren't sure about certain things, and check who else is investing because you can find that out on the platform. Be it's not just family and friends, but also experienced investors with a record and history of investing — this can be a signal to the market of the quality of the project.”