Review of the rules could give investors more incentive, writes Nina Hendy.
Crowdfunding hasn't been a viable option for investors - until now. But this space is worth watching given investors could soon be offered an equity stake in a hot new start-up.
As far as investments go, throwing some cash at a crowdfunded venture hasn't been considered a worthwhile prospect given it probably won't yield a return. But legislation governing crowdfunding in Australia is under review, and investors are sitting up and taking notice.
The idea of crowdfunding is very simple. If a company needs to raise money for a project then investors can back them by pledging money. Depending on the scheme, they get back special versions of the product, cash from sales or equity.
A discussion paper released by the Corporations and Markets Advisory Committee (CMAC) last month points out that if regulated appropriately, a move toward Crowd Sourced Equity Funding (CSEF) could enable investors to make a number of modest investments with fairly low transaction costs.
Up until now, crowdfunding has been considered more of a donation than a financial investment. Investors could be offered a small incentive in return for cash, such as discounts, free product samples or debt or equity interests in a business. Or, investors might be asked to donate money and get nothing in return. Funds certainly aren't returned to investors, let alone any profit on that investment. And there are no protections in place for investors.
Despite the risks, crowdfunding ventures continue to garner support around the world as people get swept up in the dreams of others. In a process where a single person or a team raises small amounts of money from a large number of people, the money is often handed over by people the entrepreneurs have never met who want to fund projects that matter to them.
These days, crowdfunders regularly turn to the internet to spread the word, with sites like GetUp!, Pozible, iPledg, Indiegogo, and now Kickstarter, which has just launched here. Recently, US wristwatch company Pebble sought to raise US$100,000 via crowdfunding, however its latest product was so popular it ended up attracting US$10.27 million.
ASIC says that while crowdfunding isn't prohibited in Australia, it isn't regulated, either. Existing regulatory framework doesn't support or prohibit crowdfunding, prompting the review.
But change looks likely. The CMAC review comes as crowd-sourced equity funding gains increasing attention as an alternative form of corporate fundraising for start-ups, entrepreneurs and other small to medium businesses around the world. The funding option has been growing alongside the digital economy at a rapid rate, providing huge opportunities to fund projects that would otherwise probably never get off the ground.
Aussie investors have watched as the United States changed its laws to allow crowdfunded start-ups to issue equity stakes to the public.
The CMAC is now considering allowing Australian investors to be given equity positions in projects funded on our shores. This would be a game-changer for investors, particularly for those occasional start-ups that do go on to be rich and famous.
The CMAC is also considering imposing an obligation on platform providers to make some basic checks on issuers before including them on their website to help prevent fraud.
Angel investors group Melbourne Angels believes one of the major ramifications of legislative reforms being discussed could be more online crowdfunding platforms. The founder and president of both the Melbourne Angels and the Australian Association of Angel Investors, Jordan Green, advocates the importance of only experienced investors turning to crowdfunding.
"CSEF is coming and it will bring with it new opportunities and new risks. CSEF can be a great boon to angel investors and other professional early-stage investors but, the wrong implementation will muddy the market, skew the investment process and mislead the entrepreneurs and the crowd investors," Green says.
If CSEF is introduced, it would be a game-changer for crowdfunding site Indiegogo, which pioneered the notion of perk-based rewards in 2008.
The platform's marketing and community consultant, Tony Been says people tend to contribute money to a venture for four main reasons - passion, participation, pride and perks. The perks offered include various goods and services in return for a contribution to their campaign. "The decision to offer perks and which perks to make available are entirely controlled and determined by the campaign owner. These perks can give campaign owners invaluable understanding into what exactly their audience wants, enabling them to work smarter and more efficiently during and after the campaign," Been says. "The bottom line is that people love to crowdfund as a way to be directly involved in what they're passionate about, whether the campaign is raising money for a non-profit organisation, a film or the latest tech gadget. Receiving a perk in return for your contribution is the icing on the cake."
He speculates that changes being considered by CMAC would offer several advantages to potential investors, including wide exposure to new projects and ideas, a dialogue with campaign owners and an ability to contribute without restrictive thresholds.
Been hopes a balanced approach is taken to regulation. "We believe that too much regulation could potentially stifle innovation in a budding industry, however too little regulation could possibly put entrepreneurs and investors at risk.
"It's important that companies such as Indiegogo are empowered to experiment as they have in the past, learning what works and what doesn't in order to continuously improve the platform appropriately."
The CMAC is seeking written submissions by the end of November. It will hold a roundtable discussion early next year before finalising the report. In the meantime, investors should exercise caution.
Those countless business dreams that individuals and groups are raising money for listed on crowdfunding websites might look good, but whether or not they're a worthwhile investment is another matter entirely.
"Just be sure you are comfortable with the amount you contribute," Been warns. And make sure that you "understand what you are supporting".
The ins and outs of ASIC guidance for investors and fundraisers
Managed investment schemes
ASIC's guidance states that a crowdfunding scheme that offers some sort of reward or pre-purchase incentive for investing may constitute a managed investment scheme "if funds contributed are pooled or used in a common enterprise to product financial benefits or benefits consisting of interests in property for the contributors".
This means that anyone operating a managed investment scheme needs to register with ASIC and operate through a responsible entity, such as a public company that holds an Australian Financial Services Licence, unless the scheme has fewer than 20 members or is otherwise exempt.
Fund raisingASIC's guidance states that if securities are issued by a crowdfunding scheme, that scheme "may be required to lodge a prospectus or other complying disclosure document with ASIC". There are no exemptions available for small businesses and start-up companies that wish to crowdfund a project. Small businesses and start-up companies are primarily governed by the 20/2/12 rule for small scale fund raising. This means that if a business raises funds of less than $2 million, from fewer than 20 investors over a 12-month period, it is exempt from the requirement to lodge a disclosure document with ASIC. So it may raise funds as a proprietary company, avoiding the need to convert to a public company. However, a crowdfunding scheme will typically rely upon millions of investors and would never satisfy this exemption.
Financial services licensing ASIC's guidance states that if a financial product is offered by a crowdfunding intermediary website, "the owner of Australian-based websites that facilitate this crowdfunding may be legally considered as the person making an offer to arrange for the issue of a financial product".
ASIC's guidance also states that if investors "are told that they may receive some asset of nominal value which is not itself a financial product, regulation under the Corporations Act may not apply and such arrangements are not generally regulated by ASIC".
Source: Alberto Colla, partner, Minter Ellison Melbourne
Helping hand on start-up
Melbourne woman Lauren Rielly is in the process of establishing an equity-based crowdfunding site that will give a helping hand to investors without niche knowledge on what constitutes early-stage investment potential. The site will be called StartupCrowdfunding
Rielly is the administration officer for the Melbourne Angels, lecturers in entrepreneurship at Swinburne University, is a consultant with the Mentor Entrepreneurship Group and a serial entrepreneur. Rielly says early-stage investment is a specialised, high-risk form of investment that requires vast experience, knowledge and network access for a successful return, which can be overlooked as investors get swept up in the movement of a crowd.
"First-time early-stage investors often don't have the objective skills in opportunity evaluation to determine the likely future potential of a new venture," she says.
Rielly predicts crowd-sourced equity funding is on the way and says it will open the floodgates, with a new flurry of deal sites to launch. The sheer volume of available crowdfunding opportunities will cause deal-flow chaos and fatigue in the market, she says.
"StartupCrowdfunding.com.au is being created to facilitate early-stage investment by delivering high-quality deal-flow to execution that sees both entrepreneurs and investors go through a collaborative evaluation process."
An entrepreneur must register a lead mentor and a lead investor with their application before their crowdfund bid gets under way. The lead investor needs to have a track record in early-stage investment to help with deal execution and investor relations, guiding new investors through the process.
"Entrepreneurs will be able to solicit opportunities they are passionate about, regardless of commercial viability and potential market traction," she says.
Rielly will host a workshop in Melbourne explaining how to launch a successful crowdfunding campaign, from 8.30am on Saturday, November 23 at Alvie Hall, Cremorne. To book email firstname.lastname@example.org
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