Crowd sourcing to raise funds for your business

MDL’s Business Law team look at the new CSEF provisions

A new potential source of funding for companies offers exciting opportunities for Australian businesses and investors.

Other than publicly listing a company on the Australian stock exchange, the most well-known method of raising equity in Australia (without a prospectus) is through small scale offerings. Small scale offerings are limited to:

  1. no more than twenty (20) investors being issued shares;
  2. within a twelve (12) month period; and
  3. with a combined investment limit of no more than two million dollars ($2,000,000).

Collectively, these restrictions are known as the “20-12-2 Exception”. The cost of a prospectus for offerings larger than those allowed by the 20-12-2 Exception can be prohibitive.

The new crowd source equity funding (“CSEF”) provisions (found under Part 6D.3A of the Corporations Act 2001 (“the Act”)) provide an additional means for companies to raise equity of up to five million dollars ($5,000,000) within a twelve (12) month period. Fundraisers should note however that this ‘Issuer Cap’, includes any money raised by fundraising (for example if a company raises $2 million under the 20-12-2 exception, then they can only raise another $3 million with CSEF offers).

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Crowd sourced funding has typically been limited to funding innovative ideas through donations to a company and/or ‘pre-ordering’ a product or service (before it has come into existence). Neither of these options provides equity in a company, therefore avoiding the need for regulation by the Australian Securities & Investments Commission.

After the introduction of the Corporations Amendment (Crowdsourced Funding) Act 2017, equity in early stage companies can now be purchased. The best part is that the opportunity will be open for everyone (depending on the type of offer made). “Retail investors” will be able to invest up to $10,000 in a CSEF offer, allowing everyday, small-scale investors an opportunity to become “angel investors” in companies that may have potential for huge growth.

The potential downsides of CSEF offers

Before we get too carried away though, there are some major drawbacks; particularly for the companies seeking to make a CSEF offer (“Fundraisers”).

CSEF offers are open to public (non-listed) companies only (although amendments are being considered to open this up to proprietary limited companies at the moment), specifically public companies with less than $25M in assets and less than $25M in annual revenue.

Public companies carry additional burdens including requirements for Annual General Meetings (“AGMs”), submitting and providing hard copies of annual reports and an obligation to submit to quite onerous auditing requirements.

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The Government is seeking to entice proprietary limited companies into becoming public companies (and capitalising on the new CSEF provisions) by providing companies who have recently converted to a public company, along with brand new public companies, with a five (5) year exemption from:

  1. the requirement to hold AGMs each year;
  2. the requirement to provide hard copies of annual reports (where requested by a shareholder); and
  3. the auditing requirements.

Directors should bear in mind that the exemption from AGMs does not prevent extraordinary general meetings being called by shareholders; and that directors can still be removed where investors consider that the company is underperforming.

Another limitation relates to who can actually become a Fundraiser for the purposes of the CSEF provisions. As indicated above, a public company can have no more than $25M in assets and no more than $25M in annual revenue. This limitation also includes assets and annual revenue of related entities. The term ‘related entities’ includes any other company controlled by the same majority shareholder and/or Director, a subsidiary company and/or parent companies.

The CSEF provisions are clearly targeted towards relatively new (and the government will be hoping, very innovative) companies which are controlled by relatively new players in the corporate landscape.

Considerations around the Offer Document

Without getting too carried away with procedural matters, it’s important to note that a CSEF offer is made by a Fundraiser preparing a CSEF offer document (“the Offer Document”), which contains disclosures and information about the company, its directors, its plan and how it intends to use the equity raised.

The Offer Document is then provided to an intermediary company who provides a platform and a way for a Fundraiser to communicate with investors.

An Australian Financial Services Licence (“AFSL”) with authorisation for crowd funding is required to act as an intermediary, and will, amongst other things:

    1. perform gatekeeper checks on a Fundraiser and its directors (to confirm eligibility, identity and residency);
    2. provide a communication facility where Fundraisers can communicate directly with investors;
    3. check and monitor the communication facility to ensure that there are no false or misleading representations made; and
    4. ensure that advertising (by either the intermediary or a Fundraiser) is not misleading or deceptive and that any advertising directs potential investors to the Offer Document (which should be able to found on the platform) and the general risk warning under s238 of the Act. 

Through the intermediary, investors will be able to access the Offer Document and purchase equity in the company. Retail investors are subject to the “Retail Cap” of $10,000 as mentioned above, and are provided with a legislative five (5) day cooling off period. Shares purchased by sophisticated investors will be subject to a twelve (12) month escrow period (under the ‘on-sale’ provisions of s 707 of the Corporations Act 2001).

Advantages of the new CSEF provisions

From our perspective, the most interesting aspect of the new CSEF provisions is how new and innovative companies (which are already taking advantage of the incentives for investment offered to companies and investors under the Tax Laws Amendment (Tax Incentives for Innovation) Act 2016 (“the Innovation Amendment”)) can utilise the CSEF provisions to further boost their growth.

Briefly, the Innovation Amendment allows companies to apply for status as an Early Stage Innovation Company (“ESIC”) and offer investors certain tax benefits. This is to assist innovative companies (which may otherwise be seen as ‘high-risk’) to incentivise investment in their companies and stimulate growth in this area of the economy.

There is great potential here for investors to benefit from significant tax incentives, which include:

  1. a tax offset equal to 20% of the total amount paid for shares (up to $200,000 for sophisticated investors and $50,000 for retail investors); and
  2. an exemption from CGT for a ten (10) year period from the date of purchase, for shares purchased from an ESIC.

For ESICs, the CSEF provisions will amplify these benefits by allowing companies to provide more than double the equity that they previously could.

The new CSEF provisions will change the face of fundraising in Australia. If savvy investors and fundraisers work hard to take advantage of the CSEF provisions, along with the provisions of the Innovation Amendment, it could lead to the creation of a lucrative new innovation industry in Australia.

 

To find out more about crowd funding for your business, talk to MDL

It all adds up to a very busy time for Australian companies that are willing to get on-board the CSEF magic carpet and take off through what will be a whole new world of capital raising.

Whether you’re a Fundraiser looking to ensure your Offer Document is compliant, an intermediary looking to limit your liability, or an investor seeking advice on your rights for investment, it pays to get expert advice.

Talk to MDL’s experienced Business Law team for straightforward advice about your options. Call 3370 5100 or fill out the contact form here to get in touch.

 

Brought to you by MDL’s Josh Savill.    

View Josh’s profile and get in touch here.