By Guglielmo de Stefano on Tuesday 1 December 2015
Similarly to their global peers, Australian SMEs are experiencing extreme difficulty in accessing capital to expand their operations. Many of these difficulties are to be expected. Indeed, lenders are wary about their higher credit risk, their uncertain earnings potential and their smaller (if not totally absent) pool of securable assets. But SMEs have in recent times started to explore different funding alternatives and crowdfunding is one of them.
The nature and the functioning of crowdfunding is widely acknowledged. What people might be probably missing is how the regulatory framework works specifically in Australia. While a number of markets such as the United States, Italy and New Zealand have welcomed the arrival of crowdfunding by promptly regulating the sector, Australia seems to be lagging behind.
The existing regulation
In 2012, the Australian Securities and Investments Commission (ASIC) indicated that equity crowdfunding may fall within the framework contained in chapter 6D of the Corporations Act, which is very restrictive and obliges corporations to present tons of documentation in support of fundraising rounds.
However, small businesses and start up companies might use the 20/2/12 rule for small-scale fundraisings, which is apparently less restrictive. Indeed, under this law, a proprietary company is not required to present too many documents with the ASIC, if it seeks to raise funds of less than $2 million from less than 20 investors over a 12-month period.
It’s clear that this exception is largely incompatible with crowdfunding schemes that typically rely on a far greater number of investors. In addition, the scope of Australian equity crowdfunding is limited to wholesale or sophisticated investors, who earn at least $250,000 a year or have $2.5 million in assets. Australian start-ups cannot practically access retail investors due to significant upfront compliance costs.
The conclusion is that the current equity crowdfunding regulation in Australia is too restrictive and it is likely to choke the sector’s growth. In addition, the process of making the rules smoother has progressed incredibly slowly in the recent past.
Recent regulatory developments
In 2014, the Australian Corporations and Markets Advisory Committee (CAMAC) released a report on equity crowdfunding with several recommendations, including:
• The creation of a new type of company, specifically for use by equity crowdfunding issuers
• The licensing by ASIC of online intermediaries
• An “investor cap” for individual investors of no more than $2,500 to any particular issuer in any 12 months and no more than $10,000 in total during any 12-month period
• An “issuer cap” on total capital raised through equity crowdfunding of no more than $2 million during any 12-month period.
Following on from the CAMAC’s report, in its federal budget released on May 2015, the government recognised for the first time equity-crowdfunding as a viable alternative funding option, but without disclosing details of a specific model.
In addition, Malcolm Turnbull, the Australian Prime Minister, argued that Australia should follow New Zealand’s example, suggesting that his preferred approach would be a wholesale adoption of the NZ legislative regime.
New Zealand introduced a comprehensive equity crowdfunding regime in mid-2014 and its regulation aims to balance the need for consumer protection versus the extraordinary aggregation power of the Internet. Its major features are as follows:
• All incorporated entities may raise capital through equity-crowdfunding
• The amount an issuer may raise though equity-crowdfunding is capped in a 12 month period at $2 million (excluding contributions from wholesale investors)
• Investors are required to sign a risk acknowledgement statement
• There are only recommended caps on investors
The subsequent chapter of the Australian crowdfunding regulation saga rolled on in August 2015, when the Australian government published a consultation paper, looking for opinions on whether to extend the equity crowdfunding framework to proprietary companies, and on ways to reduce compliance costs and make capital raising more flexible for small proprietary companies. In the proposal, regulators suggested the limit of AU$ 5 million for small businesses to be raised in equity crowdfunding over a 12-month period. Retail investors caps were fixed at AU$ 10,000 per offer and AU$ 25,000 in aggregate in any given year.
The consultation paper did not receive a warm welcome from businesses and experts, particularly by Paul Niederer, CEO of ASSOB – one of first investment crowdfunding platforms in the country. “Sometimes regulators can’t see the trees for the forest”, he argued.
• Traction and lower costs doubtful. AFSL holders in the capital raising area don’t get out of bed for under $20k per raise or a retainer of 5k a month. Equity crowdfunding raises worldwide with retail investors are around $100k to $300k a raise. Not good economics here. A regulatory mismatch is evident here as few startups have the $20k to get a raise started. If the intermediaries are not charging the $20k as they build deal flow then it’s not a long term viable business model (NB: AFSL = Australian Financial Services License)
• It’s about Small business funding not a new asset class. CSEF is primarily a small business financing opportunity not a reason to create a new regulatory framework for a new type of security. There is a mismatch here as businesses need finance not the burden of regulatory responsibilities and record keeping and the need to become familiar with securities and corporation law while building an innovative business.
• Jobs growth unlikely. The combination of an AFSL, a new regulatory framework, “public companies” and investor caps will result in cherry picked raises that would have mostly been funded anyway and thus no new jobs growth. Worldwide equity crowdfunding is being trumpeted for job growth opportunities but jobs only come with traction. Traction only comes with volumes of deals (hundreds) not 3 or 4 per platform per year.
The closing date for submissions was August 31st 2015 and all was silent until a few days ago, when Small Business Minister Kelly O’Dwyer announced the long-awaited changes to regulations on equity crowdfunding.
According to the Minister, the new regulation will allow public companies with $5 million or less in annual turnover, or up to $5 million in assets, to raise $5 million a year from retail investors. The legislation seems as though it will be ready before the end of the year. The Government seems also to be considering the implementation of caps on the amount individuals can invest, without having disclosed further details.
From the analysis above, it is clear that Australia needs a new policy framework as soon as possible and that regulators ought to accelerate the process if the country wants to join the worldwide wave of equity-crowdfunding.
The risks of delaying are high. Australian start-ups may be forced to go offshore in search of funding in spite of the fact that there are a large number of Australian investors who are interested in crowdfunding, robbing the Australian economy of a potential growth area.
It will be interesting to see whether the new regulatory framework will be released before the end of the year, or in other words, at some point in the next 15 days. We’ll keep a keen eye trained on the Australian space.