How can startups use crowdfunding to fund their growth? The legal stuff you need to know
Wednesday, October 1, 2014/
Is crowdfunding a viable way to fund a startup? Crowdfunding is a broad term and can easily be misunderstood. There are different ways to raise funds, including issuing shares (equity) in your company, selling products or services that the business will provide, and/or accepting donations.
Different groups use crowdfunding, including startups, political parties, not-for-profit organisations and art societies. Businesses including Kickstarter, RocketHub, Equitise and Indiegogo assist start-ups to raise money from the public.
How can private companies raise funds by issuing or selling shares in Australia?
Businesses that crowdfund by selling products or services need to comply with the Australian Consumer Law.
Companies that seek to raise funds by issuing shares must comply with the Australian Corporations Law provisions regarding fundraising.
Generally speaking, the Corporations Act prohibits small businesses from approaching the public for capital without a prospectus. A prospectus can be time-consuming and expensive to prepare.
Private companies can issue or sell shares to investors in the categories below, without a prospectus. Each type of investor is defined in the Corporations Act:
- Personal offers – to raise up to $2 million in 12 months from up to 20 investors. This includes retail investors.
- Business introduction or matching services like the Australian Small Scale Offerings Board.
- Placements to sophisticated investors who have a certificate from their accountant that their income is $250k or more and/or the combined value of their assets is $2.5 million or more.
- Placements to professional investors who manage at least $10 million in funds, and/or have an Australian Financial Services Licence.
- Placements to institutional investors i.e. offers made through financial services licensees.
- Offers to people associated with the body corporate or currently holding those securities, such as senior company managers.
There are restrictions on how these offers can be advertised and promoted.
How could equity crowdfunding help start-ups in Australia?
It is generally seen as difficult for new start-ups to access these investors, and for the public, also known as retail investors, to invest in a start-up other than under a personal offer or being associated with the company.
Equity crowdfunding would benefit start-ups by giving them access to capital from the public (retail investors). With equity crowdfunding, start-ups could advertise to retail investors who believe in their vision and have a desire to support them in the early stages.
If equity crowdfunding was available in Australia, start-ups could be better funded. Start-ups may not have to resort to using their credit cards to raise money, or using their home as security for a business loan, or having to give up large percentages of the company and/or large amounts of control of the business to attract sophisticated, professional or institutional investors – if they are able to attract these investors at all.
The key risks of relaxing the equity funding rules in Australia are that start-ups may not be required to provide the same level of rigorous disclosure as is required in a prospectus. The business would also not go through the same level of screening that a bank would typically require to loan money to a business. On top of this, the business would not be required to comply with the detailed requirements to be listed on a stock exchange and the continuous disclosure requirements to maintain the listing.
Equity crowdfunding progress in Australia
VentureCrowd is the first, and currently only, equity crowdfunding platform to take off in Australia. It enters the market following the recent release of a government report recommending a shake-up to the regulatory framework of equity financing in Australia. The recommendations made in the report have not yet taken effect, making it difficult for ordinary Australians to invest in Australian start-ups.
Another hurdle in the current legislation is that startups looking for equity crowdfunding must first become public companies. The report recommended that smaller, newer businesses become “exempt public companies” for a period of time, with a more flexible compliance requirement. After this period of time, the companies would progress to become fully-fledged public companies; easing the transition and helping start-ups take off.
VentureCrowd are selective about which start-ups they choose to work with. Only start-ups that have been privately invested into or were once part of accelerator programs are chosen. VentureCrowd also do reference checks on these investors before committing their support.
Just this week, VentureCrowd successfully sourced $1.2 million for the taxi app business Ingogo. While the majority of startups may struggle to attract private investment or accelerator graduation status, the round of investment is an important step in the right direction. It demonstrates how equity crowdfunding can give these technology-based startups the boost they need to get off the ground.
Liberalising the equity funding laws would assist start-ups to fundraise and build out their business, while allowing the public the chance to invest at an early stage. In another sense, however, the Australian Stock Exchange already provides a platform for businesses to pool funds from ‘retail’ investors.
Canada, Italy, New Zealand and the UK are leading the way towards a more liberal framework.
What level of initial information would the business have to provide to the public? How much ongoing information would the business have to provide to investors? How much influence would investors have in the business? Australia needs to address these issues to balance the desire of start-ups to raise money with the requirement for investors to be fully informed as to what they’re investing in.
The government needs to act fast for Australia to secure a place in the international equity-crowdfunding arena.