StartupSmart explainer: What’s the deal with equity crowdfunding, and should I do it?
Monday, September 17, 2018/
Last week, the Australian government passed new legislation extending equity crowdfunding to private businesses and therefore considerably more startups.
But what has actually changed, and should startups be taking advantage?
Equity crowdfunding allows investors to pledge relatively small amounts of investment into a company in exchange for equity in the business. Initial equity crowdfunding legislation passed in March last year, however, at that point the funding method was only available to unlisted public companies.
This meant startups — typically private companies — had to go through an onerous process of converting to an unlisted public company in order to take advantage of the new opportunity.
At the time, Labor MP and then shadow minister for the digital economy Ed Husic said the bill excluded more than 99% of small businesses and startups in Australia.
The amendment to extend the framework to eligible private companies was announced in the 2017 Federal Budget. However, while it was first introduced into parliament in September last year, it has taken more than a year to be passed.
Last week, the Techboard Australian Startup and Young Technology Company Funding Report 2017/18 found some 0.2%, or $6 million, of all funding came from equity crowdfunding in the last financial year — but Peter van Bruchem, chief executive and chief startup evangelist at Techboard, predicts this will increase in the next 12 months.
We have also seen one case of equity crowdfunding investors having the opportunity to exit their investments — in airport transfer comparison site Jayride — for 108% returns.
The updated legislation passed on September 12, including an amendment from Labor which means it will come into effect in 28 days.
Equity crowdfunding will now be available to private companies, but there are still some restrictions.
Companies must have less than $25 million in turnover and gross assets, and funds raised will be restricted to $5 million each year.
Startups using the method will also be subject to transaction rules and stringent reporting and disclosure obligations, with annual reports and directors’ reports required. Once companies raise $3 million or more, they will also be subject to auditing requirements.
Matt Vitale, co-founder of equity crowdfunding platform Birchal, tells StartupSmart the need to convert to become an unlisted public company was “a significant deterrent to a lot of businesses”.
However, there were concessions applied to those converted businesses that will no longer apply.
“Anyone that wanted to use the equity crowdfunding regime as a public company and rely on the concessions will need to incorporate a public company before the legislation commences,” he says.
What does it mean for startups?
The new legislation is intended to make crowdfunding a more accessible option for Australian startups.
However, speaking to StartupSmart, Marina Nehme, a senior lecturer in the faculty of law at the University of New South Wales with particular expertise in corporate law, equity crowdfunding and regulation, says the change “can be a good thing and a bad thing at the same time”.
As private companies, startups will have to comply with additional regulations designed to protect the investors. There will be “a cost that is attached”, Nehme says.
It’s a case of “finding the balance between protecting the outsiders and making a business viable”, she adds.
Nehme views the amendment as a “band-aid solution”. This fix tries to fit startups into a category of a corporation which they don’t necessarily belong in, she says.
“Startups have very high risk attached to them. Accountability is needed, but what type of accountability?
“We need to think outside the box — this legislation did not do that,” she adds.
According to Vitale, whether the additional reporting and transaction obligations will act as a deterrent for startups considering equity crowdfunding remains to be seen. However, he says the rules are “entirely appropriate” for companies raising funds from the public.
Why equity crowdfunding?
Customer-centric startups such as Xinja and cinema ticket-pricing startup Choovie cite the benefits of giving customers ownership of the product.
Bichal focuses on “companies that have a strong consumer proposition and are really excited about turning their customers into investors”, Vitale says.
“Being able to market your product and tell the world about your capital raising is great, because you can incorporate it into the regular branding of your business,” he adds.
In some cases, the method can also be an easier route to investment than seeking venture capital, Nehme says. VC firms have limited funds and some have quite specific criteria for the startups they will back, she adds.
“[Equity crowdfunding] is an easier way to access a different pool of investors,” Nehme says, “especially if it’s an exciting project and the marketing pitch is the right one.”
If the marketing is on point, and there’s interest within the first few days, “the money will keep pouring in … there is this buzz about the project”, she adds.
What are the risks?
The risks here lie largely with the investors.
There are currently no secondary markets for equity crowdfunding securities, and the ability for investors to transfer shares or release their investment is limited.
But startup investments are inherently risky, Nehme says, with some selling an idea before they have a product to back it up.
“That’s something investors need to be aware of,” Nehme says.
However, for the startups, the biggest risk is in failure. And “if they fail, they can start again”, she adds.
How do I get started?
Vitale stresses marketing and PR are “vitally important to the success of a crowdfunding campaign”, and says it’s important for companies to be organised before they go ahead.
“It does take time to prepare your offer and tidy up your affairs,” he says.
Nehme reiterates that the process “will be costly”, because of the “extra layer of bureaucracy”.
“Probably seek advice — the legislation is quite complex.
“The more people [startups] talk to, the better,” she adds.