Startup Advice

What proprietary companies need to know about a potential new equity crowdfunding regime

StartupSmart /

By Darren Pereira and Sarah Butler

Startups and small to medium businesses may soon have new opportunities to generate capital if a proposed bill passes through Parliament. A new regime allowing public companies to raise money through crowdsourced equity based funding (CSF) comes into effect in September, but draft legislation prepared as part of the 2017 federal budget could see the regime extended to proprietary companies as well. Public submissions on the draft bill closed on June 6.

If the legislation is passed, proprietary companies, together with unlisted public companies, will have access to an alternative form of finance through CSF as a means of fundraising. CSF allows individuals to make small financial investments, typically online, in exchange for an equity stake in a company. This will be transformative, in particular, for eligible startups that crucially need access to finance to kick-start their business at a time when they may be generating little or no revenue.

Read more: All the different types of crowdfunding explained

Things to think about before engaging in CSF

If you and your business are hoping to undertake CSF activities, you should familiarise yourself with the CSF regime generally, as well as the eligibility requirements proposed by the draft legislation, to ensure that you’re able to capitalise on the new changes as swiftly and seamlessly as possible if and when they come into effect.

There are a range of issues that you should consider before engaging in CSF. To name a few:

Be prepared for increased compliance. The eligibility requirements have been designed largely to protect investors by increasing shareholder engagement and mitigating the occurrence of fraud. Accordingly, the planned regime includes additional obligations (such as reporting requirements) that small proprietary companies would not ordinarily be subject to;

Related party transactions would be restricted. To protect investors against fraud and bias arising from related party transactions, proprietary companies engaged in CSF would be subject to existing related party transaction rules under the Corporations Act, under the proposed legislation;

•  You may need another director. The proposed CSF regime will not be available to sole director companies. If you’re currently the sole director of a startup, you would need to appoint additional director(s) if you’re hoping to finance your startup through CSF activities;

Be aware of restrictions on transfer of CSF shares. Currently proprietary companies are only able to have a maximum of 50 non-employee shareholders. Under the proposed new regime, CSF shareholders will not be counted as part of this cap. However, this exemption would not apply when such shares are subsequently transferred or sold, meaning the purchaser of such shares would not be a CSF shareholder and would be counted as part of the 50 non-employee shareholders cap.

What are the eligibility criteria that must be met?

The draft legislation as it currently stands provides for a host of new eligibility requirements companies must meet to be able to participate in CSF activities. Your proprietary company would be able to engage in CSF if it is able to satisfy the following additional obligations:

Minimum number of directors

You must ensure your company has appointed at least two directors and that the majority of your directors ordinarily reside in Australia.

Australian Securities and Investment Commission reporting obligations

Under the proposed regime, your company register must include:

•  the date of each issue of shares as part of a CSF offer;

• the number of CSF shares issued;

• the shares issued to each member of the company as part of each CSF offer; and

• the date on which a shareholder ceases to be a CSF shareholder.

You would also need to notify ASIC of:

• the dates on which your company starts and stops having CSF shareholders;

• new shares that have been issued if they result in your company having a CSF shareholder; and

• the cancellation of shares if such cancellation results in your company ceasing to have CSF shareholders.

Financial reporting obligations

Under the proposed arrangements, if your company has CSF shareholders, you would be required to provide ASIC with annual financial and directors’ reports prepared in accordance with accounting standards. You would not be required to make the reports public but may do so if you wish.

If your company raises more than $1 million from CSF activities, you would be required to audit the company’s financial reports. An auditor would need to be appointed within one month of $1 million being raised.

Amending the company constitution

According to the draft legislation, a proprietary company with CSF shareholders would not breach the takeover rules in Chapter 6 of the Corporations Act if its constitution contains appropriate exit arrangements to protect investors. Accordingly, your constitution would need to contain a provision requiring someone who acquires more than 40% of the voting shares in the company to offer to purchase all other securities in the company on the same terms within 31 days. However, it will be up to each shareholder to decide if they wish to sell on the terms offered.

The federal government has provided a detailed overview of the draft legislation here.

Darren Pereira is a corporate and commercial partner, and Sarah Butler is a senior associate, at law firm Holding Redlich

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