Equity crowdfunding state of play
Equity crowdfunding offers the prospect of small companies and start-ups raising capital quickly and cheaply from a large number of investors using internet based platforms.
Australia is lagging behind the US and the UK in putting in place laws to enable crowdfunded equity investments. A draft Bill was introduced in the Federal Parliament last December but it lapsed in May when the Parliament was dissolved before the Federal election.
Meanwhile in the US, the House of Representatives has passed an Act to improve its existing law dating back to 2012, and in the UK, the regulator has recently called for input into its post-implementation review of the current crowdfunding regime established in 2014. There may be lessons for Australia from these developments when the lapsed Bill is revived.
Australia
The Corporations Amendment (Crowd-Sourced Funding) Bill (CSF Bill) would have allowed eligible crowd-sourced funding (CSF) companies to raise up to A$5 million through equity crowdfunding in any 12 month period. To qualify as an eligible CSF company, a company would have to be an unlisted public company, limited by shares, with a majority of directors and its principal place of business in Australia, gross assets and annual revenue less than A$5 million and not having a substantial purpose of investing in other entities or schemes. (The Opposition moved an amendment to increase the assets and turnover limit to A$10 million.)
Under the proposals in the CSF Bill, crowdfunding platforms (CSF intermediaries) will have to hold an Australian Financial Services Licence (AFSL) and will have gatekeeper obligations, including the conduct of prescribed checks on issuers to a reasonable standard. A CSF intermediary must also not publish a CSF offer document if it is not satisfied of certain matters – including if it has reason to believe the issuer company has knowingly engaged in misleading or deceptive conduct.
The CSF intermediary will have other obligations, such as the display of a risk warning on the platform, providing an application facility with an investor risk acknowledgment and a communication facility, prominently displaying investors’ cooling off rights and any fees and interests, and obligations in relation to dealing with client money.
Investor protections in the CSF Bill include a A$10,000 cap per investor, per issuer in any 12 month period, via the same CSF intermediary, and a cooling off right which is unconditional and exercisable within 5 business days.
CSF issuers will have certain corporate governance concessions for up to 5 years from the normal requirements of public companies. These include an exemption from the requirement to hold an AGM. Financials need only be provided online, and the issuer will not be required to appoint an auditor until it has raised at least A$1 million.
Soon after the CSF Bill was introduced, the Federal Government also released for comment an exposure draft of the accompanying regulations, the the Corporations Amendment (Crowd-Sourced Funding) Regulation 2015, which details the classes of securities that may be offered under CSF (namely, fully-paid ordinary shares), the minimum content requirements for the CSF offer document, and the checks that a CSF intermediary must conduct in relation to each CSF offer.
United States amending its law
The Jumpstart Our Business Startups Act of 2012 (JOBS Act) included provisions for a new crowdfunding regime in Title III of the Act. The Securities and Exchange Commission (SEC) was given the task of developing rules. The SEC’s Regulation Crowdfunding (Regulation CF) was finally released October 2015, and became effective in May 2016.
Issuers can raise up to US$1 million in crowdfunding offerings in a 12 month period. There are investment limits for individual investors. For those with an annual income or net worth less than US$100,000, it is the greater of US$2,000 or 5% of the lesser of annual income or net worth. For those with an annual income and net worth of US$100,000 or greater, it is 10% of the lesser of annual income or net worth. The aggregate amount of securities sold to an investor through all crowdfunding offerings cannot exceed US$100,000 a year, and securities cannot be resold for a year.
Regulation CF also sets out the information to be filed with SEC for a crowdfunding offering including the offer price, a discussion of financial condition of the issuer, financial statements, a description of business and use of proceeds, information about officers and directors and holders of 20% or more of the issuer, and certain related party transactions. Crowdfunding platforms are required to be registered with SEC and be a member of FINRA and are subject to certain conduct rules relating to transparency and anti-fraud. Offers are to be exclusively through one platform at a time.
The Fix Crowdfunding Act has recently passed the House of Representatives and if enacted will allow for the use of a special purpose vehicle (SPV) structure to invest in a Title III offering. It is believed that allowing SPVs will avoid some of the problems that can arise with issuers having potentially hundreds or thousands of individual crowdfunding-sourced stockholders. The SPV (called a “crowdfunding vehicle”) could in turn issue securities (one class only) so that investors can invest in the issuing company via the crowdfunding vehicle. The SPV will have to meet certain requirements: its purpose must be limited to acquiring, holding and disposing of securities in a single company and it will not be permitted to receive commission for these activities (nor will any associate, unless the associate is or is acting on behalf of a licensed investment adviser). The SPV and the issuer will be deemed to be co-issuers of the securities.
The other change proposed by the Fix Crowdfunding Act is to widen the exemption for crowdfunding issuances from the registration requirements in Section 12(g) of the Securities Exchange Act of 1934. This section generally requires an issuer to register its securities with the SEC if it has total assets exceeding US$10 million and a class of equity security (other than an exempted security) held of record by either 2,000 or more persons, or 500 or more non-accredited investors. Regulation CF provides that crowdfunding issued securities do not count toward these thresholds, as long as the company is current in its annual reporting obligations and retains the services of a registered transfer agent; however the company still has to register if it has US$25 million or more in total assets. The amendments in the Fix Crowdfunding Act will extend the exemption from registration to any crowdfunding issuer who had a public float of less than US$75 million (or if that amount is zero, has annual revenues of less than US$50 million).The original draft of the Fix Crowdfunding Act included an increase of the cap on crowdfunding issuances in any 12 month period from US$1 million to US$5 million and a loosening of the investor caps, but these proposals were removed.
The US also has various State-based crowdfunding laws which apply to offers within the State. More than 30 States have now approved intrastate crowdfunding.
United Kingdom reviewing its rules
In 2014 the Financial Conduct Authority (FCA) established rules for investment based and debt crowdfunding in the UK. Equity crowdfunding platforms must comply with standard FCA rules for investment firms. They are also subject to rules for securities typically sold on crowdfunding platforms (which the FCA calls “non-readily realisable securities”). These rules apply to all such securities whether or not offered on a crowdfunding platform. Under the rules on non-readily realisable securities, promotions can only be made to retail consumers who receive regulated investment advice, unless they are a high net worth, experienced or sophisticated investor or can confirm that they will invest less than 10% of their net assets in these securities. Firms also have to apply an “appropriateness test” when the transaction results from marketing: they must check if customers have the knowledge and experience to understand the risks if they do not receive regulated advice, and warn the customer if they believe investing in non-readily realisable securities may not be appropriate.
In a paper issued in July 2016 calling for input into its review of the rules, the FCA has flagged some potential issues. To date the FCA has not specified levels of due diligence that crowdfunding platforms must comply with, but says that it is “potentially concerned” that this approach may not be working as well as it might, because it appears that “some businesses that successfully raise capital fail shortly afterwards.” Among other things, the FCA is also looking at how the “appropriateness test” is applied in practice, how clients are certified as high net worth, experienced or sophisticated, and the adequacy of disclosures to potential investors.
Patrick Dwyer
Legal Director