Legislation allowing Crowd-sourced Equity Funding (CSEF) for Public Companies was passed earlier this year, and ASIC is due to open applications for the regime at the end of September. However, a new Bill was introduced to Parliament last week that extends the regime to proprietary companies. The proposed changes are an exciting development for Australian startups that did not want to convert to an unlisted public company structure to access the regime.

Unlisted Public Companies

On 29 Sseptember 2019, the Corporations Act 2001 (Cth) was amended by the Corporations Amendments (Crowd-Sourced Funding) Bill 2016 (Cth) to create a framework for CSEF by eligible public companies. 

As a result of the new legislation, small, unlisted public companies can raise funds from a large number of small-scale investors without the onerous disclosure, reporting and corporate governance obligations currently imposed on public companies seeking to raise funds. It is also widely expected that the ability of public unlisted companies to use the new CSEF legislation to raise capital will be extended to proprietary companies under the Corporations Amendments (Crowd-Sourced Funding for Proprietary Companies) Bill 2017.

The legislation aims to open new funding opportunities for startups and potential investors, while ensuring there are still adequate investor protections in place.

CSEF is the term given to the process under which a company raises funds from a large number of individuals who each contribute a small amount of money in return for equity in the company. Third-party websites/platforms typically facilitate this ‘raise’ (e.g. Kickstarter). CSEF is allowed in many other countries, including the UK and New Zealand.

 

CSEF

Source: ASIC

The new CSEF framework includes:

  • eligibility requirements;
  • a cap on how much can be raised;
  • disclosure requirements;
  • obligations on the CSEF intermediaries (those who facilitate the offer of shares to potential investors, usually via their online platform);
  • a prescribed process for raising funds through CSEF; and
  • additional protections for investors.

A brief summary of each of the items referred to above is set out below.

Company Eligibility Requirements
  • The company must be an unlisted public company limited by shares.
  • Its principal place of business and the majority of its directors must be in Australia.
  • It must have gross assets of less than $25 million and annual revenue of less than $25 million (this includes related parties of the same group).
  • The substantial purpose of the company cannot be investing in other entities.
How much can a company raise?
  • Eligible companies can raise up to $5 million in any 12 month period.
Offer Process
  • A company looking to raise capital via the CSEF regime must publish a compliant CSEF ‘offer document’ on a single CSEF intermediary’s platform (see below for further information on who is an intermediary and what their obligations are).
  • Applications in response to the offer will then be made via the platform.
  • The offer must be expressly stated as an eligible offer made under the crowd-sourced funding regime.
  • The offer must be for the issue of ordinary shares to retail investors (as opposed to transfer/sale) and made by the company in which the investor will receive the shares.
  • The company must be eligible at the time of the offer and must comply with an issuer cap (currently $5 million in any 12-month period).
  • The company cannot use the funds for investing in another entity/scheme.
Disclosure & Governance Requirements
  • The requirement for a public company to prepare a prospectus or other disclosure documents no longer applies and is replaced with the requirement to prepare a slightly less onerous CSEF offer document.
  • The CSEF offer document must contain prescribed minimum information. ASIC has released a template CSEF offer document which startups will be able to use for their capital raise. It will still however require financial and legal advisors.
  • New eligible public companies will receive up to 5 years of relief from the usual reporting and corporate governance requirements that are often a barrier to becoming a public company.
CSEF Intermediary Obligations
  • A CSEF Intermediary facilitates the crowd-sourced funding, easing the administrative burden on the company in managing the application process.
  • An intermediary must hold an Australian Financial Services Licence with an authorisation to provide a CSF service and may also need to hold an Australian Markets Licence.
  • They must conduct checks on issuers before listing their offer and must review the offer document before it is uploaded to ensure that it meets the criteria imposed by the regulations and is not defective.
  • They will be subject to ‘Gatekeeper’ obligations aimed at ensuring control of their platform and user compliance. Examples include: obligations to provide communication and application facilities, display appropriate risk warnings, handle application funds appropriately, ensure investors receive cooling off rights etc.
Investor Protections
  • Individual investors can only contribute up to $10,000 per company, per year.
  • The Government will prescribe the type of securities eligible for crowd-funding, which initially is only fully-paid ordinary shares.
  • Investors are required to complete a risk acknowledgement and they will have an unconditional right to withdraw their offer within 48 hours (i.e. a ‘cooling off’ period).
  • Companies must comply with advertising rules and cannot make an offer about a company that does not yet exist.
  • Offers can only be made through a licensed CSEF intermediary’s platform – a company cannot simply source its own investors outside the CSEF platform.

 

Many commentators are of the view that the amendments fall short of helping startups access funding as the regime is only available to public unlisted companies. As the large majority of startup businesses are proprietary limited companies, in order to access the current regime they would need to transition to a public company (which increases their regulatory obligations and is an additional administrative and relatively costly exercise).

Although there are temporary exemptions from some of these obligations they are still seen as a barrier for many startups. As a result, there has been a push from the startup community to broaden the regime to include proprietary companies.

Proprietary Companies

In response to the success of the previous Bill (or possibly, the criticism) and as part of the 2017-2018 Federal Budget, the Government introduced the Corporations Amendment (Crowd-Sourced Funding for Proprietary Companies) Bill 2017  into Parliament on 14 September 2017. The Bill seeks to extend the CESF regime to proprietary companies, creating considerable opportunity for Australian startups.  

 If the Bill is passed, properietary companies will be able to raise funds through a prescribed CSEF regime which will require them to follow the regime discussed above in relation to public unlisted companies and also the additional requirements:

Eligibility
  • A proprietary company must have at least two directors (with at least one being an Australian resident).
Disclosure and Reporting
  • In addition to preparing a CSEF offer document (as discussed above), the company must prepare annual financial and directors’ reports which comply with accounting standards and these must be provided to all shareholders and lodged with ASIC.  
  • If a company raises more than $3 million from crowd-sourced funding these financial statements will also have to be audited and if they do not appoint an auditor, ASIC will have the power to do so.
  • Companies with crowd-sourced funding shareholders will have to include additional information on their corporate register about these shareholders and keep this up to date. They will be also be required to lodge their constitution with ASIC.
Investor Protections
  • The regime imposes minimum shareholder rights to participate in exit events. In effect, these rights obligate a potential purchaser who wants to buy more than 40% of the shares in the company to offer to purchase all other shares in the company on the same terms (commonly referred to as a tag along provision). This allows crowd-sourced funding shareholders to participate in what would essentially be an exit event and prevents them from being stuck in a company which is now controlled by a different shareholder.
  • If a company doesn’t include these provisions in their constitution, the company will be subject to existing complex takeover rules under the Corporations Act (which currently do not apply to proprietary companies) which will inhibit the funding and exit opportunities available to the company.
  • Restrictions on related party transactions (such as when funds are transferred to related parties for non-commercial purposes) will be extended to apply to proprietary companies. This aims to protect investors from fraud and bias arising from these transactions, particularly given these investors will have little to no control over company decision making (unlike traditional shareholders in proprietary companies).

 

If the Bill is passed, the temporary corporate governance concessions (contained in the previous Act) which are available to proprietary companies that convert to public companies will be removed. Proprietary companies will no longer need to convert to a public company to access the regime and therefore these concessions are unnecessary.

There is an obvious element of risk to investors when a regime is implemented which significantly relaxes the previously highly robust obligations on companies looking to raise capital through the public or from retail investors. The Bill attempts to manage this risk through its various investor protections and considerable flexibility to tweak the regime as needed. The hope is that this is enough to pass the legislation, as the potential benefit to startups who have been unable to raise capital through traditional means is huge.

We will be following developments with the Bill closely. If you have any questions about crowd-sourced equity funding, get in touch with LegalVision’s startup lawyers.

Madeleine Hunt
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