Crowdfunding challenges traditional financing channels, enabling startups and small businesses to broaden their investment base. On the 3rd December 2015, legislation was introduced implementing Crowdsourced Equity Funding (CSEF) into Parliament. Below, we explore how these proposed changes may affect startups, as well as New Zealand’s crowdfunding framework and its potential application to Australia.
What is Crowdfunding?
Crowdfunding enables startups to access venture capital from multiple sources on the internet and helps bridge the gap between small and large corporations at the critical early stages of development. In addition to raising funds, crowdfunding also simultaneously provides startups with a marketing platform and facilitates network building.
There are three key types of crowdfunding:
- Equity-based Crowdfunding: Investors make financial contributions in anticipation of a growing business.
- Lending-based Crowdfunding: Startups collect financial contributions and offer to repay the amount as a debt with interest.
- Donation based: Startups collect financial contributions for a social cause.
What Startups Need to Know
When building your startup, you can feel like a small fish in a big pond, competing against established and well-funded businesses. But how can startups access capital to enforce copyright? Or apply for a trademark or patent? Enter crowdfunding. Understandably, crowd investors may harbor some reservations about a platform inviting any investor to invest. The Corporations and Markets Advisory Committee (CAMAC) acknowledged the following risks in their 2014 Crowd Sourced Equity Funding Report:
- The Herding Effect: Unsophisticated crowd investors may be inclined to invest in a project simply because other crowd investors have already done so.
- Fear of Idea Hijacking: Disclosure can become a double-edged sword, inviting both investors and the exploitative. So, how can startups inform investors about their product without comprising their Intellectual Property? It is necessary to have then in place a carefully drafted non-disclosure document.
What Investors Need to Know
For investors considering participating in crowdfunding, we encourage you to consider the following:
- Understand your rights as an investor and check the platform’s terms and conditions to ensure you can reclaim your money if the startup cancels the project;
- Research the funding platform; and
- Be mindful that crowdfunded projects are primarily made up of experimental prototypes.
- Offering purchased items and claiming to have made them yourself;
- Presenting someone else’s work as your own; and
- Misrepresenting or failing to disclose relevant facts about the project or its creator to investors.
Kickstarter subsequently cancelled all investors’ pledges.
New Zealand’s Crowdfunding Framework
New Zealand liberalised equity crowdfunding early in 2014. The changes allowed businesses to raise up to $2 million a year by issuing shares to the public through crowdfunding platforms. A popular example is New Zealand crowdfunding platform, PledgeMe. Established three years ago, PledgeMe is a project-based crowdfunding platform similar to Kickstarter. PledgeMe took advantage of New Zealand’s relaxed equity crowdfunding laws and offered businesses the platform to raise capital from the public.
New Zealand’s equity crowdfunding rules do not require the investor to issue a prospectus or to comply with considerable scrutiny from regulators. There are no caps on the amount that an individual investor can invest.
On the 1st December 2014, the Financial Markets Conduct Act 2013 (NZ) (“FMC Act”) and the Financial Markets Conduct Regulations 2014 (NZ) (“FMC Regulations”) came into force, enabling crowdfunding and peer-to-peer lending services.
New Zealand’s framework defines crowdfunding as a service or person providing a platform that offers shares in a company for the principal purpose of raising funds from multiple investors. Part 6 of the FMC Act focuses on emphasising crowdfunding’s benefits in the market through three key regulations:
- Licensing crowdfunding service providers;
- Providing additional criteria and appropriate systems to ensure there is a limit of no more than NZ$2 million in a 12 month period; and
- Setting out disclosure conditions to protect both startups and investors.
Malcolm Turnbull has expressed that he favours the New Zealand model over the existing CAMAC plan. Typically, New Zealand mirrors Australia’s laws. However, this may prove the reverse. If Australia replicates its neighbour’s crowdfunding legislation and regulations, there may also present an opportunity for Australian and New Zealand’s crowdfunding markets to converge.
In 2015, developed economies including the USA, UK, Italy and New Zealand spearheaded the charge towards regulating crowdfunding. Following Prime Minister Malcolm Turnbull’s Innovation statement, Australia too has the potential to nurture startups and compete on an international stage. In 2015, CMAC made several recommendations including introducing an investor and issuer cap. Caps can potentially stifle market participation and present an additional regulatory layer to crowdfunding. New Zealand, comparatively, does not have any funding caps.
CMAC also suggested crowdfunding platforms, such as Kickstarter, should acquire a crowdfunding licence and participate in an External Dispute Resolution Scheme. CMAC’s recommendation though implies that the crowdfunding site’s rules are insufficient to protect startups and investors, ignoring Kickstarter’s swift response to startups misusing their site.
Australia’s regulatory bodies need to strike a balance between introducing a desperately needed crowdfunding framework and providing investors with certainty. Australian Small Business Minister, Kelly O’Dwyer said in November that changing Australian regulations will unlock innovation and growth.
We, at least, welcome changes to crowdfunding laws and eagerly await how they will assist Australia’s upcoming startups.
Questions? Get in touch on 1300 544 755.