Equity Crowdfunding: A Fintech Story

by Steve Kourabas*

Digital Revolution

The period following the global financial crisis of 2008 has brought with it massive changes to the digital economy. Almost every human interaction, and almost every organisation, has been impacted by the technology boom, which has brought with it new opportunities for innovation and dynamism. Developments in the area of finance have been particularly pronounced, with Fintech (a contraction of “finance” and “technology”) offering the opportunity to an increasing number of consumers around the world at all income levels to participate in financial markets.[1]

Equity Crowdfunding (ECF) is one such advancement in the Fintech space that offers the opportunity for small and medium enterprises to raise funds as well as for retail investors to invest small amounts in projects that they find exciting.

What is Equity Crowdfunding?

Crowdfunding generally refers to the use of small amounts of money obtained from a large number of people through an online portal to fund enterprise.[2] Equity Crowdfunding takes this principle and uses it to help small and medium-sized enterprises raise funds through the issue of shares, generally, but not exclusively, to retail investors.[3] There are three key actors in the process:

• Issuers: These are generally small to medium-sized enterprises that may otherwise experience difficulties raising funds. They can raise funds through the ECF process in exchange for an equity interest in their company. The key regulatory obligation imposed in issuers relates to disclosure.
• Platform Operators: Issuers are able to advertise their equity offering through online portals offered by platform operators. These operators often provide a “gatekeeper” role in the ECF process and are generally required to receive a license to operate a platform and they must also adhere to ongoing obligations.
• Investors: ECF is mainly intended for retail investors, who form the “crowd”. Most jurisdictions limit the amount that can be invested by retail investors in the ECF process for each campaign and within a pre-determined period of time. Other requirements include acknowledgments of risk and undertaking educational programs before investing. More “sophisticated” investors are also able to use the ECF process but they are typically subjected to fewer restrictions.

Opportunities for Growth and Development

ECF offers a number of opportunities for economic growth and development, particularly for small and medium-sized enterprises which have found it increasingly difficult to obtain funds through traditional financial mechanisms such as borrowing from banks and raising funds through equity markets. These difficulties have been acknowledged in the Australian context by the Reserve Bank of Australia, which noted the greater costs associated with raising equity and debt for these smaller companies.[4] These difficulties have a broader economic impact as small companies represent about 95% of the over 2 million actively traded business in Australia and account for approximately 70% of the workforce and over a third of production in the private, non-financial corporations sector.[5]

The Australian government has acknowledged the importance of ECF in addressing some of these problems. ECF has been put forward as a key measure to encourage growth, maintenance of high-wage jobs and facilitating economic prosperity.[6]

Brief Overview of the Australian ECF Regime

The Australian ECF regulatory regime was established through the introduction of the Corporations Amendment (Crowd-sourced Funding) Act 2017.[7] The new regime is found in Part 6D.3A of the Corporations Act 2001 (CA). Although initially restricted to public companies, amendments introduced through the Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Act 2018 now make the process available to unlisted public companies as well as to private companies so long as they meet certain requirements.[8]

The regime imposes most obligations on platform operators as the “gatekeepers” of the process.[9] Section 738C of the CA provides that platform operators are financial services licensees whose license authorises them to operate an ECF platform. This means that prospective platform operators must apply to ASIC for an Australian Financial Services License. Once licensed, platform operators have a number of ongoing obligations.[10] Unlisted public companies and private companies may raise $5 million annually through ECF so long as they meet a number of requirements, including that their assets and annual turnover do not exceed $25 million. Issuers generally satisfy disclosure requirements through the issue of an offer document that must, among other requirements, be worded and presented in a clear, concise and effective manner.[11] Finally, platform operators must ensure that retail investors do not exceed a $10,000 cap per company within a 12 month period.[12]

ECF in Australia Going Forward

It is too early to determine the effect of the ECF regime in Australia. While there are a number of benefits broadly associated with the process, there are also a number of challenges that we need to keep an eye on. For instance, there is a high failure rate for start-ups (that are likely to use the ECF process) with some early examples of high profile failures in overseas jurisdictions such as the UK and New Zealand.[13] We also need to continue to monitor the potential for fraud. Problems regarding fraud in crowdfunding (of the non-equity type) recently prompted GoFundMe to institute a new policy to return up to $1,000 per donor per campaign where it determines that the funds have been misused.[14] Similar problems may arise in the ECF context. To manage investor expectations, platform operators and issuers should ensure full and accurate disclosure that is easy for retail investors to follow. Finally, consideration should be given to integration between the Australian and New Zealand ECF processes as there is likely to be considerable cross-over of investment in these jurisdictions. This would help to achieve a single economic market, including through the reduction of compliance costs for businesses.[15]

* Steve Kourabas is a Lecturer at Monash University, Faculty of Law and Deputy Director at the Centre for Commercial Law and Regulatory Studies (CLARS) at Monash. Steve received his Master of Laws (cum laude) and his Doctor of Laws from Duke University School of Law. Aspects of this article are adapted from Steve Kourabas and Ian Ramsay, ‘Equity Crowdfunding in Australia and New Zealand’ International Company and Commercial Law Review 29 (9), 571-589 (Kourabas and Ramsay). This article has been drafted for the purposes of the Symposium held by CLARS on 12 November titled ‘Technological Innovation in Corporate Financing: Regulatory Challenges for the Fintech Era’. Further information on the event can be found at: https://www.monash.edu/law/research/excellence/clars/news-events/monash-law-symposium-technological-innovation-in-corporate-financing-regulatory-challenges-for-the-fintech-era.

[1] The concept and evolution of Fintech is explored in detail in Douglas Arner, Jànos Barberis and Ross Buckley, ‘The Evolution of Fintech: A New Post-Crisis Paradigm?’ [2015] University of Hong Kong Faculty of Law Research Paper No. 2015/047; [2016] UNSWLRS 62.

[2] See, Eleanor Kirby and Shane Worner, ‘Crowd-funding: An Infant Industry Growing Fast’, OICV-IOSCO Staff

Working Paper, SWP3/2014 (2014), at 8 available at: https://www.iosco.org/research/pdf/swp/Crowd-funding-An-Infant-Industry-Growing-Fast.pdf [Accessed 6 November 2018] (Kirby and Worner).

[3] Kirby and Worner.

[4] See, Reserve Bank of Australia, ‘Submission to the Financial System Inquiry’, March 2014, 130 (Reserve Bank).

[5] Reserve Bank, 124.

[6] See, Commonwealth of Australia (Department of the Prime Minister and Cabinet), ‘National Innovation and Science Agenda’ (December 2015) available at: https://www.innovation.gov.au/page/access-crowd-sourced-equity-funding [Accessed 6 November 2018].

[7] The Corporations Amendment (Crowd-sourced Funding) Act 2017 received Royal Assent on 28 March 2017 and took effect from 29 September 2017.

[8] The Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Act 2018 received Royal Assent on 21 September 2018 and took effect from 19 October 2018.

[9] Further information regarding the regulatory obligations of the key actors in the ECF process can be found at Kourabas and Ramsay 576-586.

[10] For instance, they must have in place adequate financial, human, and technological resources (CA, s 912A(1)(d)), they must have in place adequate risk management processes (CA, s 912A(1)(h)), and they must provide internal and external dispute resolution processes where they offer services to retail clients (CA, s 912A(1)(g)).

[11] CA, ss 738J-738L. The rest of the disclosure obligations are set out in regulations. ASIC provides helpful information regarding the offer document, including a template. Australian Securities and Investments Commission, ‘RG 261 Crowd-sourced funding: Guide for companies’ Issued 18 October 2018, available for download at: https://asic.gov.au/regulatory-resources/find-a-document/regulatory-guides/rg-261-crowd-sourced-funding-guide-for-companies/ [Accessed 6 November 2018].

[12] The test for platform operators to determine whether a prospective investor is a retail client is set out in s.761G(7) of the CA.

[13] Further information on these high profile failures can be found at Kourabas and Ramsay, 574-575.

[14] GoFundMe, ‘GoFundMe Guarantee Policy’ available at: https://www.gofundme.com/guarantee-policy [Accessed 6 November 2018].

[15] The single economic market agenda is explained at, New Zealand Foreign Affairs and Trade, ‘Single Economic Market’ available at: https://www.mfat.govt.nz/en/countries-and-regions/australia/new-zealand-high-commission/single-economic-market [Accessed 6 November 2018]. Further information on the potential benefits of integration are provided in Kourabas and Ramsay, 587-589.