If you’re a new business looking to supercharge your growth, equity crowdfunding might just be your golden ticket.
WRITERS: Kartick Gupta and Chandra Krishnamurti
New ASIC legislation allows publicly unlisted companies to raise funds from 'the crowd' in order to support their business ideas. With eligible companies able to raise up to $5 million per year, this could be a real gamer-changer for Australian business.
Industry observers believe that Australia will follow international trends and experience massive growth in equity crowdfunding. Investors must be wary of increased risks, as start-ups are not liquid companies. While investment periods will be much longer, this new method of financing will open new doors to those looking to reach the alpha section of their portfolios.
On September 29, 2017, Australian Securities and Investments Commission (ASIC) legislation opened a whole new world of funding for Australian business. Legalising equity crowdfunding, the legislation allows publicly unlisted companies to raise funds from the ‘crowd’ in order to support their business ideas.
With eligible companies able to raise up to $5 million dollars a year, this could be a real game-changer for the Australian business sector. So how does equity crowdfunding really work, and what are the rules?
Equity crowdfunding is essentially a method of financing that enables an entrepreneur to sell shares of their business (equity) to a group of investors through an open call on an internet-based platform.
Similar to other forms of crowdfunding, equity crowdfunding collectively raises funds, but unlike traditional crowdfunding initiatives, investors are rewarded with a slice of the business’ equity, in lieu of products and services. Importantly, if the venture succeeds, investors will also take their share of the profits.
With the ability to invest as little as $50 (or anywhere up to $10,000), investors can choose to back ideas and initiatives that really appeal to them.
Anything from fashion, movies, technology, or space is on offer, with the pitches clearly listed and presented on crowdfunding platforms.
What makes crowdfunding so valuable?
Equity crowdfunding addresses two main issues. Firstly, it reduces the capital-raising obstacles for small companies in the early stages of development. In Australia, there is lack of funding for early stage emerging companies due to a lack of interest from banks, angel investors and venture capitalists, so this really opens up new opportunities. Secondly, it provides new opportunities for retail investors to take a stake in unlisted companies, something previously unavailable to them.
Who can invest?
Historically, the capital raising space has been dominated by wealthy individuals, but since the new legislation has come into operation, equity based crowdfunding has become increasingly popular for all kinds of investors, from the everyday mum-and-dad investor, to the sophisticated financier.
In Australia, everyday investors are termed retail investors and are defined as anyone over the age of 18 who can invest up to $10,000 per company per year through on-line crowdfunding portals.
Those more in the know, are known as sophisticated investors and have recorded a gross annual income of $250,000 during the last two years or have net assets of at least $2.5 million and are not subject to investment limitations faced by retail investors.
So there are different types of investors, and with the passing of the new legislation, retail investors now have more options to invest in, and gain part-ownership of, companies that they feel passionate about.
Who are the key players?
Since the new legislation, a number of Australian crowdsourcing platforms have arisen, with Equitise, Venturecrowd, Pozible and Enable Funding being the most popular. Such platforms have the ability to host multiple start-ups who pitch their business ideas to investors.
To get started, entrepreneurs typically make an open call for funding on a crowdfunding platform by providing relevant information. Then, the crowdfunding platform provides facilities such as a standard investment contract, settlement mechanisms and due diligence.
Transactions cost, funding amounts and so on, vary across the different platforms, but in general, the process of investing is quick and easy.
Potential investors then can search the options and invest as they choose. The process is quick and simple: register online via an equity crowdfunding platform, discover the available opportunities, decide to invest and pay seamlessly online—and just like that, you’re an equity investor in a new start-up.
What are the rules?
As this is the first time that retail investors have been allowed to invest in early stage equity, several safeguards have been put in place. The first is that retail investors are only allowed to invest up to $10,000 per company per year. Further, when they invest in crowdsourced equity, a cooling-off period of five working days is allowed for each investment. This seems sensible, given the high risk of early-stage start-ups.
From the start-up perspective, the ease of access to funds means some limits must be enforced. Consequently, eligible companies are only allowed to seek investments of up to $5 million through crowdsourced equity platforms, which is generous when comparing to overseas markets that have capped this at $2 million.
Those public unlisted companies with gross assets and revenue of less than $25 million are allowed access to this source of funding. It therefore excludes proprietary companies and larger public companies. Crowdsourcing platforms must also have a financial services license.
What’s the outlook for equity crowdfunding?
Industry observers believe that Australia will follow global trends in crowdsourcing. In the United States and United Kingdom, crowdfunding markets have experienced massive growth in capital raising after enabling regulation were passed.
From the perspective of one of Australia’s key crowdfunding platforms, Enable Funding, capital raised from Australian crowdsourcing is expected to soar tenfold, from $119 million in 2016 to $1.5 billion in 2021.
What are the risks?
While retail investors now have a chance to invest in early stage companies, these investments are certainly not without risks. Start-ups are by nature much riskier investments than established entities, yet they also offer the possibility of getting in on an idea before it becomes too successful or out of reach.
Initial studies of equity crowdfunding campaigns in Australia suggest that human capital is positively associated with the number of investors and funding amount. What this means is that companies with more board members are more successful at attracting investors and can therefore raise larger amounts.
Further, studies show that the inherent risk in investing in an early stage company may be mitigated by entrepreneurs retaining more equity and providing more detailed information about risks to the potential investors. So, when entrepreneurs take a larger stake, they convince new investors that they have more skin in the game. Likewise, by providing detailed information about the risk involved in the venture, potential investors are able to take calculated risks while investing in such ventures.
Finally, investors should not look at equity crowdfunding campaigns as get rich quick schemes; they are much more likely to be long-term, high risk investments and as such, investors should take care when committing any significant portion of wealth or income. And, as always, diversification is the key to long-term investment success.
Crowdfunding platforms provide a perfect early stage and expansion capital solution. Will Leitch, CEO Enable Funding, and UniSA Business alumnus shares his insights.
Early stage businesses offer unique opportunities and challenges for investors and operators alike, and the recent changes to Australia’s crowd-sourced funding laws are tailored specifically for that scenario. With heavy regulation making it difficult for traditional investment vehicles to access startup culture, equity crowdfunding fills an important niche.
Will Leitch, CEO of Sydney and Adelaide-based Enable Funding, and graduate of the UniSA Business School, knows the benefits of connecting savvy, forward-thinking investors with opportunities that fit not only their portfolios, but their broader philosophies as well.
“This is a great opportunity to drive a sector of the Australian economy that’s been substantially lacking ever since the Global Financial Crisis,” Leitch says.
“We’re working with early stage companies, the people who have put their blood sweat and tears into the business, and aligning them with investors who really understand that business and, in most instances, have a real passion about what they’re investing into.”
Enable Funding evolved out of the Australian Small Scale Offerings Board (ASSOB), which was the world’s first equity-based crowd funder, and between its two incarnations, has been trading for almost 10 years, raising close to $150 million in capital.
The company has come to recognise the crowdfunding model provides a unique synergy between investor and business which, handled correctly, has the potential to be far more dynamic than a traditional investment scenario.
“One example would be that crowd funding can be used in a number of ways to build a customer database,” Leitch says. “Firstly, the targeted digital marketing of the capital raising campaign creates awareness for potential customers, and whilst they might not purchase equity in the company, they may sign up to try the products or services. Also, investors who do purchase equity rapidly expand the raising entity’s potential customer market.
“For example, if an online company sells equity at a minimum parcel size of $500, then these investors are likely to become members of this site. The investors then become brand ambassadors —they tell their friends about the service, and get them on as customers, helping the company to further build sales momentum, which is critical in an early stage company. That means the breakeven term on the business becomes a lot shorter and the risk decreases for investors as well.”
While Leitch acknowledges there are unique risks with investing in startup scenarios, Enable and similar platforms provide rigorous screening of business applicants, and he believes that the new legislation strikes the right balance between opportunity and investor protection.
“New business models are dominating the global market, and we’re seeing much faster evolution from startup to unicorn,” he says.
“Now, through some very good legislation from the Australian Government, everyday investors can participate in this as well. They need to understand the risks—these are not liquid companies and you have to invest for a longer time period—hence the legislation leaves wholesale and sophisticated investors unrestricted, but caps retail investment at $10,000. This provides people a new way to get the alpha section of their portfolio that they actually need.”
Dr Kartick Gupta is a member of the UniSA's Centre for Applied Finance and Economics. His research focuses on energy finance, innovation, corporate finance and corporate social responsibility
Dr Chandra Krishnamurti is a Professor of Finance. His research expertise includes asset pricing, corporate governance, market microstructure and corporate finance.