Q. I am interested in investing in “start-up” companies. Whilst I am aware of the risks, I would be happy to invest a small amount in new ventures looking to grow. I have read about “Crowd Funding”. Can you please explain how this work? What are the risks and how do I know if the investment stacks up?
A. Investing in ‘Start-up” ventures traditionally has been the domain of “sophisticated” or wholesale investors with sufficient wealth to meet the minimum investment criteria. Access to “Start-up” ventures for the retail small investor has now become considerably easier due to recent changes in legislation around crowdsourced funding.
Crowd Funding or Crowd Sourcing (CSF) is the process of funding a project or venture by raising money from a large number of people who each contribute a relatively small amount, typically via the Internet. New legislation came into effect on the 29 September that will enable ‘mum and dad’ investors to invest in small Australian unlisted Public Companies who seek investment funds via CSF. The legislation excludes foreign companies from raising capital through CSF in Australia.
Traditionally small investors have been restricted to investing in new ventures via an Initial Public Offerings (IPOs) on the share market. The new rules will provide retail investors with access to a range of investment opportunities they have traditionally been unable to reach due to the large capital requirements to be considered a wholesale investor.
Under the new CSF legislation, retail investors will be able to invest to an annual limit of $10,000 per investment. However, an investor can invest in an unlimited number of CSF offers. Some offshore CSF models allow investors to receive an investment return in the form of product or services, the Australian CSF Legislation specifically states that the investor is acquiring shares in the unlisted Public Company.
Using a new web-based funding framework, small unlisted Public Companies with less than $25 million in assets will be able to seek CSF investment funds of up to $5 million a year via licensed crowdfunding platforms or portals.
Fees paid to the CSF platform providers are similar to the fees paid to an underwriter for a conventional capital raising via an IPO. Estimated fees for companies seeking to raise funds are around 5-7%. Transaction costs to investors include Credit card and transaction fees of approximately 3% and may include performance fees.
Companies operating these CSF platforms will be licensed and regulated by ASIC. Crowd Funding sites must comply with a range of obligations such as vetting the quality of the companies seeking to raise capital, undertaking due diligence on issuers and providing risk warnings to investors. Applications for ASIC CSF licenses opened on the 29 September.
CSF platform providers already operating may convert an existing company to use the new CSF requirements. Examples of companies currently offering CSF platforms in the Australian market for “sophisticated” or wholesale investors include Equitise, CrowdfundUP, VentureCrowd, Pozible and Kickstarter. At the time of writing, it was not clear how long the ASIC license approval would take, nor which providers had applied, but some are expected to be open to raising funds under the new license requirements in upcoming months.
Under the new rules, many of the normal reporting and corporate governance requirements for Public Companies under the Corporations Act are relaxed. The new regulations will require an offer document, but it will be quite short compared to a traditional IPO. The application process for an offer will include a risk acknowledgement and a five-day cooling off period.
Whilst these type of investments will be appealing to many investors, it is still important to recognise the inherent risks in investing in start-up ventures. You may be unable to liquidate your investment for a number of years and you may also run the risk of losing 100% of the fund’s you invest.
Questions for investors to consider should be; Has the company seeking funds clearly explained what they will do with the funds raised? Have they been clear and transparent in their fundraising campaign and business plans? Have they answered clearly any questions raised by prospective investors?
Investors wishing to consider investing in CSF should consider the risks and only invest as part of a broader diversified portfolio. No doubt licensed CSF platform providers will be advertising when they are “open for business” under the new laws. Do your homework on any investment opportunity and seek advice.