By Lachlan Commins, Patterson Houen & Commins, Lawyers, Sydney.
On 29 September 2017, the Corporations Amendment (Crowd-sourced Funding) Act 2017 (‘the Act’) took effect to establish the regulatory framework for the commencement of crowd-sourced funding (‘CSF’) in Australia. There is other legislation in the pipeline, the Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Bill 2017, but as this is still before parliament, it will most likely not take effect until well into 2018.
What is Crowdfunding
Well, let’s start at the beginning: the legislation referred to above is NOT concerned with the concept of crowdfunding in the traditional sense. To put it simply, there are two types of crowdfunding: ‘rewards’ or ‘perks’ based crowdfunding, and the more sophisticated ‘securities’ based crowdfunding. It is with the latter kind that the legislation above is concerned.
‘Rewards’ or ‘perks’ based crowdfunding has been around for some time and is commonly associated with artists, musicians, inventors, entrepreneurs and social-campaigners, along with crowdfunding ‘platforms’ such as Kickstarter and Indiegogo.
How does it work?
The process, in general, works as follows:
- The artist, musician, inventor, entrepreneur or social-campaigner (as the case may be) has an idea or thing for which they require funding to develop;
- In turn, they reach out to their fans and supporters through their social media network or a via dedicated crowdfunding website or ‘platform’;
- Fans and supporters are invited to make an on-line donation via the crowdfunding website or ‘platform’ to the funding of the development of the idea or thing;
- In return for their donations fans and supporters are not entitled to receive monetary compensation in the form of payment, equity (shares), or debt (as a repayable loan);
However fans and supporters are usually rewarded by the artist, musician, inventor, entrepreneur or social-campaigner in the form of various ‘perks’ or ‘rewards’, whether token or significant, or whether tangible or intangible (common examples may be VIP tickets to the artist’s next exhibition, or the band’s next gig, or an honourable mention on the charity’s Facebook page).
The critical role in the above process is played by the Intermediary which is the outfit that controls the particular crowdfunding platform through which the crowdfunding campaign is conducted (the most well-known being Kickstarter and Indiegogo). The Intermediary acts as the trusted Gatekeeper between the fundraiser on the one hand, and the donors on the other.
Picture the situation like this:
- The Intermediary owns and operates a website (the crowdfunding ‘platform’);
- The entrepreneur wishes to raise money to fund its plans for an exciting new feline toilet-training kit;
- The entrepreneur – who has been turned down by the traditional sources of lending (banks, venture capital firms and angel investors, etc) – decides to turn to the crowd on account of the positive feedback it has received though its social media channels;
- The entrepreneur approaches the Intermediary and enters an agreement to use the Intermediary’s platform as the hosting website for the entrepreneur’s crowdfunding campaign;
- The Intermediary in return will be paid by the entrepreneur via lump sum or out of the proceeds donated to the campaign.
The entrepreneur now has a platform through which it can reach out to potential donors (that is, the ‘crowd’ element). The campaign ‘portal’ on the crowdfunding platform will contain information about itself, its idea and its campaign, including:
- What the campaign hopes to achieve (in our case, a feline toilet-training kit);
- The amount of money the campaign requires to achieve its objective (say $50,000.00 in order to manufacture the first prototypes);
- How long the campaign will last (usually in the order of three months);
- What donors can expect in return, based on the level of their particular donation, and assuming the campaign to be a success.
There are several restrictions on how a fundraiser can conduct its campaign. For instance, it may only advertise either through the crowdfunding platform itself, or through its social media network (Facebook, Twitter, etc). Further, all donations by the crowd must be made through the Intermediary’s on-line crowdfunding platform, and not directly to the fundraiser itself. In turn, the Intermediary will retain all donated amounts on trust (or under escrow to use a different term) until the time comes when and if the designated fundraising target in the campaign is achieved. At this time, the Intermediary will release the donated amounts to the fundraiser for its use in achieving its campaign objectives.
If on the other hand the designated fundraising target is not achieved within the specified time period, the Intermediary is obliged to fully refund all donated amounts in the campaign. To this extent, the campaign will not be deemed a success; although it must be said that the donors are in no worse position as their money has been refunded, and the fundraiser can always attempt another campaign at a later stage.
In this process the role played by the Intermediary is essential. They are the trusted Gatekeeper who connects the ambitions of the fundraiser with the donating power of the crowd. Further, they hold the fundraiser to account by performing various legitimacy checks on the entity itself and on the credentials of the fundraising campaign. They also provide assurance for donors that the fundraiser will not up-stumps and skip town at the first taste of a bit of cash. Essentially, they act to bridge the trust and knowledge gap between fundraiser and donor.
Which type of Crowdfunding is best for you?
So, one may ask, what is the difference between this sort of ‘perks’ or ‘rewards’ based crowdfunding, and the more sophisticated ‘securities’ based crowdfunding? Well, at heart, the two concepts share the same fundamentals but with one key difference: donors to a ‘perks’ or ‘rewards’ based crowdfunding campaign are not entitled to receive shares or debt or any other form of underlying security in the fundraising entity, whilst investors in a ‘securities’ based crowdfunding campaign are so entitled.
Donors to a ‘rewards’ or ‘perks’ based must either be satisfied with their own goodwill, or with some other reward or gift they receive at the discretion of the fundraiser. In our example of the entrepreneur above, such an award may be an original prototype of the feline toilet-training kit engraved with the donor’s pet kitty’s name.
Investors to a ‘securities’ based crowdfunding campaign, on the other hand, are entitled to receive shares in the fundraising company. This is why this form of crowdfunding is referred to in the legislation as “crowd-sourced funding” (CSF), “crowd-sourced equity funding” (CSEF) or “crowd-sourced funding of shares”. Further, as the process involves the issue of shares, it is now regulated by ASIC through the legislation referred to above (which forms an amendment to chapter 6D of the Corporations Act 2001 dealing with fundraising by companies).
The key players will by-and-large remain the same with respect to the two types of crowdfunding (with the exception of ASIC, who has now been introduced as watchdog and regulator):
Intermediary > CSF Intermediary: Remains the operator of the online crowdfunding platforms, with the key difference being they will be required to hold an Australian Financial Services (AFS) licence that has express authorisation to provide a crowdfunding service. Otherwise, their obligations to conduct background and compliance checks on fundraisers and their corresponding CSF offers is strengthened. Such checks will focus on compliance of the fundraising company’s mandatory CSF offer document.
Campaign fundraiser > Eligible CSF company: To be eligible, such stakeholders face the following requirements: to convert to a (unlisted) public company limited by shares (public company requirement);  to have consolidated gross assets of less than $25 million at the time of the CSF offer (assets cap); to have consolidated annual revenue of less than $25 million for the 12-month period prior to making the CSF offer (revenue cap); and, to be limited to raising no more than $5 million in any 12-month period through CSF offers and certain other offers not requiring disclosure by virtue of the exemptions in s 708 of the Corporations Act 2001 (investor cap). Further, some eligible companies may be able take advantage of certain temporary corporate governance and reporting concessions that would otherwise be incumbent on public companies (such as the requirements to hold an AGM, to have an auditor appointed, and to have its annual financial reports audited).
Campaign donor > retail investor: The legislation on the whole is aimed at benefiting ‘retail’ as opposed to ‘wholesale’ investors. Such investors will now be able to directly access shares in small and innovative firms and start-ups (as opposed to being restricted to large publicly listed companies). To safeguard against this increased risk, the following protections apply:
- Maximum of $10,000 to be invested per retail investor through CSF offers by the same company via the same CSF intermediary in any 12-month period (investor cap);
- Unconditional 5-day cooling-off period within which to reconsider the investment and to withdraw the application in order to receive a full refund (cooling-off period);
- Subject to the benefit of a sternly worded risk warning statement displayed prominently on the crowdfunding platform and in the CSF offer document; the exact wording and positioning of the statement is mandated by the regulations (general risk warning statement).
This article has been aimed at providing you with a brief overlook at the concept of crowdfunding, and how this concept in its original form has now evolved into an alternative form of fundraising for start-ups and other innovative firms. On the flipside, it has provided an increased range of investment opportunities for retail investors.
If you are a retail investor, be mindful of the increased risks involved with type of investing; and if you are a small company or start-up considering this form of fundraising, be mindful of your obligations regarding compliance under the Act.
 The CSF regime provided for by the current Australia legislation is restricted with respect to the issue of fully-paid ordinary shares only.
 However once the Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Bill 2017 comes into force sometime late next year eligible proprietary companies will also be able to take advantage of the CSF regime.
 The difference between a retail and wholesale investor is provided in s 761G of the Corporations Act 2001.