New challenges and opportunities await CFOs following the amended crowd-sourced funding legislation passing the Australian Senate, opening up new financing possibilities for proprietary companies to raise capital without having to be public companies or issue prospectuses.
Companies will still require annual turnover or gross assets of no more than $25m to be eligible to raise up to $5m for equity crowdfunding, so this is ideally suited to businesses which are novel, technology based, in start-up phase, with limited tangible or net assets.
It may seem like a panacea for private businesses in Australia. However, there are pitfalls and risks from this type of funding, especially where there is a lack of experience in capital markets.
While this legislation broadens the base of sources of finance to operate and expand business operations, the risk profile of SMEs which seek to raise crowd funded investment will certainly increase and without the SME actioning appropriate safeguards. With fewer resources and more elementary governance structures in place, there is a greater likelihood that smaller entities will mismanage the raising of such capital or make forward looking statements which they can’t support (or which prove to be false).
Directors must not lose sight of their Corporations Act obligations to act with care and diligence and to exercise their powers and discharge their duties in good faith and for a proper purpose. This has been recognised in ASIC’s Corporate 2018-2019 plan released on the 2nd October 2018 – announcing continuance of policy advice to the Treasury for SMEs and a new project which will review the disclosures in the CSF of a sample of companies; ‘…including offer documents and advertising on each intermediary’s platform and elsewhere, with a focus on compliance with specific disclosure obligations and deceptive and misleading statements.’
Equity crowdfunding has had some spectacular fails, largely due to poor governance, business acumen and poor internal control systems. The best way for Directors to mitigate these risks is to empower the CFO to manage the process, the participants, and treat the business like a publicly listed company. To properly navigate an equity crowdfunding venture we recommend the following ten step process:
Planning is key and involves not only mitigating risks, but also implementing the crowd-facing campaign to get support. The funding model will determine the strategy, of which there are four types: donation based, reward-based, equity based and debt-based. Each model’s plan should clearly articulate the growth and exit plans, to maximise the value of the raisings and minimise the potential for class actions from disgruntled investors.
Just with any business campaign, crowd-sourced funding requires measurable targets in a specified time-frame and the CFO is critical to ensure forecasts are appropriate and valid and consider the following:
It’s important that with any expansion, you bring in the most experienced people in the business. Consider appointing experienced independent directors to the board, including a chairman with a track record of raising capital. This also goes for key management personnel – work with HR to ensure you have the best people for the roles required.
3) Continuous disclosure
Implement systems to address continuous disclosure requirements to keep the investors and market informed on a timely basis. Consider appointing an experienced external company secretary on an as need basis. Account disclosure and assurance gives investors confidence and allows the CFO to make more informed decisions.
4) Share registry
Given the complexity of managing an investor base, having a professional share registry provider is a relatively low cost and sensible solution. It will provide confidence for investors and also set the scene for a potential IPO in future.
5) Internal control systems
Implement systems which minimise the potential for inaccurate financial reporting – consider having audited financial reports available, including an interim report every six months. Typically crowd-sourced funding doesn’t require general purpose financial reports in accordance with International (or Australian) accounting standards. However, it’s a good idea to have audited reports such that you can assert financial stability and performance of the investment. This also minimises your risk profile to an investor.
6) Investment and business strategy
It’s essential to have a longer-term investment and business strategy in place, such that any crowd-sourced funding monies raised are done so with the longer-term objectives of the business in mind. There are numerous factors that should be considered, including raising too much capital too fast. These can impact initial investor outcomes and dilute the value of the original investors unnecessarily too much.
7) Dividend policy and exit strategy
Does crowd-sourced funding provide the investor with the opportunity to sell their investment in an open market? Knowing how to exit the investment should be understood before committing funds. Exit strategies should outline how investors can be repaid. Will it be a return with interest or equity in the company? Again, the funding model will guide this decision. However, it should still be carefully articulated beforehand. This is important not only for the investor, but the business owners. Without appropriate advice and support in these capital raising endeavours, the short-term gains of crowd sourcing may result in a dilution of their ownership in the enterprise – or worse still, selling equity too cheaply (and therefore realising a lower capital gain).
8) Legal advice
Seek out lawyers with appropriate capital markets experience (in the micro-cap to mid-cap range). You need to distinguish the legal services and expertise required for effectively operating in capital markets which is different to that for proprietary companies. It may be that you retain existing lawyers but specifically engage with specialist lawyers for any capital markets issues.
9) Know the tax consequences
Corporate structuring the effect of specific transactions should be considered from a tax perspective before entering into commercial agreements. There may be direct and indirect tax consequences and consider also the potential for adverse consequences on founders and their own personal circumstances when contemplating equity raisings.
Make your campaign standout from the ‘crowd’ through the right positioning. This involves having the right corporate communications people and messages, so you get the support and raise the capital you need. Furthermore, communication is also an essential part of managing expectations to keep all stakeholders informed and ensure they feel appreciated for their investment.
Equity crowd funding opportunities will open the doors for technology and start-up businesses to raise the capital they need to achieve their stated business and investment outcomes, but at what cost? Owners and Directors need to begin with the end of mind and engage with the right parties to minimise the risk of under-selling themselves and not fully realising the value of their business and opportunities. Moreover, they need to guard against the risks of failure and the best way to start is empowering their CFO to manage this process.