Crowd-sourced funding for proprietary companies – why you might or might not

Crowd-sourced funding (CSF) is almost a reality for proprietary companies. Businesses in Australia will soon be able to access CSF without needing to convert into or incorporate an unlisted public company. If you caught our earlier article, you’ll know the existing CSF regime will extend to proprietary companies. In this article, we look at how it is different to crowd-source fund as a proprietary company and what are some obligations in undertaking CSF as a proprietary company.

History of crowdfunding at a glance

The concept of 'crowdfunding' is nothing new. Examples of debt-based, reward-based, donation-based crowdfunding are numerous. They include:

• the Irish loan fund established in the early 1700s to provide loans to the poor in Dublin as a form of microcredit, which led to approximately 300 loan funds in Ireland by the 1800s;
• the precursors of cooperatives and credit unions seen in Germany in mid-19^th century, that extended microloans from members to those in need in rural communities;
• the Statue of Liberty in late-19^th century that raised funds via donations from citizens of France who paid for the statue and citizens of the United States who paid for the pedestal;
• the pioneer of modern microfinancing, whose research project in 1976 to provide banking opportunities to underprivileged individuals, led to the Grameen Bank in Bangladesh; and
• the emergence of Artistshare, Indiegogo and Kickstarter in the creative industry in 2000s.

What is CSF?

Equity-sourced crowdfunding is different. It is a type of fundraising, typically online, that allows a large number of individuals (or the 'crowd' at large) to make small financial contributions towards a company in exchange for an equity stake in the company. In the US, the Jumpstart Our Business Start-ups Act was enacted in 2012 under the presidency of Barack Obama.

In Australia, the CSF legislation took effect on 29 September 2017, but only for unlisted public companies that wish to raise up to $5 million in 12 months through an AFS licensed intermediary who is authorised to provide CSF services. On 12 September this year, the Senate passed the bill that extended the CSF regime to proprietary companies in Australia. The Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Bill 2017, introduced by the former Treasurer (now Prime Minister) Scott Morrison to the Lower House in 2017 (Bill), will become law within 28 days after it receives the royal assent. See our previous thinking on the Bill.

As of August this year, the total number of companies registered in Australia is 2,634,282. Most of these are proprietary companies. CSF is an alternative way to raise funds, especially for innovative and early-stage or growth-stage companies that may not have the access to debt funding (via banks and other financial intermediaries) or equity funding.

CSF for proprietary companies

So how does CSF work differently for a proprietary company? Here is a summary of some key features:

More than 50 non-employee shareholders

A proprietary company must have no more than 50 non-employee shareholders under the Corporations Act 2001 (Cth) (Act). But for the new law, this requirement meant proprietary companies could not undertake CSF if it attracted a large number of small-sale investors that would result in this cap being exceeded.

Once the Bill becomes law, a proprietary company will continue to have a maximum of 50 non-employee shareholders but CSF shareholders will not count towards that cap. The restriction on the number of shareholders of a proprietary company is removed in respect of CSF offers under which a person will become a CSF shareholder of the company.

Accordingly, a proprietary company will no longer have to convert into an unlisted public company (limited by shares) in order to avoid this cap if it wants to raise funds the CSF way.

Takeover rules exemption

An unlisted company with more than 50 shareholders is subject to takeover rules under Chapter 6 of the Act. Proprietary companies that use CSF would generally be subject to the takeover rules as they are likely to have more than 50 shareholders. The takeover rules are restrictive on fundraising structures and exit options as they apply in relation to the acquisition of control up to and/or beyond 20% of a company’s voting shares.

To avoid triggering the takeover rules, the Bill provides that a proprietary company with CSF shareholders will be exempt from the takeover rules in Chapter 6 of the Act as long as it meets the conditions (if any) prescribed in the regulations. The Exposure Draft and the Explanatory Statement of the regulations as released by the Government for consultation provide some further details on the likely conditions. These conditions are aimed to limit the exemption from takeover rules to proprietary companies so long as they are eligible to make a CSF offer.

This exemption is provided in order to reduce compliance costs and avoid unduly restricting companies from adjusting their capital structure as they use CSF to grow their business.

Cooling off period for supplementary or replacement offer

Currently, a CSF intermediary must give written notice to all applicants about a one month cooling-off period where a supplementary or replacement CSF offer document is published. The Bill provides for a shorter cooling-off period of 14 days if CSF offers are made after the Bill becomes law.

This is when the CSF intermediary becomes aware, while a CSF offer is open, that the CSF offer document is defective and for the purpose of correcting the defect, the company making the CSF offer provides the CSF intermediary with a supplementary or replacement CSF offer document. This cooling off period should not be confused with the unconditional cooling-off period of five business days applicable to a CSF offer by an unlisted public company to retail investors.

Reducing the minimum amount of time that a CSF offer has to be open from one month to 14 days will provide more certainty for the company making the CSF offer and other applicants about the outcome of the CSF offer.

Corporate governance

Under the Bill, proprietary companies with one or more CSF shareholders will be subject to additional obligations. These obligations are not ordinarily imposed on small proprietary companies. They include obligations to:

• have at least two directors;
• prepare financial and directors’ reports in accordance with accounting standards;
• audit financial statements if proprietary companies raise $3 million or more from CSF offers;
• obtain the required shareholders’ approval for any related party transactions under Chapter 2E of the Act (as under the Bill, Chapter 2E of the Act will apply to proprietary companies with one or more CSF shareholders); and
• maintain more comprehensive company registers, including details about the CSF offer and the CSF shareholders as part of the company registers.

ASIC levy

Further, CSF intermediaries, unlisted public companies and large proprietary companies will be subject to the ASIC levy as part of the ASIC Industry Funding.

According to ASIC’s Cost Recovery Implementation Statement: Levies for ASIC industry funding (2017–18) as at May 2018:

• ASIC intends to publish specific guidance to help CSF intermediaries comply with their obligations. For the 2017-2018 year, ASIC is not expecting to allocate any regulatory costs to the subsector affecting CSF intermediaries, and regulatory costs will consist of implementation costs allocated proportionally across all subsectors. The CSF intermediaries subsector falls within the industry sector of investment management, superannuation and related services.
• Annual flat levies apply to unlisted public companies and large proprietary companies. This annual levy is the ASIC regulatory costs for the subsector shared equally between all unlisted public companies or large proprietary companies (as the case may be) in the financial year. There is no specific subsector for small proprietary companies on the other hand. A small proprietary company that does not fall within any of the subsectors is not subject to an annual flat levy as ASIC regulatory costs are recovered through an increase to the annual review fee.

For further information about ASIC levies generally, please see here.

A good legal adviser will guide you through the detailed rules, procedures and obligations both fundraisers and intermediaries must meet when conducting CSF offers.

In the UK market, CSF has resulted in a cumulative £634 million being raised during the period from 2011 to 2016. In the US market, the total amount of funds raised through CSF was approximately US$753 million as of March 2015. Here in Australia, CSF for eligible public companies is in its infancy but is an alternative to traditional fundraising that may be attractive to innovative early-stage or growth-stage companies. So if you would like to find out more about CSF or different fundraising options and strategies available to your business, please contact us to discuss.