In 2017 we are seeing the introduction of major changes to crowd-sourced funding and the ability for companies to raise capital from “the crowd”. The following is an overview of recent changes to legislation for Crowd Sourced Equity Funding (CSEF) and a look at what this could mean for private companies.

Crowdfunding has been around for nearly a decade with IndieGoGo launching in 2008. In 2015 it was estimated that approximately US$34billion was raised globally through crowdfunding. The World Bank predicts that crowdfunding investments will be a US$96billion a year market in developing countries alone by 2025, while Goldman Sachs describe it as “potentially the most disruptive of all the new models of finance”.

So what is it and how will it benefit SMEs?

To date, Australia has somewhat lagged behind the rest of the world, partly due to the inability for start-ups to provide equity in their venture with only rewards based crowdfunding available.

Recent developments for how companies can use crowd sourcing will mean a dramatic change to how businesses finance growth, new product development and other strategic initiatives.

It’s essentially a financial service where SME’s and start-ups can raise money from a large number of people for a specific project or venture and in return provide equity in the company.

A national Crowd Sourced Funding bill was passed into law recently and has provided start-ups and small businesses with an opportunity to be able to raise capital directly with investors.

It allows for unlisted public companies, with annual turnover or gross assets of up to $25million, to utilise CSEF to raise capital up to $5million a year from retail investors.

Retail investors include ‘unsophisticated investors’ who will be able to invest up to $10,000 each and every 12 months in whatever ventures they choose.

There is no restriction on the amount of investment from a ‘sophisticated investor’. This type of investor is one which is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.

As part of the 2017/18 Federal Budget, draft legislation was released allowing SME private companies - a structure used by the vast majority of Australian businesses - the opportunity to participate in CSEF.

This means proprietary companies will no longer need to become a public company (reducing cost and compliance burdens) to access CSEF. The legislation seeks to protect investors through additional obligations of CSEF proprietary companies including a mandatory 5-day cooling off period. CSEF offerings must be made through eligible CSF intermediaries, who hold an Australian Financial Services Licence and are responsible for publishing a CSF offer document that complies with regulations.

The Federal Government has already passed legislation that will establish a CSEF regime for public companies and this will start on 29 September 2017. The draft legislation, extending the regime to proprietary companies, is now being reviewed in light of comments provided to government. No date has been set for when the bill will be before Parliament. The current draft legislation sets the commencement date as six months after the legislation receives royal assent

Capital raising for SMEs has been challenging, often tying up personal assets as security with banks, and for some it has involved going down the road of a costly and time consuming IPO.

CSEF allows SMEs and start-ups to by-pass the traditional methods of raising capital and to source funding from the public in exchange for an equity share in the business. Before companies move down this path there are a number of aspects that will need to be considered and prepared, including:

• Market research to ensure your offer is attractive

• Marketing plan to validate your offer to potential investors

• Corporate structuring to ensure you have the most tax effective structure in place

• Intellectual property assessment to ensure your ideas and business is well protected

• R&D strategies covering how you will invest the funds raised to the benefit of investors

• Business plan which is robust and long term

• Budgeting and cashflow forecasts to demonstrate that the business or product is sustainable

• Information memorandum to set out the key elements of the offer

• Corporate governance requirements are in place and the business is well prepared to satisfy its obligations.

While there may be substantial upside to sourcing capital in this way, there are also a number of compliance obligations which will need to be considered:

• An annual financial audit if more than $1million in CSEF is raised

• A minimum of two directors of the proprietary entity

• Financial reporting in accordance with accounting standards

• Restrictions on related party transactions

• Minimum shareholder rights to participate in exit events (such as an IPO or similar).

Although it sounds attractive, CSEF may not be the best option for your product or company - it really depends on individual circumstances and timing. Other forms of raising capital can provide attractive benefits too, such as:

• Early Stage Innovation Company (ESIC) set up which provides for a 20% tax offset to certain investors that can be used with or without the CSEF concessions regarding regulation of raising capital.

• Section 708 of the Corporations Act Capital Raising’ which provides for long-standing exemption from capital raising reporting requirements when capital is raised from ‘sophisticated investors’.

Depending on whether your product is at the exploration, validation, demonstration or launching stage, there are numerous government grants available through The Department of Industry, Innovation and Science, Austrade, Australian Taxation Office, CSIRO and other Government organisations.