For the past three years in Australia, proprietary companies have been able to raise capital via Crowd-Sourced Funding (CSF), in return for equity in the business.
This process has enabled budding entrepreneurs across a vast range of industries to realise their dreams and get their businesses off the ground.
It has all been possible courtesy of the Corporations Amendment (Crowd-Sourced Funding For Proprietary Companies) Act 2017 (Cth). Prior to this legislation, proprietary companies were only able to raise capital using CSF through either donation-based funding (from people who supported the aims and objectives of a business), or rewards-based funding, (e.g., through the pre-sale of a product, project or future service).
In this article we will explore the pros and cons of Crowd-Sourced Funding.
Pro – greater efficiencies
As anyone who has built a business will attest, it can be extremely challenging in the early stages to find the time that is required to purse financing, while also focusing on the company’s week-by-week growth.
CSF is a relatively efficient and effective method of attracting seed capital, as opposed to the process of applying for a bank loan (which may not be available to an early stage company), or if a company is not able to attract or does not have the networks to access accredited investors in the early stages.
Con – eligibility restrictions
In order to undertake a CSF raising, proprietary companies must ensure that they meet the following requirements.
To be eligible, proprietary companies must:
have at least two directors – the majority of whom normally reside in Australia;
have their principal place of business in Australia;
have less than $25 million in both gross assets and annual turnover; and
not have a substantial purpose of investing in securities or interests in other entities or schemes
The key obligations proprietary companies need to be aware of include:
preparing annual financial and director’s reports;
having their financial reports audited if they raise $3 million or more from CSF offers; and
complying with existing related party transaction rules under the Corporations Act, which have
previously only applied to public companies.
Pro – instant feedback
CSF provides an ideal, real-time opportunity to hear from potential investors. Their questions or suggestions can help to shape the future of the company, while also offering a sense of what is important to the people who are willing to back the business.
Feedback from potential CSF investors can eliminate the need for expensive consultation services. By hearing straight from the “crowd” that is interested in the start-up, the business can adapt and grow to suit the demands of its target audience.
Con – managing increased shareholders
CSF inevitably comes with a crowd, so companies need to be mindful of whether their existing corporate structure and agreements can handle this influx of potentially thousands of new shareholders.
Those seeking a CSF opportunity should ensure they have considered how they will effectively manage the increase in shareholders, whist maintaining the requirements as set out in The Corporations Act 2001 (Cth).
In particular, those companies who already have shareholders will need to consider how they will manage the varying rights between the new shareholders and existing shareholders.
Pro – grassroots loyalty
Those who contribute via CSF are usually advocates of the product or service and will become loyal, long-time brand champions. Early adopters can drive momentum in CSF campaigns by sharing the idea through their social media networks and business contacts.
While there are certainly some practical hurdles to clear as part of this process, the new CSF laws are supporting emerging companies and start-ups, by providing a further avenue for raising capital.
However, it’s vital to seek out the advice of experts before embarking on a CSF, to avoid inadvertently breaking the law.
McCullough Robertson has worked on several CSF campaigns that have balanced the interests of founders, existing investors and new CSF shareholders.
For more information on your legal rights and responsibilities regarding CSF, read the first of my five-part series on the topic here.
- Ben Wood is a partner in McCollough Robertson Lawyers.