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The ‘small scale offering’ exemption is a problem that needs to be addressed alongside any changes to the sophisticated investor test

- February 20, 2024 3 MIN READ
Batman: The Dark Knight (2008). Image: Warner Bros
Rumoured changes to the sophisticated investor test will create more holes in funding for technology founders to navigate when we should be bringing more people into startup investing with education pathways. 

While jostling over whether the changes can be tweaked to lessen the damage on early-stage startup investing, the whole episode seems to fundamentally misunderstand how our industry works and why highly talented professionals want to join it as investors, founders or other top-talent.

There’s no need to re-litigate the recent history of the proposed sophisticated investor changes. You can read the background here at StartupDaily. But it is worth refreshing the latest developments.

While the Treasury and other government departments have been meeting with the technology and startup industries to hear their concerns, the line remains the same: any proposed changes to the asset and income tests for sophisticated investors comes from an ASIC submission to the review of Managed Investment Schemes and that Treasury “hasn’t finalised a view on it”.

Meanwhile, the Financial Services Council has suggested the income test could be left where it is, at $250,000 per year, instead of lifting it to $500,000. But the asset test would be lifted to $5 million from its current level of $2.5 million, as is currently proposed. That’s a marginal improvement, but only marginal.

It is useful to understand where the Sophisticated Investor Test sits in the regulatory framework.  Broadly, the ‘sophisticated investor exemption’ is an exemption to the default rule that companies raising capital need to prepare a costly ‘offer information statement’ (when raising <$10M) or a prospectus (when raising more). Raising from sophisticated investors are exempt.  

This exemption sits alongside ‘small scale offerings’ exemption which allows companies to raise without a disclosure document if their fundraising, within a rolling 12-month period, raises less than $2 million from less than 20 securityholders (which includes SAFEs).  

The problem is that unlike the sophisticated investor test, the government isn’t proposing to increase the ‘small scale offering’ exemption to allow for 20 years’ worth of inflation.

Any investors who are no longer ‘sophisticated’ will have to fit under the small scale offering exemption, yet the $2 million per year threshold is too low to compete internationally: it is just too ‘small scale’.

We represent Australian startups of all sizes. They need two things more than anything else – capital and talent. The difficulty they often have is they don’t have enough capital to compete with large Australian corporations or the global technology giants in terms of salary for top talent. They use employee share schemes to close the gap.

What an employee share scheme is at its heart is an agreement that an employee can lend their time to a startup in the form of their labour for less than market rates in exchange for equity.

For example, according to the latest Australian Tech Salary Guide, the average Chief Product Officer could expect a salary of $254,800 in 2023. Because larger companies can offer even stronger packages, a startup might offer that employee an additional $100,000 per annum in equity.  A CPO might take this package, and forgo $100K extra ‘market’ cash, because they rationally believe in their ‘investment’ in the business given their enormous amount of expertise and clout in our industry.

But, if that same employee wanted to invest their money in another startup they liked whose investment round didn’t fit under the ‘small scale’ exemption, they couldn’t. They wouldn’t qualify for the $500,000 income test. That’s insanity. This person doesn’t need protection.

Employee share schemes are available and practised in the US, UK, Israel, Singapore, all the markets in which Australia competes for capital and talent. And they will gain a further advantage over us if this passes.

Aside from also raising the quantum of the ‘small scale offerings’ exemption by the same percentages, an ‘educator investor’ pathway for sophisticated investors would be an opportunity to actually propel entrepreneurial ambition and class mobility in Australia through education, rather than creating a bigger economic divide between the haves, who can invest in high-risk high-reward opportunities, and the have-nots, who are permanently ‘locked out’. 

Smart people can and should take responsibility for their own lives.  Those smarts should be supplemented with education on risk, literacy and diversification.

But that’s an entirely different approach to what’s being proposed.

To simply lift the levels of qualification for sophisticated investor status is a terribly unsophisticated approach, and at best, ignores, or at worst, or actively sabotages, the regulatory settings that have actually helped propel our economy in the past 20 years.   

 

  • Anthony Bekker is Managing Director, APAC, of Australian, US and UK technology legal advisory firm Biztech Lawyers.