Following the Federal Government’s announcement in September 2018 regarding changes to the equity crowdfunding legislation there has been a lot of hype within the startup community about the positive impact this will have.
Equity crowdfunding is still a largely misunderstood concept. Whilst it can be a great way to put your business in the spotlight and raise funds from the ‘crowd’ understanding what it really means for your business to take on ‘retail investors’ is important.
In this article the team at Cubed by Law Squared step you through the advantages and risks of equity crowdfunding in Australia.
What is crowdfunding?
Simply put crowdfunding is the process of the public investing in your business. Traditionally, investment in private companies could only be from ‘sophisticated investors’ or investors known to the founders or existing shareholders. But crowdfunding avoids this financial hurdle to investment and allows individuals to invest in your business irrespective of their financial net worth.
Equity crowdfunding – a specific type of crowdfunding – is a process where the public can invest in public unlisted companies (and private companies from October 2018). Equity crowdfunding must take place via an approved licensee such as Equitise, VentureCrowd, PledgeMe, Birchal and others.
So what businesses should consider equity crowdfunding?
Equity crowdfunding is not for every business. Understanding which businesses have been successful can save you a lot of money, time and effort in preparing your business for this type of raise. Since the initial changes in legislation to allow companies to equity crowdfund as public unlisted companies we’ve seen companies such as ManRags, Xinja, Car Next Door and others successfully raise via this method. Each of these businesses allowed their investors to participate in some way in the business (i.e. through sock subscriptions, use of digital bank) and therefore obtained ‘buy-in’ for the product or service they provide. Instead of feeling at arms’ length with the company and providing a cash investment for mere equity, the investors were able to use or have access to the product or service that the company deals in and feel more like a part of the company as a whole.
It sounds risky – what are the advantages?
There are a multitude of advantages that can come from investing in early-stage startups in this manner:
- Investors are provided with shares – and therefore own shares or ‘have equity’ in the company;
- Equity Crowdfunding for private companies opens up the market for business — particularly early-stage startups which traditionally have been restricted to investment from angel investors or venture capitalists — to obtain funds and raise capital from a larger pool of investors;
- Investors can take smaller risks by investing quite a small amount of money (as low as $250) to get into the market; and
- The process encourages diversification of share portfolios and spreads risk across a number of different sectors.
The key potential benefit is to ride the upside of a business’ success by taking the initial risk with them at the early stages. A successful financial year, a liquidity event (such as a large capital raise) or an IPO could lead to dividends or a higher return on the investment going into the future.
What happens though if the startup fails?
In any investment, there is always the risk that investors will lose their money – that is the risk assumed when embarking on the journey with a startup. As a potential investor it is important to understand the business and consider things like:
How much money is the company looking to raise?
How much control will investors have over the company?
How will the money be spent?
How long will it take to generate a return on investment?
What is the company’s track record like?
Although statistics show that 60% of Australian startups fail within the first three years, this daunting figure shouldn’t deter a business or investor from taking the plunge.
With equity crowdfunding – and crowdfunding in general – there is a level of assumed risk for investors. But those who take the risk have the potential to be invested heavily in the business’ wins and successes. With the extension of the equity crowdfunding regime to private companies in Australia from early October 2018 – a result of the Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Bill 2017 becoming law – potential investors in the ‘crowd’ may be spoiled for choice.
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This article is written by Law Squared and was first published on Law Squared’s website.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.