Finance governance

What is crowdfunding?

Crowdfunding is a way of raising funds which secures money from a large group of investors. Also known as crowd-sourced funding (or CSF), it provides companies and not-for-profits an alternative method for raising cash to taking out a bank loan or raising equity.

What entities can crowdfund?

While crowdfunding was at first taken up by not-for-profits and business entrepreneurs for raising capital, boards of both listed and unlisted public companies are increasingly looking towards crowdfunding to provide visibility for an equity offer and to measure investor interest. Developments in technology and the rise of online crowdfunding platforms give directors and business leaders a new option for reaching investors and raising funds.

Amendments to the Corporations Act 2001 that came into force in October 2018 now provide companies with a regulated framework to participate in crowdfunding if they meet the following criteria:

  • The company is not a listed public company.

  • It holds less than AU$25 million in assets and revenue.

  • It must prepare compliant CSF offer documents.

  • It must use a CSF service platform provided by an Australian-financial-services licensed intermediary.

  • It is limited to raising no more than AU$5 million in any 12-month period.

To be eligible to crowdfund in Australia, a proprietary company needs to:

  • Have its principal place of business in Australia;

  • Have a board of at least two directors, one of whom resides in Australia;

  • Not have a substantial purpose of investing in other companies; and

  • Not intend to use any funds that are raised as a loan to a related party.

There are a variety of crowdfunding websites that reach different groups of people and specialise in particular sectors or funding ideas. Each have different fees and requirements.

What are the different kinds of crowdfunding campaigns?

Crowdfunding platforms allow for a range of money-raising initiatives, most of which sit within these categories.

Donation-based crowdfunding

Some campaigns are donation-based, meaning that the entity is not required to provide anything in return to investors. The donors simply give in order to support a cause or idea. This is the form of crowdfunding predominantly used by not-for-profits and for social or charitable causes.

Reward-based crowdfunding

Crowdfunding entities can offer different enticements to investors, promising a reward in return for their money. Reward-based crowdfunding is typified by the presale of a new product or service, often to provide some early cashflow and launch such a product or service to market. Investors in this sort of campaign are given a kind of reward, such as branded items or a discounted purchase price. Often there are different rewards allocated to different investment amounts.

Debt-based crowdfunding

Debt-based crowdfunding, or peer-to-peer lending, involves an entity borrowing from investing individuals or businesses. In this type of crowdfunding, the money lent is returned to the investor within an agreed period. Repayments are often made with interest, but not always.

This type of crowdfunding is utilised by entrepreneurs or business owners, as it allows them a way of raising capital without giving up equity in their business.

Equity crowdfunding

Finally, in an equity-based campaign, investors can expect to receive some ownership in the company. If the company does well in the future, the investor may see a return on their investment by receiving some of the profits by way of a dividend.

What are the advantages of crowdfunding?

There are many advantages to crowdfunding for both the investor and the campaign entity that are not shared by other forms of capital raising. Investors need only front a relatively small amount of capital, which opens new windows for individual investors.

Crowdfunding campaigns can also carry a lower amount of risk for both parties. If the equity goal of a campaign isn’t reached, an entity is not required to commit and the investors retain their money.

Creating awareness for a campaign can also be a lot easier for smaller entities, including SMEs and not-for-profits. The crowdfunding websites provide a forum with an existing distribution network, which allows directors and business leaders greater visibility over engagement with investors. This includes more control over the posting of an offer and its allocations. The increased potential of reaching the eyes of a more tailored group of investors or customers is also one of the benefits of running a crowdfunding campaign.

For SMEs and startups, the ability to raise funds while retaining ownership of the entity is an attractive feature. In addition, crowdfunding can provide a vital source of funds during periods when banks are tightening their lending. This means that the new pieces of legislation in the Corporations Act 2001 mark an important milestone for Australia. Early-stage companies have a lot to gain from considering using crowdfunding as part of their overall finance governance strategy.

What are the disadvantages of crowdfunding?

In crowdfunding, there is no guarantee that the campaign’s funding target will be reached within the set time period. If that target is not reached, entities may not be able to keep the funds that they raised. It is important for all directors and business owners to carefully consider the various crowdfunding websites prior to starting a campaign, as each may have different terms and conditions.

While crowdfunding platforms can offer a greater ability to reach suitable investors, equity crowdfunding in particular – while of course attractive to many investors - will not suit all proprietary companies, as the owners may wish to retain ownership of the business.

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