Will the new rules encourage unlisted companies to implement governance systems earlier?
Much has been made of the imminent introduction of Crowd-Sourced Equity Funding (CSEF) in Australia. Less considered is CSEF’s effect on governance, board formation and demand for independent non-executive directors in early-stage companies.
Crowd-sourced equity funding is an emerging form of capital raising for unlisted private and public companies. It involves companies raising capital from retail investors who usually contribute small amounts in exchange for equity, via licensed online CSEF intermediaries.
Crowdfunding is popular overseas through sites such as Kickstarter, which has secured US$3.28 in pledges for creative projects. Most crowdfunding sites have been for donations, rewards (pre-selling products) or for lending. Equity crowdfunding is a newer development.
The United States approved crowd-sourced equity funding through the Jobs Act 2012 and the United Kingdom followed in 2014. Equity crowdfunding is booming in both markets as more companies use CSEF platforms to connect with a larger investor base via the internet.
The Federal Government’s Corporations Amendments (Crowd-Sourced Funding) Act 2017 brings Australia broadly into line with international developments in equity crowdfunding. Parliament passed the Act in March; the legislation is effective from September 29.
New rules in crowdfunding
The new rules allow retail investors (those with less than $250,000 of income or less than $2.5 million in assets for each of the past two financial years, certified by an accountant) to invest up to $10,000 per company each year through a CSEF campaign. Wholesale investors have no restrictions on investment size.
Companies can raise up to $5 million in a CSEF offer. Other benefits include reduced disclosure requirements in offer documents with new CSEF rules, making it cheaper and easier to raise capital. There are also temporary concessions for newly registered or converted public companies, for up to five years, from certain reporting, audit and corporate governance obligations, lower compliance and administrative hurdles.
The Act requires CSEF intermediaries to hold an Australian Financial Services Licence (AFSL) and perform checks on companies making offers, their directors and the capital-raising offer document before publishing the offer on a CSEF platform.
The reforms are a sensible balance between the needs of capital-seeking unlisted companies and retail investors. By requiring CSEF intermediaries to perform checks, interest in the governance of companies raising capital is likely to rise.
CSEF platforms are not stock exchanges. More established intermediaries have clear admission and compliance procedures to join and stay on a CSEF platform. But requirements are well below ASX Listing Rules and continuous disclosure obligations for listed companies, meaning greater reliance on the governance of unlisted companies to safeguard investors.
Will Leitch, CEO of the Australian Small Scale Offerings Board (ASSOB), believes the new rules will encourage emerging companies to implement governance systems earlier in their lifecycle. ASSOB is Australia’s largest CSEF provider, having raised $150 million for companies, and a global pioneer of CSEF.
Here is an edited extract of Leitch’s interview with the Governance Leadership Centre:
GLC: Why will CSEF reforms lead to greater interest in governance systems in early-stage Australian companies?
Will Leitch: There are three main reasons. First, CSEF intermediaries are required to perform checks on companies before promoting their offer. ASSOB, for example, does extensive due diligence on companies before agreeing to work with them. The company’s governance structures, board, or capacity to form one, are factors we consider. Being able to demonstrate governance systems helps early-stage companies secure CSEF support.
Second, early-stage companies are, by nature, riskier than established listed companies. When assessing an offer, investors should consider the organisation’s governance and whether there are appropriate safeguards in place for investors. A strong board can help early-stage companies stand out and attract more capital via CSEF platforms.
Third, an experienced board with diverse skills is essential for high-growth unlisted companies. Those in the expansion phase need directors who can help the organisation navigate periods of intense growth through their own experience, or connections with customers or investors.
The combination of these three factors will encourage capital-seeking unlisted companies to form boards earlier than they otherwise would have. That, in turn, will lead to higher demand for independent non-executive directors over time.
GLC: What is the role of CSEF platforms in governance?
WL: A good CSEF platform can influence governance in early-stage companies in several ways. ASSOB, for example, only works with public unlisted companies that are required, by law, to have at least three directors (two of whom must be Australia-based).
The CSEF platform’s admission requirements are another influence. ASSOB requires companies to publish a quarterly report that each director must sign. That, in effect, encourages early-stage companies on our platform to hold at least four board meetings so that directors are confident in the venture’s progress and cash-flow position before signing the quarterly document.
A good CSEF platform also shapes governance by sourcing directors for companies on its platform. ASSOB has placed four directors on companies on our platform this year. We see part of our role as matching the right directors with the right companies, and helping our member companies develop governance systems that help drive their growth.
GLC: Will we see directors who are interested in governance of early-stage companies approaching CSEF platforms?
WL: It’s already happening. More directors are approaching ASSOB as we ramp up our capital-raising services and as the new legislation takes effect. Many directors want to add an early-stage company to their portfolio, or get their first or second board position via smaller companies.
Unlisted companies, too, are showing greater demand for directors. They realise that raising capital through a CSEF platform, and having hundreds of small investors for the first time, changes the governance expectation. A capital raising is often a catalyst for board formation.
GLC: What type of director suits emerging unlisted companies?
WL: This form of governance can be more hands-on and time consuming than governance of larger organisations. Directors usually need a technical background or knowledge of the industry and a willingness to bring opportunities to the organisation through their network. That might involve facilitating contact between people or encouraging investors in the director’s network to participate in the company’s next capital raising. Like with any small companies, it’s more about business building and less about high-level governance oversight.
GLC: What do directors need to know about equity crowdfunding?
WL: That it is potentially disruptive to traditional capital-raising frameworks in Australia and is a viable new capital-raising mechanism for many organisations that have struggled to raise equity or debt capital in the past. Also, that CSEF will grow quickly as Australia follows international trends.
Directors should also understand that CSEF extends well beyond seed funding or angel investing (where wealthy investors back emerging ventures). CSEF can also be used as a substitute for venture capital, private equity or debt finance for companies raising up to $5 million. Every emerging-company board should consider CSEF in the overall capital-raising strategy.
CSEF does not suit all unlisted companies and is no easy fix to raising capital. Companies that think CSEF is about promoting an offer online and letting the “crowd” do the rest are mistaken. A significant amount of work is required before, during and after the capital-raising, to minimise investor risk wherever possible.
In my view, strong governance systems and boards are a prerequisite for significant capital-raisings – a relationship that should be no different in equity crowdfunding.
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