By Shannon Finch, Robert Wright and Frances Leitch.
Finally – the long-awaited release of the camera-ready legislation to extend crowd-sourced equity funding (CSF) to proprietary companies!
The legislation has evolved following the public consultation process, and improves upon the earlier public framework. Industry was vocal in the consultation - and it is clear that government was listening.
We're supportive of the legislation as an important step forward in the development of CSF in Australia – and hopeful that the expanded framework will provide a foundation for increased flexibility as government and regulators monitor the development of this market.
There will be a period of frenetic activity now, as CSF platforms get ready to apply under the new licensing regime, with applications commencing from 29 September 2017. It is unclear how long that licensing process will take – so it may be a while yet until we see the first CSF offers under the new regime.
This article pulls together the key elements of where the CSF regime has landed - and it is now a coherent, scaleable regime. However there are a couple of key issues that will make or break the new regime's success...
The current CSF regime is just for public companies
Back in May 2017, the Corporations Amendment (Crowd-sourced Funding) Act 2017 (CSF Act) and Corporations Amendment (Crowd-sourced Funding) Regulations 2017 established a legislative framework for public companies to raise funds by issuing ordinary shares to a large pool of investors without being listed on a stock exchange, using the services of a licensed CSF platform.
That legislation is scheduled to commence on 29 September 2017, but before any CSF offers can be launched – CSF platforms need to be granted new CSF licence authorisations by ASIC.
ASIC released two consultation papers, with draft regulatory guides for companies and for the CSF platforms, in June 2017 and while it is not without its controversy, that draft policy material has been valuable in helping potential participants in the new market to prepare.
Extending CSF to proprietary companies?
The new legislation will, if passed, extend access to CSF to innovative and early stage businesses structured as proprietary companies. It responds to industry submissions on the initial CSF reforms, and adapts some of the requirements of the public company regime.
Not all proprietary companies would be eligible, and there would be some trade-offs – with increased reporting and accountability, in return for the access to "public" funding. The additional obligations proposed for proprietary CSF companies are designed to balance the protection of shareholders with increased transparency and oversight.
Proprietary companies are designed to be "light touch"
Normally – proprietary companies can have a single director, and they are limited to 50 shareholders (other than employees).
They generally do not have to prepare audited financial statements, and may not prepare any financial statements or annual reports, until they become a "large proprietary company" (i.e. any two of: annual consolidated revenue of at least $25 million, consolidated gross assets of at least $12.5 million, 50 or more employees).
They have few requirements to provide information to ASIC, and are not affected by public company restrictions on related party transactions and most proprietary companies are not affected by rules on takeovers. As a result – traditionally they have strict limits on their ability to raise funds from the public – in particular, they cannot issue a prospectus to raise money from retail investors.
Changing these rules is quite a big deal – and it comes with some trade-offs for proprietary CSF companies.
The trade-offs for proprietary companies who access CSF
If a proprietary company choses to use the proposed new regime to raise CSF, there would be some changes including:
- Two directors: The proprietary company would need to have at least 2 directors, a majority of which ordinarily reside in Australia (or at least 1 of them, if there are only 2 directors).
- Financial reporting: It would have to prepare financial reports in accordance with accounting standards.
- Audit requirements: Those financial statements would have to be audited if the company raises more than $3 million from CSF offers (even if the company is still a "small" proprietary company). This is a big win for the industry in its bid to keep compliance costs manageable – the audit threshold for CSF companies has been increased across the board from $1 million to $3 million, following further consultation.
- Related party rules: It would have to comply with related party transaction rules under Chapter 2E.
- Exception to shareholder limit: The 50 shareholder limit still applies, but shareholders who hold shares issued as part of a CSF offer do not count towards the limit. Important improvements were secured through consultation, so that CSF shares can be transferred without accidentally breaching the 50 shareholder limit.
- Records of CSF Shareholders: There are requirements for the company register to record details of CSF offers and CSF shareholders, and to report changes in relation to CSF shareholders to ASIC.
- Takeovers exemption: The CSF proprietary company is exempt from the takeovers rules, as long as requirements specified in the regulations are met. This is another key improvement from the exposure draft. Earlier versions of this bill toyed with introducing a novel form of 'mandatory bid rule' for CSF companies, with prescribed exit rights to apply – and that has been removed. While the content of any additional revised regulations is still to be released – we're not expecting to see anything too startling.
All in all – it's a workable package.
Impact on public CSF companies
To blend the current CSF regime with the extended rules, there are some changes to the governance concessions offered to companies that convert to a public company in order to access CSF.
The new bill adapts those concessions on the rationale is that concessional treatment can be achieved if a company simply remains as a proprietary company.
In particular, the new bill proposes to:
- AGMs: remove the limited exemption from the obligation for a public CSF company to hold an Annual General Meeting for the first 5 years, or until it issues a prospectus or ceases to be eligible to continue to use the CSF regime. A proprietary CSF company does not need to hold an Annual General Meeting; and
- Financial reporting: adapt the limited exemption from public CSF company obligations to prepare audited financial statements, until the company has raised $3 million from CSF (in line with the audit threshold for proprietary CSF companies).
Companies that converted to public CSF companies in the period before the proprietary company reforms come into force will be permitted to retain the governance concessions on a 'grandfathered' basis.
Stitching the CSF regimes together to create a pathway
The combination of the public CSF regime, and the proposed new rules for proprietary CSF companies would create a graduated pathway for the growth of small proprietary companies into public companies after early CSF initiatives.
This enables a start-up that is a proprietary company to gather some early-stage support using CSF while it is still a proprietary company, keep its compliance costs low, and get a taste of some of the public company requirements as it achieves scale. Once it outgrows the proprietary company regime, it can convert to a public company.
The common elements for both public and proprietary CSF companies
There are common elements to the proprietary company and public company CSF regimes:
- Location: The company's principle place of business must be in Australia.
- Assets / turnover test: The company (together with its related parties) must have consolidated gross assets of $25 million and consolidated annual revenue of less than $25 million.
- Issuer cap: There is an "issuer cap" of $5 million as the total amount of money that can be raised by a company using CSF.
- Investor cap: Individual retail CSF investors cannot apply for more than $10,000 of shares in a particular company, on the same CSF platform, in any 12 month period.
- CSF offer document: The CSF offer must be made using a CSF offer document, which contains information prescribed by the regulations (including prescribed risk warnings, information about the company, the offer, and investor rights). It is not a prospectus – but the liability regime has some similarities, and the content is prescribed in detail by the regulations.
- CSF intermediary – platform for CSF offer: The CSF offer must be made by publishing the CSF offer document on a platform of a single CSF intermediary – i.e. a crowdfunding platform that has a special new form of Australian Financial Services Licence. The company can only make one CSF offer at a time.
- CSF intermediary – gatekeeper obligations: The CSF intermediary must handle all the applications and application monies for the offer. The intermediary has special "gatekeeper" obligations – including to conduct certain checks (to a reasonable standard) on the company, its directors, and the disclosure. The intermediary has to keep records of its compliance with these obligations.
- Communication facility: The intermediary has to provide a communication facility which allows people who access their CSF platform to make, and see, posts relating to the CSF offer, and to allow for questions and answers to be posted.
- Cooling off rights: There are cooling off rights that allow CSF retail investors to withdraw their application within 5 business days.
- Prohibition on financial assistance: The CSF company, its related parties, CSF intermediaries, and their associates must not financially assist retail investors to acquire securities under a CSF offer.
- Advertising restrictions: There are some basic restrictions on advertising CSF offers (including publishing statements that refer to a CSF offer or intended CSF offer), but these do not restrict:
- the publication of information on the CSF intermediary's platform;
- general promotion of the CSF intermediary that does not refer to a particular offer;
- advertising or publishing statements that state that investors should consider the CSF offer document and the CSF risk warning, before deciding to make an application;
- statements made in good faith on the CSF communication facility; or
- notices of meeting, press reports, analyst reports, and technical publisher exceptions.
- Other rules: There are a range of other rules around how the CSF offer can be conducted, and what the intermediary has to do.
The CSF liability regime is the same for public and proprietary CSF companies
- Defective CSF offer document: There are rules preventing an offer knowingly being made under a defective CSF offer document, and provisions that allow for correction of defects with supplementary or replacement disclosure (with corresponding withdrawal rights for investors).
- Company liability: CSF companies have criminal liability for materially adverse defects, and liability for damages for a defective CSF offer document. There is potential for others to have criminal accessory liability if sufficiently involved in the company's acts (e.g. directors or management).
- Directors: Directors of the CSF company have liability for damages for a defective CSF offer document.
- Underwriters: Underwriters of the CSF offer (named with consent) have liability for damages for a defective CSF offer document.
- Statements with consent: Anyone who provides a defective statement in the CSF offer document, with their consent, has liability for damages for that statement.
- Others involved: Anyone who is involved in the company's contravention, has liability for damages for that contravention.
- CSF intermediaries: CSF intermediaries carry significant potential liability – with some novel developments for a licensed intermediary. In particular:
- Liability for defective offer document - They have criminal liability for materially adverse defects, and liability for damages if they know a CSF offer document is defective, and they publish it (or continue to publish it). They also have liability if they don't remove it, or close, or suspend the offer.
- Reasonable checks - They are treated as knowing a document is defective if they do not conduct the prescribed gatekeeper checks to a good enough standard. This element of the regime places a hefty burden on CSF intermediaries, and is not without its controversy. The regulations will prescribe the "reasonable checks" which could lighten that load or make it heavier ...
- No reasonable reliance defence – They do not have the benefit of a reasonable reliance defence – so they cannot defend themselves if they relied on information from the CSF company, and did not conduct their gatekeeper checks to a good enough standard.
- Limited defences: Persons other than the CSF intermediary have a reasonable reliance defence – they are not liable if they reasonably relied on information provided by someone else (other than their own employee, agent, or director). There is no due diligence defence – but that is because liability is largely based on knowledge (or failure by the intermediary to conduct reasonable checks).
Governance requirements will be graduated
- Financial reports: Both proprietary and public CSF companies will have to prepare financial reports.
- Audits of financial report: CSF companies only have to have their financial statements audited after they have raised $3 million from CSF (although until the proprietary company legislation commences, this will remain at the $1 million threshold).
- Directors reports: Public and proprietary CSF companies will have to prepare a directors' report.
- No disclosing entity obligations: The CSF rules do not change disclosing entity rules – so even if a public or proprietary CSF company has more than 100 shareholders, the CSF offer document is not treated like a prospectus and it does not trigger "continuous disclosure" obligations. That status would change if the company issued a prospectus or offer information statement, and subsequently had more than 100 shareholders.
- Related party rules: Related party rules will apply to both public and proprietary CSF companies, restricting financial benefits that may be given to related parties such as directors and controllers of the company.
- ASIC lodgements: Public CSF companies (like other public companies) have a range of obligations to lodge and update information lodged with ASIC. Proprietary CSF companies have fewer obligations, but will have to notify ASIC of shares issued as a result of CSF offers, and details of when it started or ceased to have any CSF shareholders (including as a result of share cancellations).
- Takeovers: The prohibition in Chapter 6 on acquiring more than 20% of certain companies' voting shares will not apply to proprietary CSF companies. For public CSF companies, the prohibition will not apply to the CSF offer itself, but otherwise the Chapter 6 regime applies. This is an area where we anticipate some "anomalies" relief may be required by ASIC, to avoid unintended outcomes – as the CSF regime is not intended to open up proprietary companies to takeover bid processes.
The combined regime is not lightweight, but it has come a long way
There are some complications to the new regime, but many issues were effectively ironed out through public consultation – particularly for the proprietary company regime.
There are a few concerns that remain – and they could dampen the success of the CSF regime – in particular:
- Is it a workable framework for intermediaries? The biggest question for the whole regime is whether it will be supported by high quality crowd-funding platforms.
The obligations on intermediaries are more onerous than those on intermediaries for major IPO's, and the liability regime is stricter for them than on any other participant. ASIC's draft policy adds additional requirements, and greater detail.
Accountability is good – but if it is out of proportion, the costs and the risk can deter the high quality participants that you really want to see involved. Early enthusiasm amongst intermediaries seems strong – but this is an issue that needs to be monitored.
- Is the disclosure regime overweight? The other big question is whether there is any difference between a CSF offer document and a normal prospectus. The idea was to streamline regulation for CSF offers, in light of crowd funding reforms around the world.
The regulations are highly prescriptive regarding the content and structure of CSF offer documents. The draft ASIC policy expands upon that with additional detail.
This is very helpful in the sense of providing certainty – but the weight of it remains troubling. If applied without flexibility, it may leave us wondering what these reforms really achieved...
The answer remains to be seen, and it may take a little courage by CSF platforms (and support from ASIC) to set a sensible standard.
However – despite those concerns, there was active engagement with industry throughout the public consultation process, and the legislation introduced yesterday shows clearly that government was listening.
There is a little devil remaining in the detail – with the final version of the ASIC policy still to come (and any additional regulations), and the opportunity remains to strike a good balance between caution and commerciality.
However, the Australian legislative reforms are a big step in the right direction. We expect that yesterday's legislation should be well received.
The CSF Act amends the Corporations Act 2001 and makes minor amendments to the Australian Securities and Corporations Act 2001.