Every self-managed superannuation fund (SMSF) will be able to invest in potentially high-growth unlisted companies, as a new era of crowd-sourced equity funding begins.
The Federal Government’s Corporations Amendment (Crowd-sourced Funding) Act 2017 takes effect on September 29, 2017. The new law provides a legislative framework for crowd-sourced equity funding in Australia.
“This reform is a game changer for SMSFs,” says Will Leitch, CEO of the Australian Small Scale Offerings Board (ASSOB).
“For the first time, SMSFs will have access to investment opportunities in emerging companies that have typically been the preserve of professional investment funds and high-net-worth investors.”
Crowd-sourced funding platforms help businesses raise funds from large groups of people who typically provide small amounts. Crowdfunding sites, such as Kickstarter in the United States, have raised billions of dollars for commercial and not-for-profit projects.
Equity crowdfunding broadens the concept by allowing earlier stage companies to raise funds from investors in exchange for equity in the business. ASSOB is Australia’s largest crowd-sourced equity funding site, having raised $150 million for 176 companies since 2008.
Under the new rules, retail investors can invest up to $10,000 per company each year through an equity crowdfunding campaign. Wholesale investors have no investment-size restrictions.
Companies will benefit from reduced disclosure requirements in offer documents, making it cheaper and easier to raise capital. Temporary concessions for newly registered or converted public companies, for up to five years, from certain reporting, audit and corporate governance obligations, will lower compliance and administrative hurdles. The Government has also released draft legislation to extend crowd-sourced equity funding to proprietary companies.
Intermediaries, such as ASSOB, that provide funding services must hold an Australian Financial Services Licence and perform checks on companies making offers and their directors, and the offer document.
“These are sensible reforms,” says Leitch. “They strike an appropriate balance between investor protection and allowing earlier-stage companies to raise equity from a wider audience, without the compliance requirements expected of large companies.”
Connecting SMSFs to high-growth companies
Leitch says the reforms will connect high-potential emerging companies with a larger pool of investable capital, principally through the $674 billion SMSF sector. “There is potential for the SMSF sector to become the capital base for outstanding Australian emerging companies. The reforms solve problems for companies and investors.”
Lack of capital has been a recurring problem for Australian entrepreneurs, start-ups and growth-stage companies. Australia’s venture capital sector is small by global standards and private equity funds usually focus on larger businesses.
Bank funding for small and medium-size enterprises is another challenge. Regulatory requirements for Australian banks to hold more capital could constrain growth in banking lending to SMEs.
The Australian Securities Exchange’s revisions to Listing Rules, in effect from December 2016, require companies to have $4 million in net tangible assets or a market capitalisation of $15 million to list.
Companies admitted under the NTA test also require $1.5 million of working capital and two full years of audited accounts. The upshot is a higher hurdle for emerging companies that seek funding through an initial public offering.
“The combined effect of these changes make it harder for emerging companies to raise capital via traditional sources, at a time of unpredicted global industry transformation,” says Leitch. “The digitisation of business models is seeing more emerging companies disrupt markets, challenge incumbent operators and create significant wealth for investors.”
Broadening SMSF investment options
Crowdfunding reforms will help SMSFs by providing easier access to emerging companies that are not listed on exchanges. Including this emerging asset class in SMSFs can potentially improve diversification, complement SMSF investment strategies and support returns on a gross and after-tax basis.
Many companies that have raised capital through ASSOB so far are in information technology, life sciences, agriculture technology or other sectors not well presented on ASX by market capitalisation.
“Typically, the value of companies on the equity crowdfunding platforms does not move up or down when the sharemarket rises or falls,” says Leitch.
Leitch says SMSFs can use equity crowdfunded investments as part of core/satellite strategies. “An SMSF might include traditional investments, such as Australian and international shares and fixed interest in their portfolio core. And have a few investments in unlisted companies as portfolio ‘satellites’ that may boost portfolio returns over time.”
He says this form of investment suits SMSFs. “Early-stage companies often require patience to realise their potential, and SMSFs typically have longer investment horizons. SMSF trustees also tend to be more hands-on. Many early-stage companies have a closer connection with their shareholders and want them to come on the growth journey.”
Potential for higher returns is another attraction. “SMSFs should never discount the risks of investing in early-stage, unlisted companies,” says Leitch.
“This market is more speculative, by nature. But it is also true that professional investors who are looking for the next Google or Facebook target early-stage growth companies before they list on exchanges.”
Tax benefits are a consideration. New government legislation provides favourable tax concessions for investors in companies that meet certain innovation tests. “Some investments in early-stage innovation companies are free of capital gains tax and/or have significant tax offsets,” says Leitch.
“The tax framework is changing to help drive higher rates of innovation and support early-stage growth companies in Australia attract capital.”
Understanding crowdfunding risks
Leitch says dozens of organisations have applied to the Australian Securities and Investments Commission (ASIC) to provide equity crowdfunding services. Although not all may be approved, it is likely that new equity crowdfunding sites will emerge.
SMSF trustees, says Leitch, should do due diligence on equity crowdfunding sites before investing. “All equity crowdfunding sites are not the same. The clear majority have limited operating records, may not have robust compliance or governance systems, or do inadequate checks on companies on their platform.
“Investing in emerging companies, through speculative equity crowdfunding platforms, unnecessarily adds to risk. That is not a place for SMSF capital.”
Launched in 2008, ASSOB was the world’s first equity crowdfunding platform. It has raised equity capital for Australian companies through Section 708 of The Corporations Act. Under the current Act, ASSOB is not able to advertise offers to anyone outside of the ASSOB database who have not signed up to the relevant terms and conditions. The reforms will allow ASSOB to market offers on its platform to the general investing public, so long as the advertisement is not misleading or deceptive and complies with the CSF regime requirements.
Leitch describes ASSOB as a “stage-four crowdfunding platform” that has detailed screening of companies and high compliance and governance requirements. “To ASSOB’s knowledge, every other potential equity crowdfunding site in Australia is at stage two or three: they provide early online investment opportunities, and matching services, without the same screening, compliance or governance standards.”
ASSOB last year introduced IMENCA’s Business Evaluation Calculus – a world-class business evaluation process that is based on extensive academic research. Professor Kevin Hindle, an internationally awarded Australian entrepreneurship academic, helped developed the underlying intellectual property, which evaluates companies in a particular way on 15 business model factors.
The evidence-based research underpinning IMENCA’s BEC, exclusive to ASSOB, significantly increases the odds of picking successful investment opportunities.
Leitch says: “We spend an enormous amount of time choosing the right companies for our platform and requiring that they have high level of compliance, governance and quarterly reporting. Not every company will succeed, but ASSOB does everything it can to reduce risk for investors.”
There have been no reported cases of fraud from companies on the ASSOB platform and more than 75 per cent of companies on it are trading profitably – a favourable success rate in a market that historically has a higher number of failures.