Equity Crowdfunding: What It Is And How It Works
Most new or small businesses find it difficult to attract funding from traditional sources such as angel investors, venture capital or even banks and are unable to list on the stock market.
Over the last decade, equity crowdfunding has emerged as a reliable alternative for some businesses, enabling them to raise funds from the general public in return for a financial stake in the venture.
We look at how equity crowdfunding works, what are its risks and benefits, and what are the main platforms through which one can participate in it.
What Is Equity Crowdfunding?
In simple words, it is an alternative method of raising capital under which a small business or startup can raise funds from the general public in return for part-ownership of the business in the form of shares.
Equity crowdfunding is a relatively new concept in Australia, with the first licenses only issued in 2018. Since then, however, it has become an increasingly popular method for early stage businesses, proprietary firms, limited companies and unlisted public companies to raise equity capital.
It is typically used by startups and small to medium companies to raise funds to grow and scale their business.
Since 2018, Australia has seen 426 equity crowdfunding offers, raising a total of more than $315 million.
How Does It Work?
Equity crowdfunding, also known as Crowd-Sourced Funding (CSF) in Australia, works similar to an initial public offering on the stock exchange but does not include the onerous compliance and disclosure obligations and costs associated with a stock market listing. The shares are not publicly quoted.
The share sale process can only be conducted through specialised online platforms like Birchal, Equitise and Swarmer that are licensed to host offers. These are regulated by the Australian Securities and Investments Commission (ASIC) under the Corporations Act.
Every company seeking to raise funds under the CSF regime must prepare an offer document and publish it on a crowdfunding platform to give potential investors information that allows them to assess whether or not to invest. This includes key details about the business, capital structure, financial statements, risks as well as the terms of the offer, the amount of capital being raised and the offer price of the shares.
An equity crowdfunding campaign generally has two phases:
Express of Interest (EOI)
This is a three- to four-week marketing period preceding the CSF offer campaign, designed to give the company an understanding of the market interest in their offer and how much they may be able to raise. It also gives potential investors the opportunity to learn about the company and their upcoming offer. Businesses can seek non-binding indications of investment interest from the public during this period.
CSF Offer Campaign
This is generally a two- to four-week campaign in which eligible companies make an offer of shares to retail and wholesale investors using an offer document. Often the offer campaign will have a private phase and a public phase.
The private phase is an early access period when the offer is available to investors who have made an expression of interest (EOI). Some CSF offers reach the maximum subscription amount during this period. In the public phase, the offer is open to everyone regardless of whether or not they submitted an EOI.
Every offer has a defined period for which it is open — typically a few weeks but with a maximum offer period of three months.
They also have a minimum and a maximum fundraising target. If the investment exceeds the minimum target within the offer period, it will be successful. If it reaches the maximum target, it must be closed, so these offers can’t be oversubscribed.
How Risky Is It?
Investmenting in a business via equity crowdfunding is typically considered high-risk and speculative. This is because most businesses raising funds through this format are either new or in the early stages of development, have limited trading history, and may not achieve commercial viability for a number of reasons.
“Crowd-sourced funding is for early stage, high-growth businesses, and by definition, it is a risky asset class, which underscores the importance of the consumer protections that exist,” says Matt Vitale, co-founder and CEO of CSF platform, Birchal.
Consumer protections include an investor cap under which retail investors are limited to a maximum investment of $10,000 per company per year, while businesses can raise a maximum of $5 million through the crowd-sourced funding regime annually.
Others include a disclosure document with prescribed content requirements, with a liability for directors that make statements under the offer document, which is reviewed by the intermediaries to ensure compliance. Investors reviewing the offer document can also seek additional information in real time on the CSF platform through a regulated communication facility that is live while the offers are open.
Additionally, there are cooling-off rights allowing retail investors to change their minds and withdraw their investment within five business days of making an application.
Still, all investors should holistically consider their investment strategy and diversify their portfolio across different asset classes, and within asset classes as well, Vitale said.
“But if you are going to invest in an early stage opportunity, CSF is an excellent way to ensure that you’re investing in a regulated mechanism where there is a rules-based framework and a regulator that is enforcing those rules,” he notes.
Read the full article: https://www.forbes.com/advisor/au/investing/what-is-equity-crowdfunding/
