26 February 15 Equity crowdfunding – the what, the who and why you should know about it.

The crowdfunding model continues to evolve. Equity crowdfunding is the next iteration and a new way to get projects, events, campaigns, products and companies off the ground. What is equity crowdfunding and will it last?

In this article, I asked whether we are taking the crowdfunding model too far semantically. I argued that by using the terms investment and crowdfunding interchangeably, we were broadening the definition to a point that it changes the meaning and expectation of what constitutes crowdfunding.

I have to admit, at first I thought broadening the definition was a bad thing. I believed we should keep the terms separate, defined and confined. Black and white – no grey area or room for speculation.

But as I dug a bit deeper to research this follow-up, my position started to change.

Let me show you why.

Oculus and the rift…

You may be aware of the Oculus Rift debacle post their sale to Facebook.

Originally a Kickstarter campaign that raised $2.4 billion, Oculus Rift were the recipients of a social media storm from early crowdfunders of the project. You may recall comments such as ‘I helped Oculus get sold for $2 billion and all I got was this lousy T-shirt’ plastered all over the media.

The sale of the company made us question whether crowdfunders should be given equity in situations such as the Oculus Rift project.

To add insult to injury, venture capital firms, such as Spark Partners and hedge fund Matrix Partners, who invested in Oculus Rift post the Kickstarter campaign, reportedly made a $361 million return on their initial $19 million investment. Read that again. They made a $361 million return on their investment.

At the time of the sale, equity crowdfunding didn’t really exist. If it did, it wasn’t talked about like it is now.

There’s been heaps of articles that have addressed whether or not Oculus Rift crowdfunders should have been granted equity in the company post the Kickstarter campaign. That’s not my focus. What I want to highlight is that the situation helped to spark an evolution in the crowdfunding model.

Enter, equity crowdfunding.

What is it?

Equity crowdfunding is when a business makes an offer of equity, shares or securities to a group of people in return for a financial contribution.

It does this without going through the traditional process of preparing a prospectus or other complex offering document.

Equity crowdfunding uses the ‘borderless’ online marketplace to find people who want to invest in a business, rather than a product.

 

 

 

Because this model is relatively new in the broader realm of business, it currently goes by a range of names including crowdfund investing, hyperfunding, crowdinvesting and even crowdfunding (legalised).

That last label came from the US Senate which passed legislation to legalise crowdfunding. I think it just causes confusion with the more traditional definition of crowdfunding.

According to Wikipedia, there have been calls to standardise terminology, and that’s an awesome idea.

Equity crowdfunding is illegal because a business cannot make an offer to the general public for securities in return for money. Unless it is supported by a prospectus or formal offering document. This is true in all countries.

However, the offer can be made to ‘sophisticated investors’ without a prospectus if they comply with the provisions set out in the law governing financial transactions.

In Australia, a sophisticated investor is defined as someone who has more than $2.5 million in investable assets, or earnings of approximately $250,000 per annum.

What are its roots?

Equity crowdfunding originated in the United States and after much lobbying and debate, it was included in the 2012 JOBS Act (Jumpstart Our Business Startups Act).

The Act allows licensed broker-dealer relationships to participate in equity crowdfunding or via a funding platform that is registered with the US Securities and Exchange Commission (SEC). A funding platform could be one such as EquityNet, CrowdCube or Seedrs.

But all that glisters is not gold. There are legislative limits on the value of securities that can be offered, as well as limits imposed on individuals investing through crowdfunding platforms.

And as we all know, where there are limits there’s normally people who want to find a way around them. This case is no different.

Many States in the US are considering enacting their own exemption laws to make equity crowdfunding more accessible. These States include Kansas, Georgia, Michigan and Wisconsin.

Who are the major players?

The first equity crowdfunding firm to start operating was the US-based EquityNet. It calls itself the leading business crowdfunding platform and claim to have raised more than $260 million dollars in equity crowdfunding.

The explanatory video on its website describes how the model works. In accordance with the JOBS Act, it can only receive investment from sophisticated investors.

In the UK, the Financial Conduct Authority regulates loan-based crowdfunding. Three platforms have sprung up since. These are Seedrs, BankToTheFuture.com (and endorsed by Richard Branson) and CrowdCube. Unlike the US, equity crowdfunding is open to anyone in the UK who wants to support a company through a model that gives them equity or shares in return for a financial contribution.

What about us down under?

To set the scene, crowdfunding is legal in Australia when seeking donations or raising funds without any promise of equity.

If you do attempt to solicit investment, then the Corporations Act 2001 comes into play and there’s all manner of requirements and regulations that can quickly make things messy. The current situation is like the US. Equity crowdfunding is possible for wholesale or sophisticated investors with more than $2.5 million in assets or an annual income of approximately $250,000.

Of the 23 million Australians this means approximately 200,000 people are able to engage in equity crowdfunding.

In May 2014, the Corporations and Markets Advisory Committee (CAMAC) released a report with recommendations to the government on crowd-sourced equity funding (CSEF). Ultimately, it wants to make it easier for businesses to raise capital through equity crowdfunding in Australia.

And I totally agree with them. Especially when it comes to cultivating Australia’s technology start-ups.

Tech start-ups are the types of businesses we should be encouraging to stay in Australia. The current norm is that a large portion of Australian tech start-ups eventually seek overseas funding.

But if the acceptance of equity crowdfunding could help the shift of this norm – even just nudge it a little – and start-ups begin choosing to remain in Australia I think we should try and make it happen.

Of the recommendations CAMAC made, one stands out. Instead of equity crowdfunding only being available to sophisticated investors, the model would be open to any person who wishes to engage in it.

But there’s two provisos:

• You would only be able to invest a maximum of $2500 per company.
• Your equity crowdfunding investment limit would be capped at $10,000 per year.

Sound realistic and achievable? It is. These limitations ensure that people who want to invest small amounts can and that those who are investing larger amounts diversify their portfolio.

Every little bit counts when helping a start-up. It also goes towards contributing to the Australian economy and that can only be a good thing for us in the long term.

Two equity crowdfunding platforms already exist in Australia and are gearing up for changes to legislative amendments in this space. They are Equitise and VentureCrowd.

Tim Heasley, COO of VentureCrowd and Artesian Capital Management, told StartUpSmart that equity crowdfunding is an ‘easy to way to democratise venture capital’.

Of course, equity crowdfunding, like any form of investment, comes with risks and a need to make an informed decision before parting with your money. As Heasley notes:

We would say crowdsourced equity funding is a pretty risky investment category and people should be educated in both the risk and potential rewards.

Equitise and VentureCrowd are transparent about the risks of equity crowdfunding. There are changes in the market, it’s a high risk and long-term investment.

People should not take the decision to engage in equity crowdfunding lightly, however, it is a model that more people in Australia may be able to access soon and should learn more about.

In February 2015, the Federal Government announced it had put together a timeline for a legislative framework around equity crowdfunding.

The Small Business Minister, Bruce Billson, engaged in roundtable discussions with the Financial Services Council chief economist James Bond and Equitise co-founder Chris Gilbert.

They addressed CAMAC’s recommendations and Billson announced plans to allow general consumers (retail investors like you and me) to participate in equity crowdfunding. Legislative proposals are to be introduced in the spring session of Parliament.

This is awesome, isn’t it?

Well, the response has been mixed.

Say what?

Post CAMAC’s recommendations, entrepreneur Adir Shiffman wrote this article for BRW on why equity crowdfunding for start-ups is wrong for Australia.

Shiffman compares equity crowdfunding to a game of roulette rather than buying a listed index and I tend to agree. His point: equity crowdfunding is highly speculative and high risk.

What’s interesting is Paul Niederer’s response to Shiffman’s article.

Niederer argues that statistically businesses using equity crowdfunding have a small pool of investors to choose from. And that the notion of crowdfunders storming their campaign to invest is misleading and unlikely.

According to the Australian Small Scale Offerings Board (ASSOB), of which Niederer is the chief executive, a start-up generally has “a personal ‘crowd’ of about 660” people providing start-up capital. To add to this argument, statistics from ASSOB indicate that most companies using equity crowdfunding have less than 200 investors providing capital.

This may change in the future and it would be awesome to see more local technology companies accessing equity crowdfunding under the proposed Australian model.

Let me leave you with this…

Equity crowdfunding is an evolving model that provides greater investment choice, helps people to contribute to our economy and supports start-ups.

I think it’s important for people to know about equity crowdfunding and that plans are afoot for its development, particularly in Australia.

It’s a way to show how a once disruptive business model is now an evolving niche market. It may grow over time and shift our technology start-up landscape. Fingers crossed.

If you’re interested in equity crowdfunding or completely disagree with the idea of this model I’m keen to hear your thoughts. Feel free to add a comment below.