Prepared by Nicholas Cardone
Intermediaries will perform a pivotal role within Australia’s new crowd-sourced equity funding (CSF) regime as the link between start-ups seeking external investment and investors wishing to acquire equity in those start-ups. This ‘connection’ will be provided through an online platform, with functionalities that would enable the CSF intermediary to host CSF offers (made by start-ups) and collect money from investors. All CSF intermediaries are required to hold an AFSL with a crowdfunding authorisation to perform this role.
With ASIC currently finalising the AFSL applications for Australia’s first batch of CSF intermediaries, it is now a timely opportunity to map out some of the considerations CSF intermediaries will need to work through when navigating the new CSF regime.
In a 12-month period, retail clients are only able to invest a maximum of $10,000 in any one start-up through a CSF intermediary’s platform. However, it is currently unclear whether any investments made by the companies, trusts or SMSFs that a retail client controls will be grouped together with a retail client’s personal investment for purposes of this cap. Theoretically, retail clients could personally invest $10,000 in a start-up and then have a company/trust it controls invest a further $10,000 into the start-up.
The intention of the cap is to limit the exposure that an investor can have on any one CSF offer, but the drafting of the legislation does not currently reflect this given the cap will not apply to companies and trusts controlled by that same investor. While we wait to hear from ASIC on how this sits with the legislation’s over-protective nature, CSF intermediaries need to have controls in place for managing the investor cap when accepting investments from retail clients and should be cautious in accepting investments from their related companies/trusts unless the CSF intermediary confirms that the investor is a wholesale client, which by implication, will make the companies and trusts that it controls wholesale as well.
If a CSF intermediary outsources any function related to its AFSL, ASIC considers that the outsourced provider will need to be an employee, director or authorised representative of the CSF intermediary. ASIC provides this guidance in context of a CSF intermediary outsourcing its gatekeeper obligations or the provision of its communication facility (described below), but it is unclear if ASIC intend this guidance to also apply to lawyers and accountants (who may assist the CSF intermediary comply with its obligations and financial requirements under its AFSL).
The practical effect of this will be that lawyers and accountants may need to be appointed as a CSF intermediary’s authorised representatives which does seem a little weird. Lawyers and accountant may be reluctant to accept these appointments due to commercial and compliance risks, which will obviously hamper a CSF intermediary’s business and ongoing compliance. ASIC definitely needs to clarify this issue and, we hope, take a practical approach.
Supervision of communications facility
CSF intermediaries must provide a communications facility on their platform that allows investors to ask questions or provide comments to start-ups publishing a CSF offer (similar to current investor forums). To comply with the legislation, CSF intermediaries must remove (or prevent the disclosure of) all posts that are misleading or otherwise unlawful or clearly irrelevant.
To comply with this obligation initially, CSF intermediaries will need to adopt procedures which adequately oversee the designate the responsibility of overseeing the communications facility and for this purpose may implement pre-vetting procedures for all communications on the facility. Moving forward, artificial intelligence could potentially be developed to undertake this role.
Fees for CSF intermediary services
ASIC has been clear that a CSF intermediary can structure its fee arrangements as it pleases provided those fee arrangements do not give rise to an unacceptable conflict of interest. So, fees based on a percentage of funds raised, a flat charge or a combination of fees and equity will all be acceptable. Fees based on the success of a raise will require more scrutiny to determine whether they pose an unacceptable conflict of interest for the intermediary.
Commercially, the Hosting Agreement should be very clear on the fees payable (and what happens where an offer is abandoned or withdrawn) so that CSF intermediaries are adequately remunerated for any services performed and to avoid fee disputes. The obvious commercial risk here is that a start-up will likely have no funds to pay any fee if a CSF offer does not complete, but this could be mitigated by requiring the directors of the start-up to sign a guarantee, or by taking security over a start-up director’s assets.
Other comments and future considerations
Given the onerous obligations that are imposed on CSF intermediaries (through the legislation and AFSL conditions), there will likely be a low number of CSF intermediaries operating in Australia. This will provide CSF intermediaries with an excellent opportunity to initially differentiate themselves in the market and create competitive advantage. Moving forward, there is also significant opportunity for CSF intermediaries to utilise technologies such as blockchain in removing friction points for start-ups in managing their investors going forward (i.e. member communications and registers).
Given this is a completely new regime, overcoming the initial compliance hurdle and navigating ASIC’s inadequate guidance will be the biggest challenge for CSF intermediaries to overcome. Appropriate advice should be sought if a legal or commercial issue arises to ensure that the AFSL is not breached or subsequently cancelled by ASIC.
Our Rescue product helps CSF intermediaries manage all of their AFSL and regulatory obligations. Get in touch if you want to know more.