Crowd funding or crowd-sourced fundraising represents a burgeoning industry in Australia, and a financial resource for projects, small business and other start-ups trying to get off the ground; however, it also represents a legal minefield for the unwary writes lawyer DEAN FRITH.
Crowd funding is a new and rapidly expanding form of capital raising that has been embraced by small enterprises. Generally speaking, it encompasses schemes which seek to raise funds, typically for business or other project proposals, through donations from internet users.
A vast sum of money is changing hands in crowd funding schemes. It has been estimated that crowd funding platforms raised nearly $US1.5 billion worldwide in 2011, and it was predicted that this figure would rise to US$2.8 billion in 2012.
Presently, Australian law limits crowd funding to relatively modest individual and community projects, where contributors receive non-financial rewards. It is recommended that anybody considering participating in a crowd funding scheme proceed with caution.
So far, crowd funding has mainly been used for artistic projects, but there is an emerging trend toward entrepreneurs utilising the scheme as a way to side-step bank lending and venture capital to raise funds for profit making initiatives, promising funders shares and ownership stakes. In Australia, such activities may be subject to heavy penalties if they do not comply with certain legal requirements.
For example, if a promoter offers shares in a start-up, the crowd funding platform could be viewed as dealing in a financial product, requiring an Australian Financial Services Licence and be subject to a rigorous disclosure regime. Similarly, if a promoter offers stakes in a project, it might be seen as fundraising and it will be required to lodge a prospectus and comply with other requirements, as well as be exposed to liability.
ASIC issued a media release in August 2012, stating “crowd funding, as a discrete activity, is not prohibited in Australia nor is it generally regulated by ASIC”. Despite this position, crowd funding website operators and those considering taking part were advised to consider the various risks they face in undertaking such activities. In particular, depending on the nature of the project and the reward offered to investors, crowd funding may give rise to issues of:
Financial services licensing and disclosure;
Advertising financial products;
Fundraising disclosure regimes; and
Managed investment schemes.
In addition, the general law relating to misleading and deceptive conduct, and contract law, are likely to be relevant.
A need for change?
Early this year, a number of technology start-ups urged ASIC to introduce crowd funding specific regulation, warning that there could be a mass exodus of local talent to the United States to take advantage of changes set to take place there later this year that will allow crowd funded start-ups to issue equity stakes to the public.
In addition, it has been argued that given the amount of money involved and the potentially borderless nature of the internet, the Australian framework needs protections in place for investors.
American site Kickstarter claims that since inception it has launched 34,762 new projects with $US393 million from 2.5 million people. In late 2011, an English group managed to raise one million pounds in 32 days from 143 worldwide investors in order to launch a new nightclub. In return, contributors were offered a total of 10% of the new company’s equity.
How crowd funding usually works
Individuals can make online pledges of anything from $1.00 to $1,000.00 (or more) to help an entrepreneur reach a nominated target amount for their idea, in return for a reward once the project is completed. The underlying product or service is usually advertised on an intermediary crowd funding website (such as iPledg or Pozible). Potential investors can view advertisements for multiple crowd funding ventures and choose which scheme appears most attractive to them. The nature of the reward varies from project to project. If the target isn’t reached, all pledges are generally refunded.
Although still relatively new in Australia, crowd funding has the potential to evolve rapidly. The rules developed in the US are facilitative, rather than restrictive, and promote crowd funding as a means to raise capital while at the same time establishing appropriate investor protections.
In Australia, regulators are currently adopting a “wait and see” approach, relying for the moment on existing managed investment, capital raising and financial services laws. This is not a suitable long term solution. If crowd funding continues to develop in Australia, the regulatory framework in which it operates will need to be substantially updated. Any future specific legislation will need to strike an appropriate balance between facilitating capital raising through informal social media and ensuring prospective investors are adequately protected against the inherent risks of investing in speculative ventures.
