Across the capital raising spectrum there are various forms of fundraising that are available to companies in the Australian market and, in particular, there have been interesting new forms of funding that have arisen in recent times (including crowd-sourced equity funding).
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It goes without saying that most companies will require a capital injection, often on incorporation and at various stages of development. Significant growth often cannot be achieved quickly without a capital injection at the right stage.
Some key challenges that can arise in the early stages include:
- access to capital as and when required – particularly as a private or public unlisted company, with generally liquid shares;
- limited alternative strategies without revenues and/or ‘bricks and mortar’ to give as security for debt funding; and
- managing the ongoing control and dilution of founders and other key stakeholders in the company (but remembering that dilution of existing holdings is often a necessary part of growth – with the mantra of ‘100% of nothing versus 17% of a significant company’).
It is also important to have a capital raising management strategy, with a view to reducing the need to seek funding at the eleventh hour and understanding what options and alternatives may be available.
Business angels are generally high net worth individuals with cash reserves to invest in high risk or high growth businesses (taking a portfolio approach to investing). An angel may require involvement in the business, and are often active in development and bringing skills, contacts, experience and personal branding to the company.
It is generally a more informal investment process – often with an interview and/or panel process. Angels may not be easily accessible – often being found through business contacts, though there are increasing marketing activities in this area (e.g. Shark Tank, or more locally RiverPitch and Creative).
The documentation may be as simple as a subscription agreement (often on the preferred terms of the angel investor), together with potential edits to any shareholders’ agreement. It is generally a medium-term investment.
Other sources of seed capital can include:
- employees (noting the ESS tax rules)
- suppliers or customers;
- family offices; and
- government grants.
- Specialist financial intermediaries who seek a high return from higher risk industry specific ventures.
- Usually having active involvement with an influential role (i.e. board position and involvement in key decision-making processes).
- Generally require a predetermined exit mechanism within a set time frame (e.g. IPO or trade sale within three to five years).
- Investment can range from $1 million to $10 million – sometimes staggered for the achievement of agreed milestones – with a targeted 25% to 40% per annum IRR over the life of the investment.
- More formal investment process and documentation – e.g. a series of pitches, an information memorandum, term sheet and confidentiality deed, due diligence, and subscription agreement.
- There are often a number of venture capital terms to be familiar with (e.g. founder vesting and/or liquidation preference rights).
Crowd funding is not a new concept (but just a new term) – for raising small amounts from a large group (or ‘crowd’) of supporters for the relevant venture (via an intermediary platform).
Crowd-sourced equity funding
Crowd-sourced funding of shares is different to the donation-based crowd funding typically used by artists or entrepreneurs to raise money for one-off projects and is also different to investment-based crowd funding, which may involve investing in a managed investment scheme.
Effective from 29 September 2017, this type of fundraising is only available to new and existing Australian public companies who want to get funding by issuing ordinary shares but are not listed. However, in September this year the Senate passed the bill that extended the CSF regime to proprietary companies in Australia with additional requirements and hopefully this law will be effective by the end of 2018.
Companies typically raise small amounts from a large number of investors. Each investor can invest up to $10,000 a year in a company and in exchange they’ll receive securities in the form of shares.
Eligible companies can raise up to $5 million a year using crowd-sourced funding, but they must have less than $25 million in assets and annual revenue and must use a crowd-sourced funding (CSF) platform, usually a website, to make their investment offer. The website is run by an intermediary that must have an AFS licence which authorises them to provide crowd-sourced funding services according to ASIC RG262.
The intermediary acts as a ‘gatekeeper’ between the company and investors and checks the company and the investment information the company provides before the offer is placed on the website.
IPO as an alternative
The Australian market is generally supportive of earlier stage companies and an IPO can often present an opportunity, and alternative avenue for raising funds, for such companies. An IPO can provide an exit mechanism and a potential liquidity event for investors.
The company must satisfy the relevant stock exchange rules (e.g. the ASX Listing Rules) such as the offer of securities will generally require a prospectus – under section 706 Corporations Act and satisfy either “Profit Test” or “Asset Test” and “Spread Test” as follows:
- Aggregate of $1 million for last 3 full financial years
- Consolidated profit of $500,000 for last 12 months
- Audited accounts for the last 3 full financial years*
- Net tangible assets after IPO costs of $4 million
- Market capitalisation of $15 million at the IPO issue price
- Audited accounts for the last 2 full financial years*
- Commitment to spend half of the cash and have assets readily convertible to cash
* Note: Reviewed half year accounts if full year ended more than 6 months and 75 days before IPO application
At least 300 non-affiliated investors (in the main class of shares), each holding at least $2,000 worth of shares at the issue price (excluding those subject to escrow)
Tax Institute of Australia, 2018 Private Business Tax Retreat Plenary 5: Financing start-ups, written and presented by Ben Wood, Senior Associate of McCullough Robertson Lawyers
Crowd sourced funding, https://www.moneysmart.gov.au/investing/crowd-sourced-funding
The material and opinions in this article are those of the author and not those of AP Group. The material and opinions in the article should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests or resort to professionals for assistance.