Jones Partner

Crowd Source Funding for Retail Investors. Good idea or the potential for them to be the new Ponzi scheme?

28/08/2017 by Bruce Gleeson

The Corporations Amendment (Crowd Source Funding) Bill 2016 is due to come into operation on 29 September 2017. Crowd Source Funding (“CSF”) continues to be a popular way that allows entrepreneurs/start-ups to raise funds from many investors. Until recently CSF in Australia has been aimed at “sophisticated” or “wholesale” investors. The above Bill effectively establishes a regulatory framework to facilitate CSF by small, unlisted public companies aimed at attracting retail investors.

There is no doubt that new funding models such as CSF which enable new ideas to get off the ground and fly and contribute to productivity growth are a good thing. However, I do see the potential for misuse and some comparisons to Ponzi schemes come to mind. What is a Ponzi scheme? Wikipedia describes this type of scheme as one where “the operator generates returns for older investors through revenue paid by new investors, rather than from legitimate business activities or profit of financial trading”. The analogy here is that the concept/assumptions around the business are overstated and/or further capital raisings being based on the potential for the product/service being overplayed.

Retail investors should apply the same scepticism, fundamental analysis and industry research they do to a company listed on a stock exchange before deciding whether to invest via the CSF platform. This also applies to other platforms such as kickstarter and others.

The fact that CSF is (or will be) typically done online and facilitates a large number of individual (or retail) investors to make small (but still important) financial contributions highlights the potential for mis-use. Retail investors need to absolutely accept that investing in start-ups or small businesses present high risks of financial loss. ASIC insolvency statistics confirm that the overwhelming number of corporate insolvencies are micro to small medium enterprises. As a Registered Liquidator, I see this frequently.

Whilst the regulatory framework in this Bill has been designed to balance the barriers for business seeking CSF with an adequate level of protection against risk and fraud for retail investors, only time will tell whether some CSF companies seek to take unfair advantage of this new form of funding. Some of the key requirements for those making a CSF offer are:

  • The offer must be for the issues of securities in the company making the offer [ie. can only be an unlisted public company limited by shares];
  • The company making the offer must be an “eligible CSF” company and its principal place of business must be in Australia;
  • The securities must satisfy the eligibility conditions [ie. a CSF company’s substantial purpose can’t be investing and it must have gross assets and turnover of < $25million respectively];
  • The offer must comply with the “issuer cap”. [ie. CSF companies can only seek to raise $5million in any 12 month period];
  • The company must not intend to use the funds obtained under the offer by it or a related company to invest in securities or interests in other entities or managed investment schemes.

Relevantly the CSF offer generally will not need to be as detailed as a prospectus and other disclosure documents.

All CSF offers will need to be made via the platform of a CSF intermediary and such intermediary will be required to hold an AFSL – thus there are some in-built protections to the retail investor, but dangers still lay in the quality of the offer and the individuals standing behind it.

The maximum cap per retail investor is $10,000 in any 12 month period and there is a 48 hour cooling-off period. Retail investors should ensure they do their due diligence if they may be seeking to invest via such platforms and try to make an objective assessment of the investment risk versus return scenario. And importantly remember, the bigger the return, the bigger the risk.

by Bruce Gleeson