Avoid a crowd-sourced equity disaster

I’ve got a checklist.

Legislation supporting CSEF has been passed by more than 15 countries and this year Australia’s Parliament passed legislation allowing unlisted public companies to advertise their campaigns on licensed crowdfunding portals and raise up to $5 million a year.

Investors earning less than $250,000 a year and owning less than $2.5 million in assets would be limited to investing $10,000 per company per year. However, by restricting CSEF to unlisted public companies, this precluded 99.7 per cent of Australian businesses, mainly private SMEs and start-ups, from accessing crowdsourced funding.

As a result, Treasurer Scott Morrison has announced new CSEF legislation which aims to relax the earlier laws. This new bill will allow CSEF platforms to advertise offers from private proprietary companies, allowing the public to invest in a much larger range of businesses, including start-ups and SMEs. Private companies will now be able to raise up to $3 million through CSEF platforms before requiring an annual audit of their financial statements. These investments will be made on ASIC-licensed crowdsourcing platforms.

The last few years have seen the rise of crowd-sourced equity funding (CSEF). Hailed by entrepreneurs and investors as a democratic form of investing, it allows the public to invest in fledgling businesses that have previously been the domain of high net-worth individuals, family offices and professional investors.

In light of Guvera’s downfall, after 3000 Australian “mum-and-dad” investors poured $180 million into the failed music streaming start-up, proponents of the new CSEF regime should be wary. While the new regime opens the door for the public to invest in a range of businesses, investors and CSEF platforms must exercise caution, as irresponsibility is likely to lead to disaster.

Portfolio approach

Firstly

Investors need to approach CSEF investments the same way they would any other investment, be it a listed company or property trust on the ASX. While there is a $10,000 limit each investor can make per company each year, there’s no limit on the number of companies for an investor.

Investors should consider adopting a portfolio approach, ensuring all their eggs aren’t in one basket. Investing $10,000 in only one company is akin to drawing only one horse in a Melbourne Cup sweepstake. If the company does well, the investment may provide a manifold return. But the historical performance of start-ups suggests many fail. Spreading investments across a range of companies will achieve a level of diversification. While you may sacrifice some absolute return, you’re also likely to limit losses.

Investors should also do their homework on target investments. For start-ups, this involves assessing their current levels of traction and product-market fit. Chatting with existing or potential customers can be helpful too. While time-consuming, proper homework may save significant heartache later.

CSEF platforms have a responsibility to develop and enforce a systematic screening process before allowing private companies to run campaigns on their platforms. Minimum requirements over and above the checking of directors’ and founders’ bona fides is a must.

These platforms should provide a high level of transparency around the companies seeking funding, such as backgrounds of founders, historical financial statements, business plans and forecasts. Platforms should demand companies provide high levels of information to allow investors to make informed decisions. They should also work with companies to ensure investors receive an appropriate flow of information post-investment. It’s very likely companies will require additional rounds of capital so maintaining strong relationships with investors will increase the chances of being funded for future success.

Though the promise of CSEF is unlimited, especially for start-ups, it’s critical investors and platforms don’t lose their heads in the rush to invest and attract investors.