By Gareth Vaughan
Light touch, too easy and too lax.
These were three ways New Zealand's equity crowdfunding regime was described in a recent Australian Financial Review article. They're not descriptions that fill you with confidence, making crowdfunding sound like the new wild west of the NZ investment scene.
So let's take a look.
The Government gave the Financial Markets Authority (FMA) the power to grant crowdfunding licences through the Financial Markets Conduct Act 2013. To date five licences have been awarded with the recipients being PledgeMe, Snowball Effect, Crowdcube, Equitise and My Angel Investment.
Then Commerce Minister Craig Foss trumpeted the awarding of the first crowdfunding licences last July, saying NZ needed more innovative businesses to increase economic growth and this was one way for early stage and growth companies to source the risk capital they need to flourish.
NZ was leading the way in the Asia-Pacific region with a "robust framework" that would give these services the best chance of succeeding, Foss boasted. And, according to Foss, the initiative was part of the Government’s Business Growth Agenda to build NZ’s capital markets and drive business growth, exports and jobs.
$8.3mln raised to date
According to the NZ Crowdfunding Association, to date we've had 14 companies raise $8.3 million via campaigns on licensed NZ equity crowdfunders. Note, by equity crowdfunding I'm talking about money obtained by companies from investors via crowdfunding platforms to fund their business. We're not talking about donations or charity crowdfunding here.
Equity crowdfunding is a fledgling industry in NZ and there's plenty of pro-active public relations about it and upbeat media coverage on funky companies and entrepreneurs with big dreams raising money. To my somewhat cynical Generation X eyes some of this comes across as predictions of endless blue skies being peddled by smiling Gen Yers. Perhaps we can blame the Dot-com bubble for this, but I digress.
So just what are the punters investing in companies via crowdfunding getting themselves into?
They're buying shares in a small or start-up business and thus becoming a part owner. That means they take on all the risk, and potential rewards, alongside the other shareholders. It's not like buying bonds or putting your money in bank term deposits. There'll be no interest paid to you by the company for the privilege of getting your money. And unlike buying shares in an established, sharemarket listed business, there's unlikely to be any dividends paid for a considerable time, if at all.
The companies seeking money through NZ crowdfunding platforms aren't required to publish audited financial accounts, and there are no ongoing reporting requirements. And the FMA points out it doesn't check the companies raising money through crowdfunding, rather it merely checks and licences the crowdfunding service provider. Here's the FMA's conditions for crowdfunding licences.
Selling your shares, should you wish to, could be difficult, and investing in new or rapidly growing companies can be a speculative punt, with the real risk of losing your money.
"We won't be able to help you get your money back if the company fails," the FMA warns.
Licensed crowdfunding services must have systems in place to run "some basic checks" on the companies who want to raise money, including checking company senior managers or directors aren't bankrupt, or that they don't have convictions for fraud or dishonesty. They must also have a system in place to handle complaints and belong to an independent dispute resolution scheme.
And, by law, the companies raising money are supposed to be truthful about who they are and what they're planning to use the money for. Here's more crowdfunding information from the FMA.
All the crowdfunding platforms carry warnings for investors. The Snowball Effect one here is very detailed.
And here's what PledgeMe says;
Equity crowd funding is risky. Issuers using this facility include new or rapidly growing ventures. Investment in these types of business is very speculative and carries high risks. You may lose your entire investment, and must be in a position to bear this risk without undue hardship. New Zealand law normally requires people who offer financial products to give information to investors before they invest. This requires those offering financial products to have disclosed information that is important for investors to make an informed decision. The usual rules do not apply to offers by issuers using this facility. As a result, you may not be given all the information usually required. You will also have fewer other legal protections for this investment. Ask questions, read all information given carefully, and seek independent financial advice before committing yourself.
The International Organization of Securities Commissions, or IOSCO has published a working paper on crowd funding. This includes a sobering case study.
Bubble and Balm was a fair trade soap company. In 2011 it became the first company to raise funding for its start-up through the equity crowd-funding platform Crowdcube, based in the UK. It raised £75,000 from 82 investors, who each contributed between £10 and £7,500 in return for 15 per cent of the company’s equity.44 In July 2013 the business closed overnight, leaving investors with no way of contacting the company or to recover losses. The investors lost 100% of their investment.
IOSCO also notes there probably won't be a secondary market for the equity of start-up companies and the equity itself is difficult to value. It goes on to discuss investor protection.
As most are private companies, start-ups face no requirements for disclosure or transparency. And if the company does survive its stock is likely to be diluted through further issues. Generally, the only realistic chance an investor has of liquidating their holding in a start-up investment is if the company survives until a public float. But the probability to do this is not high given the high attrition rate among start-up companies.
Liquidity risk will depend on the type of investors involved. In essence the lack of liquidity is similar to other seed capital investments such as private equity. If the investors have experience with low liquidity investments, and are aware of the risks of being locked-in, the lack of liquidity will be of little concern. However, if the investors in equity crowd-funding are inexperienced and unaware, they might overreact in times of stressed market conditions or difficult personal circumstances.
This raises concerns about investor protection and has led to many jurisdictions placing limits on who can invest in such equity. In some cases platforms are only allowed to market to sophisticated investors, and/or are limited to the number of individuals such investments can be marketed to.
Interactive & transparent
On the opposite side of the coin investing in a small company with big ambitions could get you in at, or near, the ground floor in what might one day turn out to be a big, successful business.
PledgeMe lists, as the benefits of crowdfunding; democratised funding decisions, lowering the barriers for companies to seek funding and for investors to invest, more transparency, making the process easier, widening the reach, being more interactive, creating long term relationships with investors. And points out "you could make a return."
PledgeMe also points out crowdfunding makes it easier for investors to invest.
"All you have to do is register with us (so we can check you are really a person!) and then pledge to the campaign you want to invest in."
So what about the companies raising money, or seeking to raise money, through crowdfunding? They're a diverse bunch. For example, whilst working on this article three press releases landed in my email inbox promoting new crowdfunding campaigns. One's about Red Witch, a maker of guitar effects pedals, another's about vegan food company Angel Food, and the third is about taxi application, Tapp a Taxi.
The most a company can seek to raise through equity crowdfunding is $2 million in any 12 month period. There's no legislative restriction on how much a person can invest through a crowdfunding platform within any given time period. However, licensed crowdfunding providers are able to impose their own limits.
Vouchers with your shareholding
Mad Group is one of the companies currently seeking to raise money through crowdfunding. It's the operator of the Habitual Fix and Mad Mex food stores.
Mad Group is looking to raise at least $750,000,and up to $1.5 million through the sale of between 7.11% and 13.27% of the company's equity. Mad Group has provided quite a lot of financial information including financial projections out to 2018 and details on potential exit strategies for the current shareholders.
It outlines what it plans to use the money raised for and provides information on how Mad Group's board values the business. It also includes offers of vouchers for investors to use in the group's stores.
Mad Group's chairman and group managing director James Tucker tells me the financials haven't been independently audited, but the annual accounts and tax filings are prepared by external accountants.
"These projections were prepared by Mad Group and then reviewed and tested by our external accountants, which was a requirement of Snowball Effect. All up we've spent about $25,000 on external advisors and many months of our time to get the offer live on Snowball," Tucker said.
The Retirement Income Group, which has just successfully sold 3.3% of itself through Equitise raising $455,300, plans to use the money raised to fund working capital and to meet Reserve Bank insurance solvency capital requirements.
What those who've bought into the Retirement Income Group have bought are so-called Class B shares, which give the owners the same economic rights as ordinary shares, i.e. the same risk and reward potential as everyone else, but no voting rights to try and change things if they become unhappy.
Financial information available from the Retirement Income Group includes forecasts out to 2021 by which point the company expects to deliver a net profit after tax of just under $5.5 million.
'The process is made too easy in New Zealand'
The aforementioned AFR article quotes Chris Gilbert, who is co-founder of the Sydney-based Equitise, in a discussion about what Australian regulations should look like. He reckons the NZ regime is too lax and has apparently lobbied the Australian government for a tougher regime over there.
"The thing that scares me is that the process is made too easy in New Zealand," Gilbert is quoted saying in the AFR article. "It should be difficult to get a licence to operate an equity crowdfunding platform. We don't want to make it too loose with what's required [in Australia] because that could result in Ponzis going through. We don't want retail investors to be fleeced."
But it doesn't sound like his concerns will be addressed. In a separate, later, article the AFR quoted Australia's Communications Minister Malcolm Turnbull blaming bureaucrats for delaying crowdfunding legislation. And it appears Turnbull wants to copy NZ lock, stock and barrel.
"I'm very attracted to just taking the New Zealand law, deleting New Zealand and inserting Australia. Imitation is the sincerest form of flattery and I'm happy to flatter the Kiwis as much as we can on this one," the AFR reported Turnbull saying.
Yet another AFR article says Aussie entrepreneurs are divided over the Productivity Commission's recommendation for a two-tiered approach to crowdfunding separating sophisticated investors from 'mum and dad' retail investors.
'Not without restrictions'
Closer to home, what does our government make of its crowdfunding regime being described as a light touch and lax? I asked Commerce and Consumer Affairs Minister Paul Goldsmith.
Via a spokesman, Goldsmith said equity crowdfunding in NZ isn't without restrictions. There were no plans to require the provision of audited financial accounts, he added.
"However, an equity crowdfunding platform could require the provision of audited financial accounts as a condition of the service. This reflects the approach of giving platforms flexibility to develop an appropriate mix of mechanisms to meet the regulatory objectives," Goldsmith's spokesman said.
Goldsmith also notes that an investor’s confirmation, which the provider must obtain from each investor, must state they understand the risky nature of crowdfunding, that they may lose their investment and that they could bear that loss without undue hardship.
Ask lots of questions
In the internet and social media age, equity crowdfunding is here to stay. Albeit perhaps, and hopefully, with stricter regulations over time. Independently audited accounts would be a good start. Hopefully both NZ companies and NZ investors will, on the whole, have a good experience. But there will be business failures and investors will lose money.
A concern I have is some companies may turn to crowdfunding because they can't raise money anywhere else.
I'm not a financial adviser. But for those considering investing via crowdfunding it seems key to me to really believe in the company's management, and preferably also in their business plans. If you're not sure, go and meet them, look them in the eyes and ask lots of questions.