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A Stockhead review of equity crowdfunding in Australia found the concept has yet to live up to the hype with at least seven businesses failing to reach their fund-raising targets and one going bankrupt before its campaign finished.

Today journalist Rachel Williamson looks at the response from regulators and investors.

Investors in equity-crowdfunded businesses should not be surprised if those businesses fail.

That’s the message from Australia’s corporate watchdog following a series of Stockhead articles that found the new fund-raising system was so far failing to live up to expectations.

Equity crowdfunding started in Australia earlier this year as a new way for early-stage companies to raise money without having to go cap-in-hand to professional venture capital investors or to the ASX.

Under licence from the regulator, businesses can raise up to $5 million from everyday investors, who can each put in up to $10,000.

Stockhead revealed last week that so far seven of 17 equity Australian crowdfunding campaigns had failed and one company even went bankrupt before it finished.

But such failures are not surprising to Australian Securities and Investments Commission commissioner John Price.

“Our view is the Australian experience with the new equity crowd funding laws is not out of line with the experience seen in many other jurisdictions,” Mr Price told Stockhead.

“Crowd funding is often used by early stage businesses with no track record. That may mean it is difficult to raise the funds needed or if the funds are raised that the business later fails.

“It is still early days to make any more considered assessments.”

However Mr Price said the watchdog would take into account Australia’s experience of crowd-funding to date ahead of a broadening of the scheme this month.

“We also need to consider, in due course, the impact the recent law changes to enable proprietary company CSEF [Crowd-Sourced Equity Funding] offerings from late October.”

Flood gates to open

Later this month crowd-funding — now only open to public companies — will open up to private companies with revenue up to $25 million, allowing campaigns of up to $5 million.

That worries some investment professionals because it could encourage a flood of fund-raising campaigns from businesses that have been rejected by venture capitalists or the ASX.

One professional investor who declined to be named, told Stockhead the move could bring “an avalanche of tears”.

“When [private companies] can play there’s going to be so much crap that goes onto these equity crowdfunding platforms,” said the investor.

A spokesperson from the ASX said the stock exchange commonly rejected listing applications from companies that were under-prepared.

“Our listings team spends a large portion of its time discouraging companies from listing too soon,” the ASX spokesperson said.

“ASX generally supports the [crowd-funding] regime as another option for start-ups to access capital at a point where they’re not ready for listing.

“[But] it’s important for the crowd funding regime’s credibility that appropriate disclosure arrangements are in place to protect retail investors.”

Venture Capital rejects

Grant Chamberlain, principal at venture capital fund OneVenture, has concerns that companies ending up on crowdfunding platforms will be the ones VCs have already passed on.

Stockhead has confirmed this is the case for at least two of the 17 companies we looked at.

Mr Chamberlain believes equity crowdfunding can be good as a marketing tool to acquire customers, such as neo-bank Xinja which gained more than 800 retail investors (though almost 400 sophisticated investors accounted for the bulk of their raise).

CPA Australia’s head of policy Paul Drum says crowdfunded equity may not be the right kind of money for most companies — and could be very risky for investors.

“The issue is whether they should be shopping around to see if it’s the best option for them to raise funds,” Mr Drum told Stockhead.

“Given long-term aspirations, is the long-term cost to them greater than if they’d just taken a debt instrument?

“For the investor there is a higher degree of risk, I would suggest here, than other forms of investments.”

Retail investors are allowed to put in a minimum amount specified by the fundraiser — often about $250 — up to a maximum of $10,000.

However there’s little to stop an investor from dumping in more than $10,000 by using different email addresses.

Valuation concerns

One common concern among corporate advisors is that crowdfunded companies are not being valued realistically.

Valuations set during an Initial Public Offering are set by brokers or other experienced hands, who look at everything from peer comparisons to cash-flow models.

OneVenture’s Grant Chamberlain says he has experts audit a company’s “tech stack” or have accountants “scrub” the books.

With equity crowdfunding, a company may effectively set its own valuation.

Xinja — which ran a successful crowd-funded campaign — raised money at a $40.1 million valuation. Yet it was still testing the tech, had no product and no customers.

The heads of the most prolific crowd-funding platforms, OnMarket, Equitise and Birchal, all say they review the valuations but do not do, or require companies to do proper valuations partly because it would be too expensive.

Equitise managing director Chris Gilbert, however, said he forced crowd-funded movie tickets reseller Choovie to halve its valuation to $2.5m — it last raised at $4m — and was negotiating with an electric scooter company that wants to raise via equity crowdfunding with a valuation that was “way too high”.

Businesses that raise at sky-high valuations may have to deal with disgruntled investors if more money must be later raised at lower prices  — a so-called “downround”.

Heading for the exit

Crowdfunded business aiming for a later ASX-listing may face particular challenges said Morgan Barron, a partner at corporate advisory Ventnor Capital.

“Crowdfunded companies coming to ASX need to be mindful of the end product – does the valuation stack up?,” Mr Barron said.

“Do they have the right shareholders on the register?

“If the product isn’t right and the capital structure isn’t fit for ASX it may result in a disappointing listing which potentially impacts management reputations, changes to the board and an inability to raise capital in the future.”

Ventnor Capital is one of the only Australian advisors to have relevant experience with a crowdfunded company coming to the ASX, as they worked with Croplogic (ASX:CLI) on its IPO.

Croplogic tried equity crowdfunding in New Zealand.

The IPO in September 2017 at 20c was a disappointment and investors have sold off the stock, which reached a low of 2.1c last week.