CrowdFunding for high-risk start-up investments

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By Mahesh Sharma

As the government considers whether to introduce new legislation allowing groups of punters to buy equity stakes in start-up companies, a local venture capital firm will launch an equity-based crowdfunding website for high net-worth individuals to collectively invest in early-stage, high-risk ventures.

In February, Artesian Venture Partners will launch VentureCrowd, a marketplace for investors to buy stakes in early-stage companies sourced from 18 different partners, including Blackbird Ventures, start-up accelerator Startmate, and incubator BlueChilli. Artesian also manages the investment funds on behalf of some of its partners.

Artesian managing partner Jeremy Colless said that because of current regulations, only wholesale not retail, investors were easily able to participate in online equity-based crowdfunding. In this way the website was simply an extension of Artesian’s existing venture capital business, he said.

While VentureCrowd screens the companies sourced from its partners, it is still a “high-risk, high-return” proposition. “More than 50 per cent of start-ups fail and the risk distribution of the asset class is asymmetrically skewed, with 90 per cent of returns coming from the top 10 per cent of start-ups,” Mr Colless said.

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“A limited capital allocation and a properly diversified early-stage securities portfolio are important strategies to mitigating the risk of loss to investors of invested capital, and maximising the opportunity for gains.”

In December, the Corporations and Markets Advisory Committee published the 39 submissions to the government’s review of crowdsourced equity funding, which is considering relaxing the Corporations Act to allow individuals, who aren’t typical venture investors, to buy equity in a start-up or small company. For example, 1000 individuals could buy a $1 share each in a company aiming to raise $1000.

The review asks whether Australia should follow the lead of the US, Britain and Canada, and allow companies to sell equity to a large group of unqualified investors.

A crowdsourced equity funding regime could inject large amounts of capital into early-stage start-ups, and was supported by most respondents, including the Australian Securities Exchange and Australian crowdfunding website Pozible, law firms and start-ups.

However, a few aren’t buying the hype. Dr Marina Nehme, senior lecturer at the University of Western Sydney school of law, said deregulation would negatively affect the three key objectives of securities regulation: protecting investors; ensuring market fairness, efficiency and transparency; and reducing systematic risk.

She said it would increase fraud. “Certain crowdfunding platform providers have dismissed this risk by noting that the ‘wisdom of the crowd’ would help discover potential fraudulent projects,” Dr Nehme wrote in her submission.

“As such, certain platform providers only check whether the entrepreneur behind the project has a profile on social media. No other check about the veracity of their claim is done. This would, of course, raise the risk of potential scams.

“When a scam occurs, confidence in the system is shaken and regulators will be at the front of the firing line. Additionally, honest entrepreneurs will be negatively impacted.”

Elaine Liew, a senior associate solicitor at HWL Ebsworth Lawyers, believes the risks to uninformed investors outweigh the benefits to start-ups. “It may be more suitable for such business projects to raise funds through non-financial product means until they grow to a sufficient commercial standing that it can raise funds [in] the more traditional way,” she said.

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