ECF

CYGNUS LAW’S GUIDE TO EQUITY CROWDFUNDING

Equity crowdfunding (ECF) is an easier alternative to traditional public share offers for companies seeking to raise up to $2m from the general public to grow their businesses.

In this guide we provide information on legal factors you may need to consider when getting ready for, and running, an ECF campaign.

As well as legal factors, there are other important factors to a successful ECF campaign including finding the right platform, getting your marketing strategy right and engaging with your crowd. The ECF platforms will be able to help you with some of those things.

If you’d like to know more please contact Simon Papa (+64 (0)22 644 7193, simon@cygnuslaw.nz) or Judy Zhou (+64 (0)27 8866 010, judy@cygnuslaw.nz). 中文服务请联系Judy.

If you’re thinking of investing in a crowdfunded company you can find guidance on the Financial Markets Authority’s website.

Important Note: This guide provides summary information only, does not cover all potential legal matters & is not legal advice.  Cygnus Law’s T&Cs apply.  This guide considers crowdfunding by a New Zealand company that operates from New Zealand and that is planning to use a New Zealand-licensed ECF platform.

What is Equity Crowdfunding?

Equity crowdfunding (ECF) in this guide is about companies that raise capital by offering new shares to investors via NZ-licensed online platforms. ECF provides an opportunity to obtain investment from a large number of investors who invest relatively small amounts.  What sets equity crowdfunding apart from other ways of raising capital is that it is a fairly easy and cost-effective way to offer shares to the general public.

ECF in this form became possible in 2014. Since then dozens of companies have successfully raised capital using ECF through NZ-licensed platforms.

ECF is different from rewards and donations-based crowdfunding, which do not provide for investments. Instead they involve either getting a reward (e.g. a concert ticket, a book) for a financial contribution or simply giving to a good cause.

ECF is just one way that companies can raise capital.  There are many other potential options including funding from founders, angel investors, government grants and bank loans.

Who can equity crowdfund?

Only companies (from NZ and overseas) can equity crowdfund through the NZ-licensed platforms. ECF can be used by companies in a wide range of businesses and of varying sizes. ECF is particularly popular with technology companies and companies with strong consumer brands (e.g. food & beverage businesses).

Can social enterprises equity crowdfund?

Only companies can equity crowdfund via licensed platforms. Directors of NZ companies are mostly required to act in the best interests of shareholders.  Unlike countries such as the United States (with its “B Corporation” regime), there is no form of New Zealand company that can have, as a key goal, providing a public benefit. However, a New Zealand company can legitimately seek to support good causes (e.g. environmental, social) where that forms part of its business model.

Why should I use equity crowdfunding?

The key benefit of ECF is that you get an exemption from the quite stringent legal obligations for public share offers, including those relating to disclosure (there are other exemptions available but they don’t support offers to the general public). This means that it is generally simpler and cheaper to run an ECF campaign, compared to a traditional public share offer. To benefit from the exemption you have to make the offer via a NZ-licensed platform.  ECF can provide other potential benefits, including as a way to:

  • promote your products or services, and brand, to a wider audience
  • attract passionate shareholder customers who may act as brand champions
  • identify and reward loyal customers through discounts & other benefits linked to the shares
  • provide greater focus for the business.

The platforms themselves can provide added benefit, including because they provide:

  • online tools that simplify the share offer process
  • support to get the company ready for an offer
  • access to the platform’s own “crowd” who may invest in your offer.

The ECF process can have benefits even if you don’t go through with an offer or if the offer isn’t successful. The process of getting investment ready will, in itself, likely help you to focus more on the business’ future, and to prepare the business for its next steps.

How much can I raise using ECF?

A company can raise up to $2m in any 12 month period via ECF on a licensed platform (you may also be able to raise additional capital through other channels at the same time). There are no caps on how much each investor can invest. There are some additional conditions- see the more detailed How much can I raise? section below for more information.

What are the limitations on equity crowdfunding?

In addition to the $2m cap, there are other legal limitations on offers made via ECF, including:

  • You can only offer shares in a company.
  • You cannot offer options to buy shares or other types of convertible securities (including shares that can convert into another type of security).
  • You cannot sell existing shares using ECF- you can only issue new shares (see How Do I Manage Post-Offer Share Sales? for information on share sales).
  • The funds raised cannot be used solely to purchase shares (or other financial products) except shares that could otherwise be offered using ECF (see the “nominee company” condition in the standard conditions for crowdfunding platforms- an exemption to that might be available in special cases).
  • “Investment companies” are prevented from using ECF when they offer certain classes of shares or have certain types of entrenched service providers. An “investment company” is, in broad terms, a company that invests in financial assets or real estate.  The FMA interprets “investment company” to cover a company that carries out property development, including new builds for sale.  However, property-based crowdfunded offers are possible. The FMA has an “information sheet” for platforms that want to support property-based offers- potential offerors may find it helpful also.
  • The ECF exemption (discussed under Why Should I Use Equity Crowdfunding? above) only applies to offers to people in New Zealand (see the Can I Offer Shares Outside New Zealand? section for information on making offers outside New Zealand).

What should I tell potential investors?

You need to provide investors with summary information that presents a “fair view” of the company, the business and your plans for the investment. That information should be presented in a way that’s easy to understand. See the Disclosure to Investors sections for more information on what you can and should tell potential investors.

Which platform should I use?

Each platform has a particular market focus, way of operating and special features. It’s best to do research and to talk to the platforms, to see which is the best fit for you. The NZ-licensed platforms are:

Each platform has its own terms & conditions – we briefly consider some common terms & conditions in the What Do Equity Crowdfunding Platforms Do? section.

Do I need professional help?

Yes. While ECF is relatively simple (compared to traditional public offers) there are basic things you need to get right, including in relation to issuing new shares and disclosure of financial information. In some cases there may be benefit in getting help with other aspects of an offer e.g. in relation to marketing (including help to produce a video).

A company can raise up to $2m in any 12 month period via ECF on a NZ-licensed platform. The $2m cap includes any amounts raised in the same period in reliance on the “small offers” and/or P2P lending exemptions.

There are no limits on how much you can raise from each individual investor, subject to the overall $2m cap.

You can raise additional funds in the same offer, beyond those limits. You will need to do that in reliance on other exemptions from full legal obligations for share offers. The FMA provides information on the exemptions that are potentially available.

You need to make an offer on a NZ-licensed ECF platform to get the benefit of the ECF exemption (see Why should I use equity crowdfunding?). You use a platform to list and promote your offer on-line. Platforms have functions that allow you to provide information to investors and that allow investors to invest. Each platform is different. Some are relatively “hands off” and will leave it mostly to you to get ready. Others will get more closely involved in the offer. Platforms may help to promote the offer through their own crowd.

Some platforms also host private offers, that is offers that don’t rely on the ECF exemption and that are only open to investors who meet certain criteria.

Platform Fees

The platforms earn revenue by charging the company making the offer a success fee, usually a percentage of the capital raised (investors don’t usually pay a fee). The platform may charge other fees including a one-off application fee (which may be refundable, if the offer succeeds). Check with the platform at the outset about fees.

Platform Terms & Conditions

Each platform has its own terms and conditions. Key T&Cs may include minimum disclosure obligations and an exclusivity period. Platforms typically want exclusivity for share offers during the offer period and for a period of time after that- a break fee may be payable if exclusivity is not honoured.

Some platforms may seek a commitment from the offeror company to have at least one independent director. While independent directors can play an important role, in some cases it can be difficult to find independent directors, especially if the company is at an early stage. An independent director is a member of a company’s board of directors who has no other material relationship with the company or related people e.g. key shareholders.

Due Diligence, Disclosure & Warnings

Platforms are required by law to carry out some checks on the offeror company and its directors & senior managers. The checks include confirming identity and identifying potential character issues e.g. previous personal bankruptcy.

Platforms are required to provide the potential investors with a disclosure statement that includes detailed information about how the platform operates. Platforms are also required to provide a warning statement to potential investors, which highlights that ECF can be risky and that investors may lose their whole investment.

Platforms must also carry out anti-money laundering checks on the company and investors, including verifying the identity of investors.

Investor Funds

The platform holds all payments made by investors until the offer successfully closes and the company confirms it has issued the shares to investors (see How Do I Complete A Crowdfunded Offer? for more information). Platforms usually keep any interest earned on the investor funds during the offer period.

You will need to take steps to get your company ready for investment. From a legal perspective that means making sure that the share register is up-to-date and that key contractual and legal matters are in order. The best time to make any changes in those areas is before an offer is made. It can be harder (or impossible) to make changes once crowdfunded investors are on-board.

Share register

You need to be 100% confident that the share register includes all shareholders and their correct shareholdings. You should check that there are no outstanding obligations to issue shares or other types of security. A common example is a promise to give shares to an employee or contractor (“sweat equity”). You need to give potential investors details of any shares (or other securities) you may be obliged to issue in the future e.g. via an employee share option.

Business considerations

You should consider whether there are any outstanding issues with the business that may cause potential investors concern or that should be disclosed. For example, if key software is owned by a director you may need to consider transferring ownership of the software to the company. If you don’t transfer ownership in that example it’s likely you’ll need to explain to potential investors the arrangement between the company and the director.

It may help to tidy up financial matters. For example, it may help if the company repays loans from shareholders or converts them to shares.

Pre-offer restructure & share issue

If your company hasn’t had outside investment before it may need to issue more shares pre-offer. That’s because there are usually too few shares (e.g. 100 or 1,000) to allow you to issue enough new shares to investors. Investor shares are often issued at a price of $1.00 per share (that makes the maths easier for everyone). The number of shares issued pre-offer is usually equal to the pre-offer value less the value of shares already issued (assuming all shares are worth $1.00 per share). For example, if the company has 100 shares and a pre-offer value of $1.2 million, the existing shareholders will issue a further 1,199,900 shares to themselves to make a total of 1.2 million shares pre-offer.

To be legally effective pre-offer shareholding changes need to be properly approved by the company. That will include passing board resolutions and possibly shareholder resolutions or approvals. Your legal adviser will be able to help with that.

Constitution

A constitution sets out additional rules for the company and its shareholders. It’s important to have an appropriate constitution in place before an offer is made, since it provides additional flexibility in relation to issuing new shares and other matters. Your company may have an existing constitution but that may not be appropriate for a crowdfunded company. For example, the existing constitution may give existing shareholders the first right to purchase new shares – some crowdfunded companies prefer to have freely tradeable shares.

Due diligence

Due diligence in relation to ECF is the process of reviewing the company and business to check that everything is in order and to identify any matters that may need to be resolved and/or disclosed. The due diligence process is important and supports you to get investment ready, to prepare offer information and to make sure that information you disclose presents a “fair view”. How you run the due diligence process is up to you- it doesn’t need to be particularly formal (but for larger businesses it would be advisable to be fairly organised). If you founded and run the business it’s likely you’re already familiar with most (if not all) aspects of the company and business. So you’re best placed to identify any matters that may need to be resolved and to decide what needs to be disclosed to investors. You can seek help from advisers, who may be able to validate some information. For example an accountant can help to review and validate the financial information (more on that in the Disclosure to Investors- How Do I Disclose Financial Information? section). Your lawyer can help you also.

A key question that will arise is- what class of shares should you offer to investors? The default share class is ordinary shares. You can also offer non-voting shares, preference shares and other classes of share (though there are limits on that e.g. with respect to some “investment companies”- see What are the limitations on equity crowdfunding? for more information). Ordinary shares and non-voting shares are the most common share types offered via ECF. You can offer more than one type of share in the same offer e.g. non-voting shares for smaller investors and voting shares for larger investors.

Non-voting shares usually have the same economic rights (rights to receive dividends) as ordinary shares but cannot vote on most matters affecting the company including on appointment (and removal) of directors. A key factor favouring non-voting shares is company financial reporting and takeover law:

  • Any company with 10 or more voting shareholders is required to prepare audited financial statements annually as well as meeting some other reporting obligations. While there’s a lot to be said for giving investors the confidence of audited financial statements, for smaller companies the cost and effort of preparing them may be significant.
  • Takeover rules apply to any company with 50 or more voting shareholders (with some exceptions). Those rules may complicate simple share transfers and share issues. While there are other mechanisms to legitimately avoid the application of the takeover rules, keeping the number of voting shareholders below 50 is a simple way to do that.

Some platforms offer the option of using a nominee company. The nominee company is controlled by the platform and holds the shares issued via an equity crowdfunded offer on behalf of investors. The only new shareholder of the offeror company is the nominee company. This model has benefits including avoiding some potential takeover law requirements and simplifying administration but it also imposes some complexity and costs.

It’s likely the offeror company will need to have one or more of a subscription agreement, shareholders’ agreement and constitution before making the offer (see What Investor Agreements Do I Need? below)

It’s likely the company will need to have one or more of a subscription agreement, shareholders’ agreement and constitution before making the offer. See How Does The Company Get Investment Ready? for information on the constitution. Some platforms provide functionality that allow an investor to sign a subscription agreement and/or shareholders’ agreement when investing.

Subscription Agreement

A subscription agreement is the agreement between the company and investors for the issue of the new shares to the investors. The agreement deals with key matters such as the class of shares being offered, purchase price and payment & settlement terms. Some (but not all) platforms require that the offeror company has a subscription agreement. It’s generally advisable to have a subscription agreement. However, you could include the offer terms and conditions in other documents such as the IM.

Shareholders’ Agreement

A shareholders’ agreement deals with matters between shareholders including rights to appoint directors and whether some key business decisions need shareholder approval. If you have an existing shareholders’ agreement it’s likely it will need to be amended or replaced before crowdfunding.

A key benefit of a shareholders’ agreement is that it is private (unlike a constitution, which has to be placed on the online Companies Register). However, under a crowdfunded offer it isn’t possible to keep the shareholders’ agreement fully private. So a simple alternative option is to include relevant matters directly in the constitution. There are pros and cons in that approach that you can discuss with your lawyer.

Shareholder discounts and other benefits are commonly offered in equity crowdfunded offers, particularly by companies operating consumer businesses. There are be contractual, legal and tax considerations.

By law shareholder discounts (and potentially some types of benefit) must be formally approved by the board of directors before they are offered. The board has to be satisfied that the discount is fair & reasonable to the company and to all shareholders, and that the company will remain solvent after offering the discounts.

It’s advisable to include terms & conditions for the discounts or benefits in the offer.  Potential terms and conditions include that there is no cash alternative, the discount/benefit cannot be used in conjunction with other offers.

In some cases a shareholder discount or benefit may be treated as taxable income of the shareholder, because of its connection with the shareholding. There may be ways of addressing this including the company itself paying the tax on behalf of the shareholders. So it’s advisable to seek tax advice if you’re planning to offer discounts or benefits to shareholders.

Share offers made on NZ-licensed platforms are exempted from many of the usual share offer requirements in New Zealand.  That’s the key benefit of making an equity crowdfunded offer. However, investors outside of New Zealand are not covered by that exemption. On one hand New Zealand law doesn’t stop you from making equity crowdfunded offers outside New Zealand.  On the other hand it’s likely that the law in the country where an overseas investor is based will apply to a NZ share offer, even though everything may happen online. So, if you’re planning on finding investors outside New Zealand, seek advice on whether the offer, and acceptance of the offer, are permitted in the relevant countries.

While Australia has a somewhat similar equity crowdfunding regime, offers made on a NZ-licensed platform are not treated as a crowdfunding offer under Australian crowdfunding law (and vice versa).

To make a crowdfunded offer you’ll need to decide on the pre-offer value for the company. That value is important because it impacts on investor decisions and because it will determine how many shares will be issued (and therefore how much existing shareholders will be diluted). A valuation isn’t required by law but there are some legal considerations.

There are various ways to decide on the company value. For early stage companies traditional valuation methods (e.g. some form of revenue or profit multiplier) may not be very meaningful. Your accountant or other adviser may be able to help you to decide how to value the company and to assist with the valuation.

Whether the value you choose is appropriate is determined by the potential investors. However, legal considerations do come into play. The valuation method(s) you choose should be disclosed to investors and you should carry out the valuation in a fair way. For example, if you’ve based your valuation by reference to valuations of comparable companies, you need to be confident that you’ve carried out a valid comparison – that will include making sure that the other businesses are truly comparable and that the values for them come from reliable sources.

Directors owe duties to the company and, in some cases, to shareholders and third parties. Directors of a company that crowdfunds will need to pay closer attention to their directors’ duties. The law takes into account that directors need to be able to take appropriate business risks. So, for example, the failure of a company to meet targets set in its IM does not, in itself, mean that the company or its directors have acted inappropriately.

To meet their obligations at law with respect to share offers it’s important that the directors take steps to ensure that the information disclosed about the company, its business and the offer provides a “fair view” (see the Disclosure To Investors sections below for more information).

Directors can rely on appropriate professional advice in that process e.g. from an accountant. That reliance must be reasonable and a director must still maintain a general overview and question information provided. For example, a director is expected to read and understand the company’s financial statements prepared by an accountant. But the director isn’t usually expected to, for example, understand the details of the accounting policies that underpin the financial statements- the director can rely on the accountant to get that right (unless the director is an accountant).

An information memorandum (IM) is prepared for most offers. The IM includes key information about the company, the business and the offer. Some or all of the IM information is also posted on the platform offer pages. For information on disclosure obligations see Disclosure to Investors- How Do I Present a Fair View? and Disclosure to Investors- How Do I Disclose Financial Information? below.

There is no standard (or required) form of IM- each offer is different. Have a look at previous IMs (available on some platforms even after an offer has closed) for ideas. Your IM can present information in a positive way that reflects your culture and brand including through graphics & pictures. The Australian regulator ASIC has prepared a template IM for equity crowdfunded offers. While some content is only relevant to Australian crowdfunded offers it is a useful example of an IM outline.

Try not to get lost in the detail when you start writing the IM. It can help to start with a high-level statement about what you do and what you want to achieve, and then work from there. Due diligence (which we consider in the How Does The Company Get Investment Ready? section) will help you to identify information that should be disclosed.

Your IM will be unique to your company and business but there are key matters that are usually included. Key information that you are likely to include in your IM is:

  • Summary: Key offer information such as the nature of the business, minimum & maximum capital raise targets, price per-share, share class(es) offered, minimum investment amount, offer closing date and a brief summary of how the funds raised will be used. The summary page is likely to include a video.
  • Business: Key information on the business including products/services, history, business model, market (including information on market characteristics & competitors).
  • Use of funds: Information on your plans for the funds raised, identifying the areas where the funds will be applied. Offerors usually include a breakdown of how funds will be applied for both a minimum raise and a maximum raise (and for any specified targets in between).
  • Future Plans: You may set out plans for the future including any further capital raising (your plans have to be based on reasonable assumptions). With respect to exit plans (e.g. a future sale to a competitor after strong growth), you should present realistic scenarios. So, for example, while some companies have an ambition to eventually list on a stock exchange, given how few new listings actually occur in New Zealand, it’s unlikely (in most cases) that this can be included as a goal.
  • People: Biographies of key people in your business including the directors, CEO/GM and other senior managers. Make sure you state each person’s role or roles (e.g. director, marketing manager) and other relevant information.
  • Shares & Shareholders: Potential investors need to see a snapshot of the current shareholders and their holdings. You also need to show how many shares existing shareholders, and the new investors, will have after a successful raise (usually for at least two scenarios- a minimum and maximum raise). You should also disclose:
    o Anyone who has a right to be issued shares under share options and similar arrangements and key terms.
    o The class(es) of shares being offered including a summary of the rights attaching to those class(es) of shares (or otherwise refer to the relevant part of the constitution).
  • Risks:
    o All offerors disclose key risks associated with company and its business. The risks disclosed will depend very much on the nature of the company, the business, the market and other factors. The directors and senior management are best placed to assess and describe risks. The risks should be those that are significant for the company and business.
    o The IM may also outline potential mitigating factors for specific risks. However, statements about those mitigating factors need to be balanced and not exaggerate their effectiveness. Take care not to suggest that mitigating factors largely or completely eliminate risk unless you can validate that with strong evidence. If your mitigants lead you to conclude that the business faces few, or no, real risks then you’re likely exaggerating the impact of the mitigants.
  • Related party disclosures: There is no specific obligation to disclose related party matters. But there is a risk that the offer may be misleading if such disclosure is not made. Examples of related party matters include that a director owes money to the company, a director owns key intellectual property that is used by the company.
  • Financial Information (and valuation): IMs always include financial information, usually both historic and forecast.  For more information see the Disclosure to Investors – How Do I Disclose Financial Information?
Introduction to Disclosure Rules

Details about an offer are included on the platform including via an information memorandum (“IM”). We consider IM content above (see Disclosure to Investors – How Do I Prepare An Information Memorandum?). Offer information can be provided to potential investors in numerous other ways including via a Q&A function on the platform’s website, at meetings, in emails and on social media.

Potential investors are looking for (and must be provided with) summary information that presents a “fair view” of the company, the business and the plans for the investment funds. That information should be presented in a way that’s easy to understand- for example it’s usually best to avoid using jargon that potential investors may not understand. You don’t need to provide lots of detail- try to summarise information in a clear way so investors can come away with a good understanding.

We explain below, and in the Disclosure to Investors- How Do I Disclose Financial Information? section, key disclosure obligations in more detail.

What is “fair dealing”?

“Fair dealing” rules govern what you can say about a company and its offer, and how the offer is conducted. The rules apply to statements and conduct in New Zealand and in other countries.

In broad terms the fair dealing rules say that statements about an offer must not:

Fair dealing rules prohibit misleading or deceptive statements in relation to a wide variety of specific matters including statements about quality, quantity, the existence of approvals & endorsements, existing agreements to acquire, rights at law e.g. under the Consumer Guarantees Act.

We consider the meaning of “misleading”, “deceptive” and “unsubstantiated representation” below.

Who is responsible for fair dealing compliance?

The company is responsible for compliance with fair dealing rules. Directors must also support compliance and may have liability in some circumstances, if the company is non-compliant.  There are strong penalties for non-compliance.

Disclaimers about the offer, and the offer information, are unlikely to completely protect the company and its directors from responsibility for disclosures – the primary focus should be on making sure that the information disclosed complies with the fair dealing rules.

What do “misleading” & “deceptive” mean?

There isn’t a fixed definition of “misleading” or “deceptive” – whether a particular statement, or particular conduct, is misleading or deceptive always very much depends on the specific circumstances. Some key considerations are:

  • Silence, omissions and “half-truths” can constitute a fair dealing breach.  Something may be literally true but can still be misleading, if you omit to mention other relevant information. For example, while it may be strictly true to say that a company currently has “sufficient cash reserves” for future operations, it’s likely to be misleading if the company fails to mention it has had problems previously with its cash forecasts and has an on-going deterioration in cash balances.
  • You have to take into account people from a wide variety of backgrounds. That means it’s the average person you need to consider when preparing offer information, not someone with quite a lot of knowledge and experience (but you don’t need to factor in someone who has extreme or fanciful interpretations of what you’re saying).  Statements made to a more sophisticated person (e.g. an experienced business person) may be less likely to be misleading or deceptive (in comparison to statements made to a less experienced person). However, in a crowdfunded offer you should assume that there will be a wide cross-section of people who may consider investing in the offer.
  • You may not be able to fix a misleading “dominant” message by qualifying it later in the same document or in a separate document. For example, a company says on the first page of its IM that it has “1,200 CUSTOMERS”. If this is a key selling point it may be misleading if the company only mentions on page 22 of the IM that 850 of those customers are on a free trial and it’s likely that a significant number will not become paying customers.
  • A statement can be proven to be misleading or deceptive without needing to show a specific person was misled or deceived. So when preparing IM, and promoting the offer, the focus should be on whether a statement complies with the law, not on whether it’s likely that a particular individual may be misled or deceived by it.

The FMA has a relevant guide called Fair dealing in advertising and communications – crowdfunding and peer-to-peer lending.  The guide notes that:

Terms like ‘safe’, ‘relatively secure investment’, ‘limited poor returns’, ‘guaranteed’, ‘inflation proof’, ‘recession proof’ and ‘highly liquid’ can give the impression that investors are immune to losing their investment and that returns are guaranteed. These terms should be avoided.

It is advisable to avoid statements about the offer that imply scarcity, e.g. “limited availability” or “rare investment opportunity”, unless you can substantiate that (often that’s not possible). The same caution applies to time limitations e.g. “closing soon”- investing is an important decision and you should ensure that investors are able to make considered decisions.

Using “puffery” is ok. Puffery is using an obviously exaggerated statement that no-one would consider is literally true e.g. “Red Bull gives you wings”.

What does “unsubstantiated representation” mean?

A representation is a statement of fact or opinion e.g. “total revenue for the last financial year was $260,440”. A representation is unsubstantiated if the person making the representation does not, when the representation is made, have reasonable grounds for believing it is true.

It’s not enough that you think relevant information is correct- you need to confirm it before making a statement. For example, if you state that sales in your business sector in NZ grew by 10% a year over the last 3 years, you need to confirm that by reference to reliable sources e.g. government publications, authoritative industry publications. In addition, to avoid being misleading, you should also give context for that type of statistic e.g. is that correct for each year or did sales increase by 30% in the first year with no increases in the next 2 years? Also avoid being misleading by omission e.g. it may be correct to say that sales in the sector grew by 10% a year but it may be misleading if you don’t disclose that changes to regulations are likely to lead to a drop in sector sales in the future.

What are the rules for advertisements & other communications?

Advertisements and other communications are also caught by the fair dealing rules during the offer period (and sometimes pre-offer) e.g. information provided in emails and on social media, a response to an investor question on the platform’s Q&A facility. The FMA sets out some key points to consider when promoting your offer using the media (see Fair dealing in advertising and communications – crowdfunding and peer-to-peer lending), including that:

  • Any warnings, disclaimers and qualifications should be prominent enough to effectively convey key information to an average person at first glance, and should not be inconsistent with other content in an advertisement.
  • If the communication is an audio advertisement, it should be read at a comprehensible speed for the average listener.
  • Be careful not to omit any material information that gives a skewed impression of your products or services.
  • Advertising is misleading when graphics cover only a short time period or financial information from a volatile time period. This does not provide potential investors with adequate information to make an investment decision.
  • Think carefully about whether a particular media channel is suitable for providing balanced information to consumers.

Make sure that information provided in different media present a consistent view, so that different investors are receiving the same overall information.

Wherever possible provide potential investors with, or with a link to, the IM. If that’s not possible tell investors where they can find the IM.

Most offers include historical financial information and a forecast of future financial performance. Potential investors will be particularly interested in forecasts so real care is required with forecasts. You should get assistance from an accountant or other qualified professional to prepare financial information.

The law does not specify what financial information you need to disclose (but the platform may). In practice companies usually disclose statements of financial performance (profit & loss statement) and of financial position (balance sheet). The statement of financial position can be particularly important for investors, including by identifying existing liabilities of the company.

Historical financial information must correctly reflect the company’s past financial performance. The FMA notes that “You should also avoid ‘cherry-picking’ past performance information to create a misleading picture for consumers.”  You should make it clear that past performance is not necessarily indicative of future performance.

Forecasts should be presented as something “that might happen” not something “that will happen”. For example, you shouldn’t state or imply that investors “are guaranteed to receive a return of at least 200% on their investment”.

The assumptions that underlie the forecasts are key to the forecasts. Directors are responsible for the assumptions. Directors should take the following into account:

  • You cannot just rely on your accountant to prepare the forecasts- the accountant needs key information from directors to prepare the forecasts e.g. an assessment of how long it will take to step up production (and sales) once the investment funds are available.
  • The assumptions must be reasonable at the time they are made.
  • You cannot simply rely on historical performance and trends- directors need to carefully consider what the business can achieve in the future based on realistic plans and a realistic estimate of available resources (usually you’ll have a business plan that supports that process).

Forecasts can be misleading (and unsubstantiated) if directors don’t honestly believe the forecasts are true or if there aren’t reasonable grounds for the assumptions. To put it another way, forecasts cannot be unrealistic or fanciful. For example, you might want sales to grow from $1m to $80m in two years and you may even believe that they will. But it will be misleading if you state that in the offer, where you don’t have a realistic plan for achieving the increase at the time the forecast is prepared.

Once an offer has successfully closed you need to take steps to complete the offer.  A key step is to update the company’s share register to add the names and details of the new shareholders. This is the share register kept by the company itself, not the shareholder details recorded on the online Companies Register.

The platform will provide the investors with a statement showing how much they invested and how many shares were issued. You can also communicate with the new shareholders- it’s likely to create a positive impression if you communicate pro-actively from the beginning.

Key questions that are always asked by potential investors is whether shares can be sold later and how can they be sold. Usually, there’s a very limited market for shares in crowdfunded companies so the number of future sales is likely to be low. So be careful not to state or imply that there will be a ready market for the shares.

Often investors in crowdfunded companies are hoping for a later “exit event”, like a trade sale, that they hope will allow them to realise the value of their investment. So they may not be interested in selling shares before then.

Whether shares are in fact freely tradeable will depend on the constitution of the company.  While small private companies usually require shares to be first offered to existing shareholders, some crowdfunded companies opt for freely tradeable shares.

Secondary markets

There are no licensed secondary share markets that can be used to list and trade shares issued in an equity crowdfunded offer. The company that issues the shares has the right to run a “matching service” that connects potential sellers & buyers of shares and can potentially rely on other exemptions to support trading of shares. A licence may be required to provide a more extensive service.

Share sales by investors

The law in some cases restricts the sale of shares purchased via crowdfunded offers for the first 12 months after issue of the shares. When that applies shares have to either be sold via a full “regulated offer” or via an exemption. Investors are responsible for compliance but it may be advisable to make investors aware of potential restrictions on sale in the 12 months post-issue. You should also be careful about involvement in share transfers if there is a risk that a transfer is being made in breach of law.

After the 12 months has expired shares can be sold without restriction subject to other limitations, including:

  • those noted below in relation to directors & other people who control the company; and
  • any limitations in the company’s constitution or a shareholders’ agreement.

Share sales by directors and other people who control the company

There are stronger restrictions on sales of shares held by people who “control” the company- those people include directors. If those restrictions apply the person with “control” must either sell their shares in compliance with regulated offer requirements or under an exemption. That is a continuing restriction.

There is another restriction that applies to directors and potentially related parties (such as a trust company shareholder controlled by a director). If the director holds price sensitive information that is not publicly available there is a form of “insider trading” restriction, which prevents directors from selling shares for more than their “fair value” (or for purchasing them for less than their “fair value”).

Company administration obligations don’t fundamentally change just because the company has gained shareholders via a crowdfunded offer. However, there may be some additional obligations, for example where the company has 10 or more voting shareholders after the offer. Also, post-offer, the company may have gone from being a company with very few shareholders (who all know each other) to a company with potentially tens or hundreds of shareholders. Those shareholders will have a legitimate interest in the company.

We’ve briefly summarised below some (but by no means all) administrative matters to consider post-offer.

Annual meeting of shareholders

A company must, in most cases, hold an annual meeting of shareholders within 6 months after its financial year end. There are usually few, if any, matters that need to be voted on by shareholders at an annual meeting. An annual meeting is a good opportunity to engage with shareholders (though often few shareholders actually attend).

Non-voting shareholders have the right to be invited to, and to attend, the annual meeting, even if they do not have the power to vote at the meeting. It is possible to allow shareholders to attend remotely e.g. using online conferencing applications.

Financial Reporting, Auditing & Annual Reports

Companies with fewer than 10 shareholders (note below how those shareholders are defined and counted), and that don’t have high revenue, are not required (subject to some exceptions) to prepare financial statements by law, to appoint an auditor or to prepare an annual report (unless a minimum number of shareholders opt-in). Obligations to prepare financial information may still apply under tax law regardless.

For the purposes of determining financial reporting obligations, the number of shareholders is based on shareholdings at the beginning of the relevant accounting period. However, shareholders in connection with financial reporting, auditing and annual report obligations do not include all possible shareholders- they only include shareholders who hold “voting shares” (a key reason to consider offering non-voting shares).

Companies with 10 or more voting shareholders can opt-out of some of these requirements but this requires a high proportion of the votes of those shareholders to do so. So it is usually impractical for companies with a large number of voting shareholders to do that.