The last couple of years has seen crowdfunding become an international phenomenon. The idea that you can raise funds through an online ‘open-call’ has seen start-ups become multi-million dollar companies overnight. While crowdfunding has its unique advantages, it also carries a number of risks.
Types of crowdfunding models
The application of the law depends on the type of crowdfunding model adopted by the entrepreneur. In this regard, there are four types of crowdfunding models in the market today, with the latter two models gaining the most traction in our global economy: charity, lending, rewards-based and equity.
Rewards-based crowdfunding
Rewards-based crowdfunding allows people to contribute towards a product or service that is yet unbuilt. The funds are made in the form of a donation or advance-purchase in return for a reward or intangible benefit.
Regardless of the amount of reward a funder may receive, the crowdfunding becomes a ‘deal’ that attracts obligations under Australian Consumer Law (ACL). Accordingly, entrepreneurs must appreciate that they have just entered a legal contract with the funders. Like any contract, a rewards-based crowdfunding project is based on promises that an entrepreneur must keep. A breach of a promise may amount to misleading or deceptive conduct under the ACL.
Equity-based crowdfunding
Equity-based crowdfunding allows investors to own a share of the pie. In other words, money is raised by offering equity to investors. But unlike traditional investment options, crowdfunding provides an added level of complexity. One of the major issues facing private company start-ups looking for crowdfunding is the limit of 50 shareholders in the Corporations Act 2001 (Cth). If a private company breaches the limit of shareholders it will be forced to convert to a public company and comply with significant additional governance, disclosure and reporting requirements.
Accordingly, there has been a recent call for the need to ease securities regulation regarding equity-based crowdfunding in Australia. The Australian Government introduced the long-awaited Corporations Amendment (Crowd-sourced Funding) Bill 2015. While this Bill falls short of legitimising equity-based crowdfunding for private companies, it allows start-ups to incorporate as unlisted public companies with reduced governance and other reporting requirements for the first five years.
Other legal implications
Entrepreneurs must look out for intellectual property protection in circumstances where the project involves an invention or a unique service. Registration for trademarks and patents are just some of the risks associated with seeking public funding from the crowd.
Last but not least, entrepreneurs must also be aware of their tax obligations. Unless your crowdfunding is a hobby, financial contributions received may form part of your assessable income and attract income tax. Entrepreneurs should also look out for the goods and services tax (GST) particularly if the reward that is provided to funders is a taxable supply and other crowdfunding activities are subject to the GST.
Disclaimer: This article contains general information only and is not intended to be a substitute for obtaining legal advice.