2.1.1 Problem stream

While individuals may only attend to one problem at a time, the division of labour in governments allows them to deal with a number of issues at the same time (Zahariadis, Reference Zahariadis, Sabatier and Weible2007, pp. 28–29). As such, at any one time, policy-makers and members of the public may be applying themselves to remedying a range of problems, such as government budget deficits, inflation, environmental disasters and overstretched medical systems. These problems come to the attention of the relevant authorities as a result of indicators, focusing events and feedback (Kingdon, Reference Kingdon1995, p. 90).

Indicators may be generated from the routine monitoring of various activities and events by relevant authorities. They can also be deduced from studies conducted on a particular issue by the government, non-government agencies or academics. It is important to note that indicators, while powerful, are flawed and have serious deficiencies (Kingdon, Reference Kingdon1995, p. 94). As such, the method that leads to the gathering and interpretation of indicators may be subjective and may attract criticism (Kingdon, Reference Kingdon1995, pp. 90–94). Additionally, indicators may require a nudge to come to the attention of governments. This nudge is sometimes provided as a result of a focusing event such as a crisis or disaster that makes the problem more prominent.

However, it is rare for a crisis by itself to carry a subject to the top of the government agenda. A pre-existing perception that there is a problem may need to have existed in people's minds. In certain instances, the crisis may be viewed as a warning that requires investigation. A repeat of the crisis may redefine the problem (Kingdon, Reference Kingdon1995, pp. 94–100). Lastly, feedback about the operation of certain programs may further highlight existing problems. Ultimately, recognition of the problem/s may bring the subject to a prominent place in the government's agenda.

2.1.2 Policy stream

The policy stream is characterised by Kingdon as a ‘policy primeval soup’ of ideas that compete against each other to win acceptance by policy-makers (Kingdon, Reference Kingdon1995, p. 116). At any one time, communities of specialists (‘policy communities’) will be putting forward different ideas/solutions to various problems. These policy communities may be formed by specialists in a particular area and may include bureaucrats, politicians and their staff, academics, think tanks, interest groups and not-for-profit organisations.

While a large number of ideas/solutions will be put forward by policy communities, only a few will attract attention. These ideas are generated, debated, redrafted and accepted for consideration as genuine alternatives to the existing system (Kingdon, Reference Kingdon1995, p. 122). The process of amendment and reconsideration of ideas may be incremental and may depend on the nature of the policy communities. If such communities are fragmented, it will be harder and so take longer to achieve a consensus (Kingdon, Reference Kingdon1995, pp. 119–120). The consensus reached will, in the end, be the result of both persuasion and diffusion (Kingdon, Reference Kingdon1995, pp. 139–140). Further, the solutions put forward are context-dependent and will reflect the ‘dominant thinking of the day’ (Althaus et al., Reference Althaus, Bridgman and Davis2013, p. 35). If viable solutions to a problem are available for adoption by the government, the chances the problem will be placed on the government's agenda are increased, since sufficient information on the problem and ways to remedy it will be able to be provided to decision-makers.

2.1.3 Political stream

The political stream has its own dynamics and rules, and is independent of the problem and policy streams discussed above. Its composition is made up of a range of factors such as the national mood, administrative or legislative election results, and pressure group campaigns (Kingdon, Reference Kingdon1995, pp. 87, 145–164). For example, the national mood may influence government agendas, as it reflects the way a large number of people are thinking along similar lines regarding a particular problem. Similarly, if organised pressure groups lobby in relation to a particular issue, the government may view such support as a consensus to implement change (Kingdon, Reference Kingdon1995, p. 163). Consequently, changes in national mood and the consensus of pressure groups may lead to the promotion of certain items to the government's agenda or to their removal from it (Kingdon, Reference Kingdon1995, pp. 146, 150).

Additionally, administrative and/or legislative changes in government have a big impact on a government's policy agenda, as it may result in a new political ideology and/or new priorities taking effect. While, in the policy stream, consensus is built through persuasion, consensus in the political stream is very differently achieved, as it focuses on compromise and bargaining between political parties. Here consensus is created as a result of the granting of concessions in return for support of a particular cause (Kingdon, Reference Kingdon1995, p. 159).

2.2.1 Problem stream

Small and medium enterprises (SMEs) – including start-ups – are no longer viewed as mere stepping stones to big businesses, but are recognised as key contributors to employment and economic growth (Harper, Reference Harper1998, p. 17) in both national economies and the global economy (Ayyagari et al., Reference Ayyagari, Beck and Demirguc-Kunt2007, p. 415). For example, in 2014, small businesses accounted for 48 per cent of private-sector employment in the UK. Similarly, 2013 data indicate that SMEs are major employers in the Australian economy, as they hire almost 70 per cent of the workforce and are considered a major source of innovation (Commonwealth of Australia, 2014, pp. 1–15). The situation is similar in the US (Kobe, Reference Kobe2012, p. 1).

While this may be the case, a range of indicators have illustrated that there is a shortfall in the finance of SMEs (Ebben and Johnson, Reference Ebben and Johnson2006, p. 851). Traditionally, these firms cannot access public capital and raise funds from the market. As such, they may need access to external private financing (Berger and Udell, Reference Berger and Udell2002, p. F32). However, information asymmetry resulting from the opacity of the management and finances of these businesses and the higher risk that may attach to them has led to credit rationing by lenders (Stiglitz and Weiss, Reference Stiglitz and Weiss1981) and made it more expensive for small businesses to raise external funds from banks and investors. The situation is compounded for start-ups, as financial institutions cannot observe a start-up's track record for quality purposes and this makes lending to these ventures riskier and more unlikely (Cassar, Reference Cassar2004, p. 265).

This reality has meant that SMEs have been relying on personal wealth, family support and internal finance to fund their businesses (Hussain, et al., Reference Hussain, Millman and Matlay2006, pp. 592–593). However, once a business has exceeded the internal financial resources available to it, its growth becomes dependent on external financing (Berger and Udell, Reference Berger and Udell1998, p. 627), which may be unavailable due to asymmetry of information and transactional cost. The shortfall in financing then creates an obstacle to the growth of the business (Schiffer and Weder, Reference Schiffer and Weder2001).

It is important to note that the indicators attached to the problem of a shortage of finance for SMEs as well as start-up businesses may be flawed. For example, Oakey (Reference Oakey2007, p. 224) found that financing SMEs is not an issue except in certain industries. Therefore, the problem may not be as widespread as believed. However, the conventional wisdom remains that the shortage of supply of finance from financial institutions and investors is the root of the inadequacy of the financing of SMEs (Torre et al., Reference Torre, Peria and Schmukler2010, p. 2280).

This perceived problem relating to a shortfall in external funding for small businesses has become more prominent as a consequence of the GFC. The resulting shock to the banking system had a negative effect on the supply of credit to these businesses as the cost of corporate and banking borrowing rose, leading to a fall in the lending volume of financial institutions (Ivashina and Scharfstein, Reference Ivashina and Scharfstein2010, pp. 319–320).Footnote ⁵ There is now an even bigger shortfall of funding for SMEs as a result of the tightening of lending practices (Organisation for Economic Co-operation and Development (OECD), 2009; Australian Centre for Financial Studies, 2014).

Lastly, changes to regulatory regimes significantly impact on the lending practices of banks. For example, the decline in lending may be the result of the implementation of risk-based capital standards under the Basel Accord (Berger and Udell, Reference Berger and Udell2002, p. F44). Concerns have been raised that the adoption of Basel III may run the risk of limiting the availability of credit, raising the cost of lending and reducing the economic activity of nations (Allen et al., Reference Allen, Chan, Milne and Thomas2012, p. 159; OECD, 2013, p. 32). All these factors have emphasised the problem of the shortfall in finance for SMEs and have made this issue more prominent than was previously the case.

2.2.2 Policy stream

As a consequence of the key role SMEs play in the economy, a range of options and ideas to help finance these ventures – such as bootstrapping, venture capital funding and government-sponsored credit programmes – has been put forward over the decades (Beck and Demirguc-Kunt, Reference Beck and Demirguc-Kunt2006). From the early 1990s, micro-finance has been adopted by a range of countries as a means of combating social exclusion: this form of finance may provide an opportunity for people who come from disadvantaged backgrounds to establish small businesses through the availability to them of small loans.

The development of the Internet, social media and crowdsourcing has allowed micro-finance to be repackaged and launched in an online environment in a new format: crowdfunding (especially P2P lending) (Globble, Reference Globble2012, p. 5). This has led policy communities to view crowdfunding in general as a type of funding that could provide the necessary capital for both charitable and business ventures (Board of the International Organization of Securities Commissions, 2015, p. 31; European Commission, 2013, pp. 6–9). However, community-focused types of crowdfunding, especially reward crowdfunding, have their limitations, as they do not allow investors to receive a financial return for their investment. A business wishing to raise only a small amount of capital may prefer reward crowdfunding but, if the capital required is more substantial, the business might consider profit-sharing types of crowdfunding (Sharp, Reference Sharp2014).

As such, the model of P2P lending became more appealing. As noted previously, US$11.08 billion was raised worldwide in 2014 through this form of finance (Massolution, 2015, p. 14). However, P2P lending may not be attractive to businesses due to the costs it involves, since, in addition to the setting-up cost, the business has to repay the loan with interest to its investors irrespective of whether the business is profitable or not (Freedman and Jin, Reference Freedman and Jin2008, p. 3). Further, P2P lending does not provide investors with equity in the business: the investors can only be lenders, and this limits the choices and rights that investors may have. Investors may also be attracted to having a stake in the business (Pesok, Reference Pesok2014, p. 148). This is especially apparent in the US, where ‘more than $15 million in funding has been waiting on the sidelines [to] be invested in over 1,000 companies now that this bill [the Jumpstart Our Business Startups Act (JOBS Act)] has become law’.Footnote ⁶

Policy communities seem to have come together around the idea that CEF may provide a solution to dealing with the shortfall of finance available for small businesses (CAMAC, 2014). The challenge then faced by the policy communities is that, in most countries, this type of finance is illegal and so requires a change in legislation (Schwienbacher and Larralde, Reference Schwienbacher, Larralde and Cumming2012, p. 379). A review of the different proposals put forward in countries such as the US, UK, Italy, NZ and Australia has highlighted a consensus that the law needs to be amended to allow CEF to take place and prosper. The policy communities were united in putting forward proposals that focus on the establishment of three types of safeguards for investors. These safeguards target the regulation of businesses, intermediaries and investors, and they vary from one country to the next (CAMAC, 2014). Accordingly, while there is a consensus that CEF may provide additional financial support to SMEs, the proposals put forward to introduce it into the legislation of different countries has varied and the final solution to be adopted has depended on the local context and political agenda.

2.2.3 Political stream

Most government philosophies and ideologies support proposals that promote employment, innovation and the cutting of red tape for SMEs (European Commission, 2015, p. 2). The occurrence of the GFC has pushed governments around the world to think of new ways to broaden the funding opportunities for these businesses to counteract the economic downturn, as this would have a negative impact on the national mood (Weinstein, Reference Weinstein2013, p. 427). For example, in the US, the White House noted the importance of allowing small businesses to raise funds from investors efficiently, with President Obama observing that SMEs are key drivers for the recovery of the economy (White House, 2012). In Italy, the Italian Minister of Economy and Development requested a taskforce to put forward proposals to encourage and enhance the establishment and development of innovative start-ups (Taskforce on Startups Established by the Minister of Economic Development, 2012, p. 3). Similarly, in Australia, the 2015–16 Budget supported initiatives that ‘will help small businesses invest more, grow more, and employ more [people]’ (Commonwealth of Australia, 2015, p. 2). Accordingly, governments around the world are considering different options to enhance the flow of capital to SMEs.

2.2.4 Opening of a window

The perceived shortfall of funding for SMEs combined with the GFC and the resulting drying up of funding for these businesses brought this problem to the attention of a number of governments around the world. As there seems to be an acceptance in the general community that the development of technology would allow crowdfunding to prosper and enhance the national as well as the global economy, partisan support was easier to establish in relation to this matter due to the national mood being supportive of crowdfunding. Further, the popularity of crowdfunding in general made it feasible for policy communities to reach a consensus that CEF may provide an opportunity to remedy the perceived problem. Consequently, the convergence of the three streams meant that CEF rose to the top of government agendas. A window of opportunity was opened to implement change to support this new form of finance. In fact, a range of countries such as NZ, Italy and the US are implementing new amendments to promote the use of CEF.Footnote ⁷ In Australia, changes in this area are also currently being considered, with the government putting forward a new Bill – the Corporations Amendment (Crowd-source Funding) Bill 2016 (Cth) (‘The Bill’) – in front of the parliament.

3.1.1 Law on fundraising

Under the current Australian regime, public companiesFootnote ⁹ are the only companies that are allowed to issue securitiesFootnote ¹⁰ to the public if they comply with the disclosure requirements set out by the legislation.Footnote ¹¹ Such a company will have to issue a prospectus to advise potential investors of any information a reasonable person needs to know to be able to make an informed decision about whether to invest in the company or not.Footnote ¹² However, this disclosure document can be costly. Consequently, other alternatives to prospectuses have been put forward to increase the efficiency of fundraising rules and reduce the cost to businesses. For example, depending on the situation, companies may use short form prospectusesFootnote ¹³ or an offer information statement.Footnote ¹⁴

The legislation further allows companies to raise capital without the issue of a disclosure document if certain criteria are met.Footnote ¹⁵ The main offers of securities that are exempted from the disclosure regime under the Corporations Act 2001 (Cth) (‘CA’) are:

• • Small-scale, personal offers: personal offers in a company do not need disclosure to investors if the offer is made to no more than twenty investors and the offer does not exceed AUD$2 million during a period of twelve months.

• • Sophisticated investors: a person may be classified as a sophisticated investor and does not need to receive a disclosure document if they fulfil one of the following criteria:

  • o the minimum investment made to purchase the securities is at least AUD$500,000; or

  • o the person to whom the offer of securities is made has net assets of at least AUD$2.5 million, or has a gross income for each of the last two financial years of at least AUD$250,000 per annum, as determined from a certificate given by a qualified accountant no more than six months before the offer is made; or

  • o the offers are made through a financial services licensee to experienced investors where the licensee believes on reasonable grounds that the investors have previous experience in investing in securities and can assess the merits of the offer.

• • Professional investors: disclosure documents are not required in a case where the issue of securities is aimed at professional investors. The definition of professional investor can be found in section 9 in the CA and includes financial services licensees acting on their own behalf.Footnote ¹⁶

Additionally, if an offer, or intended offer, of securities requires a disclosure document, a person (not just the securities issuer) must not advertise the offer or intended offer or publish a statement referring to the offer or reasonably likely to induce people to purchase the securities.Footnote ¹⁷ This general restriction on advertisement and publicity is aimed at ensuring that the disclosure documents remain the main source of information for investors.

3.1.2 Australian Small Scale Offering Board (‘ASSOB’)

Policy communities have been considering the issue of financing SMEs for decades. For example, in 1997, the Australian Industry Commission issued an Information Paper that noted the importance of allowing SMEs to trade their shares in new markets (Industry Commission, 1997). This influenced Australia's financial services regulator – the Australian Securities and Investments Commission (‘ASIC’) – to issue exemptions that then allowed ASSOB to be established (Vitins, Reference Vitins2013, pp. 109–110). This online platform allows public unlisted companies to issue shares in their companies to the public without the need for a disclosure document (ASSOB). This has been viewed by a range of authors as a form of CEF (Maguire, Reference Maguire2014, p. 47).

However, such classification may be misleading. ASSOB has been able to go around the fundraising rules through its reliance on the small-scale personal offers exception. Further, this platform has received an exemption from the advertisement restrictions imposed by fundraising legislation (ASIC, Class Order 02/0273). Accordingly, while raising funds through this platform is targeting the public, investments in the company are limited to twenty investors (the ceiling for small-scale personal offers). This has been an issue in the past for SMEs, as the amounts invested cannot be characterised as small amounts of money. For instance, if a company sought to raise AUD$1 million through this platform, certain investors would have to invest a minimum of AUD$50,000. In fact, the average investment through ASSOB is AUD$30,000 (ASSOB, 2013, p. 1). This would put ASSOB at the high end of the scale for crowdfunding.

Accordingly, even though ASSOB has helped raise over AUD$145,003,286.58 since it has been established, it has been lobbying for the removal of the twenty-investors ceiling, as the ceiling is considered to be hindering certain businesses from achieving their targets (ASSOB, no date). Consequently, the ASSOB format is not the answer to achieving the policy objectives behind CEF. Specific reforms to the fundraising system are needed.

3.2.1 Need for protection

Although CEF may provide a financial solution for businesses looking for extra capital to expand their ventures or transform their ideas into reality, the deregulation of fundraising provisions comes at a risk as investors attracted to crowdfunding in general are not your ‘standard, experienced’ investors. They are more likely to view crowdfunding as a social phenomenon (Belleflamme and Lambert, Reference Belleflamme and Lambert2014, p. 290). Even in instances where CEF provides the necessary funds for a business and the business does in fact prosper, the investors may not realise at the time they are investing that there will be few options available to them to subsequently sell their shares, as there is no, or a very limited, secondary market for the trading of such shares (Bouaiss et al., Reference Bouaiss, Maque and Meric2015, pp. 23–24).

Further, the allure of possible easy riches may attract a range of investors to invest in companies without assessing the likelihood of success or failure of the venture. This is especially the case as CEF is being endorsed by prominent leaders such as US President Obama (Dorff, Reference Dorff2014, p. 498). This would accentuate a range of pitfalls attached to investments in general. For instance, CEF raises the risk of fraudulent activities. While fraud is a common problem in business (Robb, Reference Robb1992), this may be accentuated in an online environment. Since raising money can be quicker online, a fraudster may raise capital quickly and then abscond with it before anyone realises that a fraud has been committed (Tomboc, Reference Tomboc2013, p. 266). While very few scandals have appeared in the context of CEF, this source of funding is in its infancy and, as such, may attract fraudulent activities in the future. This is a lesson that can be learned from other types of crowdfunding, as they all have been the subject of fraudulent activities. For example, Kickstarter, a popular US crowdfunding intermediary, has promoted a range of projects that were fraudulent (Numez, Reference Numez2014). For instance, one project called the ‘Kobe Red’ was all about producing the first 100 per cent Japanese Kobe Beef Jerky made from beer-fed cattle. The project raised US$120,309 from 3,252 backers. The amount raised was in fact fifty times more the campaign's original goal. However, it was soon discovered that the project was a scam (Numez, Reference Numez2014).

Additionally, it is important to remember that equity investment in small business is risky in any event, as small businesses have well-documented high rates of failure (Sharp, Reference Sharp2014, p. 825). Start-ups are even riskier. In Australia and the US, in the first ten years of their existence, the rate of failure of these businesses is 95 and 90 per cent, respectively (Marmer and Dogrultan, Reference Marmer and Dogrultan2012, p. 4). In the UK, over 50 per cent of start-ups fail by their fifth year of operation (Anderson, Reference Anderson2014). Further, with P2P lending, for example, rates of default on repayment to investors have been so high that they may even ‘rival or exceed those of credit-card borrowers at big banks’ (Chaffe and Rapp, Reference Chaffe and Rapp2012, p. 507). In the context of CEF, the investor will be a shareholder in the company and, under the current regime in Australia, if the business fails, the investor will be unlikely to recoup their losses until all the creditors have been paid.Footnote ¹⁸ This puts them in a vulnerable position.

With the promotion of CEF, business failure may become more pronounced, as it is important to remember that merely attracting the funds sought is not a guarantee of a business's success. Businesses still need to convert their pitch into reality and this can be challenging, as many businesses are start-ups and do not have the necessary know-how or experience to achieve their objectives. One key problem that emerges from the review of crowdfunding projects in general is that they may be underfunded, since entrepreneurs may have concerns about asking for too much money from investors. They may also underestimate the costs involved in their project (Symposium Panel II, 2013, pp. 66–67). Further, even well-funded projects may have trouble achieving their aims because of the multi-faceted interlinked aspects of production: if the business fails to achieve one step in the long production line, the business may face delays and extra costs and may fail (Mollick, Reference Mollick2014, p. 11).

3.2.2 Getting the balance right

In view of the benefits and risks attached to CEF, it becomes vital to provide a legislative exemption that protects consumers while allowing CEF to thrive. Achieving such a balance has its challenges. On the one hand, having laws that deregulate the system for the purpose of promoting competition to the detriment of consumer protection may enhance entrepreneurship, but may also negatively affect the stability of the financial system as fraud and business failure may become more prominent. On the other hand, having exemptions so targeted at the protection of consumers that they fail to promote businesses defeats the purpose of including a CEF exemption in the legislation, since very few businesses will then be able to raise capital via this form of finance. In short, it is easy to skew the balance towards one side or the other.

A perfect example of a system that has not yet achieved its aims can be found in Italy. In 2012, Italy became one of the first countries in Europe to enact CEF laws.Footnote ¹⁹ The change of the law to facilitate CEF has failed to remedy the problem that led to the promotion of this form of finance in the first place: providing funding to SMEs. The Italian CEF exemption to fundraising laws is based on providing protection to consumers through the regulation of businesses, intermediaries and investors.Footnote ²⁰ However the first protection especially – ‘the regulation of businesses’ – has restricted the growth of this form of finance, as highlighted below:

• • Business regulation: Italian law permits a business to raise a maximum of €5 million through CEF.Footnote ²¹ While this amount is substantial, CEF is only available to certain types of businesses classified as ‘innovative start-ups’.Footnote ²² Very strict rules apply to this classification: the definition requires a business to have been in existence for no more than forty-eight months and be recognised as ‘innovative’ by the Chamber of Commerce, a concession that has to be updated every six months.Footnote ²³ A business may be viewed as innovative if its purpose, for example, is ‘the development and commercialisation of high-tech value products or services’ (Ministero Dello Sviluppo Economico, 2012, pp. 2–3). The strict classification excludes a number of businesses including many start-ups, which goes against the reason for having introduced the legislation in the first place (Taskforce on Startups Established by the Minister of Economic Development, 2012, pp. 16–17). Consequently, since the introduction of the exemption, fewer than twenty projects have been able to rely on CEF to raise the capital necessary for them to get off the ground. Further, the total amount raised through the CEF exemption has been less than €1.5 million (Moody's Investors Service, 2015).

  For this reason, in 2015, the Italian government expanded the eligibility criteria from ‘innovative start-ups’ to ‘innovative SMEs’. However, even the expanded criterion is viewed as narrow and restrictive, as the ‘innovative SME’ has to comply with a range of rules to qualify for CEF (Angelilli, Reference Angelilli2016). Further, this addition still excludes SMEs that are not viewed as ‘innovative’.

• • Intermediaries: CEF online platforms must follow specific rules to ensure that they comply with anti-laundering laws and the EU Markets in Financial Instruments Directive (MiFID)Footnote ²⁴ and they must be classified as ‘permitted managers’.Footnote ²⁵ Further, they are responsible for verifying that the businesses advertising on their platforms have satisfied all the requirements necessary to enable them to access finance through crowdfunding.Footnote ²⁶ They are also required to match investors’ profiles with investment risk.Footnote ²⁷ Such requirements are designed to protect investors. However, this regulation adds a burden on intermediaries who have to establish the infrastructure necessary to comply with these rules. In this author's opinion, this has contributed to the fact that, in Italy, there has only been one intermediary platform that deals with CEF (CrowdFundingHub, no date). The intermediaries registered in Italy are more focused on donation and reward crowdfunding, as there is less regulation attached to running such portals (CrowdFundingHub, no date). This can be contrasted with NZ, where friendlier legislation regulates online platforms: there are seven intermediaries that have been established in 2014–15 (CrowdReady, 2015).

• • Investors: investors are required to complete a questionnaire to ensure that they fully understand the risks attached to crowdfunding.Footnote ²⁸

The Italian law additionally requires professional investors, banks or start-up incubators to play a role in the process of CEF, as they must own at least 5 per cent of the equity of a crowdfunded firm after the crowdfunding exercise takes place. If such an investment does not eventuate, the fundraising would be invalid.Footnote ²⁹ While the aim behind all these safeguards is to protect investors from business failure and fraud, the restrictive Italian regulation fails to provide a workable solution for the motivations and problems that led to the introduction of the CEF exemptions to the system. As a result, a more balanced approach is needed.

3.3.1 Business regulation

One of the safeguards proposed in Australia is the imposition of certain regulations on businesses who are trying to raise capital from the public.

The cap: both the CAMAC and the NZ models impose a cap on investments through CEF. The proposed cap under both models is AUD$2 million in any twelve-month period limited to one class of shares – ordinary fully paid shares. This cap is appropriate for the following reasons:

• • Around the world, to date, the average amount raised by different types of crowdfunding is less than AUD$2 million. For example, in 2014, the average amount that a business raised from P2P lending was US$103,618. In the case of CEF, the average amount varied from region to region, with averages ranging from US$175,000 in North America to an average of US$342,260 in Asia (Massolution, 2015, p. 15).

• • The AUD$2 million cap is consistent with the seed capital requirement that the majority of start-ups may need (CAMAC, 2014, p. 58).

However, the Bill model ignores both recommendations and introduces a cap of AUD$5 million in any twelve-month period. While this cap is supported and promoted by ASSOB (2014, p. 3), no justification has been put forward to explain the need to raise the cap to this amount. The cap supported by the CAMAC and NZ models seems more justifiable than the one put forward by the Bill model. Accordingly, a return to the AUD$2 million cap is recommended.

Type of c ompany: the NZ model allows all types of companies to raise capital through CEF. This approach is simple and allows companies of all sizes to benefit from this form of finance. However, to apply such a system in Australia is difficult due to the cap imposed on proprietary companies: such companies may not have more than fifty non-employee members.Footnote ³⁰ The existence of this cap goes against the spirit of CEF, which is trying to raise small amounts of money from large numbers of people. Accordingly, the CAMAC and Bill models have stated that only public companies would be able to rely on CEF to raise funds from the market. Such a limitation is problematic, since it would exclude small businesses, who are most likely to be proprietary companies, from raising capital through this form of finance. Additionally, proprietary companies form 98.9 per cent of companies in Australia (Austin and Ramsay, Reference Austin and Ramsay2015, p. 169).

While it can be argued that proprietary companies may convert to public companies and this would allow them to raise funds through CEF, this suggestion does not take into account the reality that, even if a company becomes a public company, it may not have the necessary resources or funds needed to comply with the legislative requirements attached to public companies (Wong, Reference Wong2013, p. 98). For this reason, CAMAC put forward a proposal for the establishment of a new type of company: the exempt public company. Such a company would be exempt from following the compliance requirements imposed on public companies by the CA for a period of up to three to five years (Australian Government, 2014, p. 9.). At the end of that period, the company would revert to being a public company and would have to comply with the compliance requirements set out in the legislation. This option was partially adopted by the Bill model. While not creating a new type of company, the Bill provides that companies that qualify for CEF – unlisted public companies with share capital – may be eligible for limited governance requirements for five years if they have just been created or they have recently been converted to a public company and they plan to raise capital via CEF.Footnote ³¹ Such companies have the following concessions:

• • Unlike general public companies, they are not required to hold an annual members’ general meeting for five years.

• • They are only required to provide online financial reports to shareholders for a period of five years. No hard copies are required to be sent to the members.

• • While public companies have to appoint an auditor within one month of registration, for the first five years, companies eligible for limited governance requirements do not need to do so until they raise more than AUD$1 million from CEF or other offers requiring disclosure.Footnote ³²

Although this proposal deals with the shareholders limitation imposed on proprietary companies, there is doubt regarding whether the limited governance imposed on these companies is enough to encourage proprietary company to convert to public company to access CEF. For instance, if the company raises more than AUD$1 million, it will have to appoint an auditor. Further, costly continuous obligations under the CA will apply, as the company will be deemed as unlisted disclosing entities.Footnote ³³ Half-yearly reports will also then be required to be provided by such companies.Footnote ³⁴ Consequently, the current concessions are really minimal and do not necessarily encourage proprietary companies to be converted to a public company, as the governance cost remains high.

Other restrictions: the Bill model currently excludes 99.7 per cent of companies from raising capital through CEF. However, it goes further by limiting the types of eligible companies. In addition to the fact that public listed companies and their related parties cannot raise capital via CEF, the only companies that are allowed to do so are companies that fulfil the following two requirements:

• • companies that have a consolidated gross asset of less than AUD$25 million; and

• • companies that have consolidated annual revenue of less than AUD$25 million.Footnote ³⁵

It is assumed that companies that fulfil these requirements will be SMEs. However, all the restrictions regarding company size and type make the Australian limitations regarding the types of businesses who may raise funds through CEF akin to the limitation present in the Italian model.

One positive development is the fact that the Bill requires the companies wishing to access CEF to provide a CEF offer document. However, the Bill does not provide information regarding the content of such document.Footnote ³⁶ It mainly states that the information in the document must be ‘clear, concise and effective’.Footnote ³⁷ It is expected that the production of such a document will be cheaper than a prospectus. The fact that the Bill does not provide further information about the CEF offer document makes it difficult to assess the cost of creating such document.

Further, the Bill protects the investors by penalising businesses if they issue a misleading CEF offer document.Footnote ³⁸ This creates an incentive for businesses to stay clear from fraudulent conducts. Lastly, restrictions regarding advertisement of CEF offers are also put forward by the Bill to ensure that the investors have the necessary information available to them before investing in CEF.Footnote ³⁹

3.3.2 Intermediaries regulation

The second safeguard proposed relates to the regulation of intermediaries. Such regulation is especially important due to the key role online platforms play in bringing together businesses and investors (CAMAC, 2014, p. 87): the intermediary controls which projects go on its platform and which investment opportunities are available to investors. As these platforms play the role of gatekeepers, it is in their best interests to limit fraud and attract successful ventures, since poor-quality projects would negatively impact their profitability. If an intermediary can develop a reputation as being trustworthy, this would raise investor confidence in the platform and would attract more investors to it, as they would trust the platform to promote viable projects (Heminway, Reference Heminway2013, pp. 185–186).

Licence r equirement: in view of the role that online platforms play in the process of CEF, both the CAMAC and the NZ models require intermediaries to be licensed (Australian Government, 2014, p. 9). This would permit ASIC to monitor each online platform and ensure that the conditions of its licence are met. Due to the nature of the intermediary, there are two possible existing licences that might apply:

• • an Australian financial services licence (AFSL)Footnote ⁴⁰ ; and

• • an Australian market licence (AML).Footnote ⁴¹

The Bill model requires intermediaries to hold a new type of AFSL that expressly authorises the provision of crowdfunding services (Explanatory Memorandum, the Bill, p. 30). This approach makes sense and is to be commended. Applying for this licence is both more straightforward and less costly than applying for an AML. An AFSL would also present fewer entry barriers to intermediaries, since such a licence is issued by ASIC if the legislative requirements are met,Footnote ⁴² while an AML may only be issued at the discretion of the relevant minister.Footnote ⁴³ Further, an AFSL would provide investors with a range of protections,Footnote ⁴⁴ including the establishment of compensation arrangementsFootnote ⁴⁵ and internal and external dispute-resolution processes.Footnote ⁴⁶

Due d iligence: under both the CAMAC and the NZ models, the intermediary is required to conduct limited due-diligence checks on businesses that are raising capital on its platform, and may not provide financial advice regarding any investment. Instead, they are to provide a generic risk warning to investors (Australian Government, 2014, p. 9). The Bill model adopts a similar approach by referring to the intermediary as a gatekeeper. The due-diligence requirement will help reduce the risk of fraud (Bradford, Reference Bradford2014, p. 375), while the generic risk warning requirement will highlight to investors the risks their investment may involve. Under the Bill, the intermediary will be required to conduct prescribed checks and must not publish information about a company if it is not satisfied as to the identity of the company, its directors and officers.Footnote ⁴⁷ While these obligations may be costly, they are essential to ensure the protection of investors and enhance the good corporate governance of the intermediary.

3.3.3 Investors regulation

The third safeguard proposed relates to imposing regulation on investors. A review of the different approaches adopted or lobbied for around the world indicates that the level of obligations imposed on investors varies, with some countries adopting very few limitations on investors while others have more restrictive rules that curtail investors’ freedom. For instance, NZ allows investors to invest in CEF as long as they have signed a document acknowledging the risk that this form of finance involves.Footnote ⁴⁸ Italy goes one step further by requiring investors to complete a questionnaire to ensure that they understand the risks attached to CEF.Footnote ⁴⁹ However, the most popular model, adopted in countries such as the USFootnote ⁵⁰ and the UK (Financial Conduct Authority, 2016, 4.7.7, 4.7.10), is very restrictive, as it imposes a cap on the CEF investments that a person can make in a period of twelve months.

The c ap: in Australia, the CAMAC model only allows a person to invest AUD$2,500 in any one business in a twelve-month period, with a maximum of AUD$10,000 to be invested in CEF during that period (CAMAC, 2014, p. 146). This proposal is more rigid than the NZ model, which does not have any compulsory investment caps attached to it (Australian Government, 2014, p. 10). Further, the total cap on investments in CEF proposed by the CAMAC model is much lower and less flexible than the caps adopted in countries such as the UKFootnote ⁵¹ and the USFootnote ⁵² and, as such, had little appeal. The Bill model proposes a watered down cap, which is aimed to protect investors while giving them the choice and the right to invest their money as they wish. A AUD$10,000 cap per investor in a period of twelve months (with the possibility of altering this cap by regulation) is introduced.Footnote ⁵³ However, this cap is qualified, as it is the maximum amount that can be raised by an individual on one platform and in the same company. This does encourage investors to diversify their investments and will allow them to invest in other companies if they wish to do so.

The n udge: the imposition of investment caps stems from the nudge theory. This theory seeks to enhance the understanding and management of heuristic influences on human behaviour which affects the decision-making of individuals. With this understanding, it aims to reshape existing choices of individuals through choice architecture: if left without limits, investors would be able to invest their money as they wished and would make poor decisions (Thaler and Sunstein, Reference Thaler and Sunstein2009). This situation is not constructive for investors, as only when they are faced with a small number of alternatives they understand can a person make the best choice based on the advantages and disadvantages of a particular option (Thaler and Sunstein, Reference Thaler and Sunstein2009). In the context of CEF, if there were no investment cap, individuals would be faced with a large choice of possible companies to invest in and consequently would have to rely on alternative strategies to make their decision/s. These alternative strategies may be flawed, not taking into account the full picture – but, if investors are limited to certain investments so that any losses they might make are small, they are thereby ‘allowed’ to make errors and be forgiven. They may also do a better job at managing complex choices they face. As such, the cap on investments restriction may be viewed as a form of framing, with the aim of limiting an individual's investments in CEF: without such a cap, it is considered that investors may commit themselves to a bad investment due to overconfidence and their personal biases. Accordingly, the investment caps recommended by the CAMAC model are designed to change behaviour by limiting the number of businesses individuals can invest in. The fact that there is a limitation is intended to stop a person from rushing into any particular investment and instead make them reflect on whether such an investment is possible or whether they should save their funds and invest it in other, more promising businesses (Thaler and Sunstein, Reference Thaler and Sunstein2009, pp. 53–56): curtailing investment choices through caps is a paternalistic approach to CEF.

However, applying such a paternalistic approach may be not only justified, but warranted, as people's decision-making is not generally based on objective factors – a herd mentality may apply (Thaler and Sunstein, Reference Thaler and Sunstein2009, p. 66). These deficiencies are likely to be accentuated in an online environment where investors may be trading more actively and speculatively (Barber and Odean, Reference Barber and Odean2002, p. 456). Some may even say that the crowd is destructive, impulsive and will exhibit a new persona separate from its members as the individual consciousness vanishes from the crowd (Bon, Reference Bon2008, pp. 13, 18). The crowd is then perceived as a single being and ‘is subjected to the law of the mental unity of the crowd’ (Bon, Reference Bon2008, p. 13). As a result of this, the crowd is viewed as irrational, and this characteristic would be dangerous in the case of CEF, where fraud and business failure may become rife.

Other research, however, suggests that the crowd may not be irrational (Benkler, Reference Benkler2006; Libert and Spector, Reference Libert and Spector2007). For instance, the rush towards bad investments in the past may not have been conducted by an irrational crowd. The crowd may have had promising leads and motivations and reasons that guided them to particular investments (White, Reference White1988). Additionally, a crowd may be wise (Surowiecki, Reference Surowiecki2005). The aggregate judgment of the crowd is more accurate than the judgment of individuals (Galton, Reference Galton1907; Aristotle, Reference Aristotle and Barker1972, p. 123). With crowdsourcing, for example, the crowd has been able to provide more original and superior problem-solving outcomes (Bragham, Reference Bragham2008). Individuals involved in crowdsourcing are motivated by extrinsic and intrinsic factors to make a contribution to a particular project (Wexler, Reference Wexler2011, p. 12). The technology now allows for millions of independent ideas to come together without the danger of too many compromises being made by individuals in the crowd (Bragham, Reference Bragham2008, p. 80).

Further, with CEF, a range of people will be coming together from different backgrounds with different knowledge and experience and that may make the crowd wiser (Davis-Stober et al., Reference Davis-Stober, Budescu, Jason and Broomell2014, p. 80). The more diverse a group is, the better it is at solving problems, as each member of the group will be bringing new information that will enhance its decision-making in the end (Page, Reference Page2011; Hong and Page, Reference Hong and Page2004). Homogeneous groups, on the other hand, are often victims of ‘group think’ (Janis, Reference Janis1982): their mental efficiency and moral judgment are influenced by in-group pressure, which may lead to the deterioration of decision-making (Janis, Reference Janis1982, p. 9). Accordingly, the diversity of people that will be attracted to CEF may result in better outcomes for investors.

Of course, this does not mean that people will always make good decisions when investing in SMEs through CEF, as there is always the danger that the crowd may become polarised and homogeneous (Vaga, Reference Vaga1990, p. 39). Further, some investors may be investing as a result of a hyped-up project without considering the value of the project properly. As such, investor-targeted protections need to be in place. However, such protections do not need to adopt the paternalistic approach of the investment cap. The approach to investor regulation proposed by CAMAC is also problematic from an enforcement perspective: who will enforce the caps? To require the intermediary to ensure that investors on their platform are in compliance with the cap may be costly for the intermediary.

Promoting financial literacy: it is suggested that CEF may be viewed as a social experiment to boost financial literacy (Friesz, Reference Friesz2015, p. 146). Financial literacy is very important, as it can develop and promote individuals’ autonomy of choice: it will open the door for the average person investing in CEF to be treated as a free rational being and would prevent the CEF exemption from sliding into overbearing paternalism. People who are becoming interested in investment will be self-motivated to learn how to enhance their decision-making in this area. A culture that enables them to find out what they need to know will lead to better decision-making of the crowd. It is important to allow people to adopt the right norms and practices in their investments (Sunstein and Hastie, Reference Sunstein and Hastie2015, p. 13). One key element that an education campaign to boost financial literacy should highlight to investors is the fact that there are a number of signals that ought to be considered when investing in CEF. These signals provide information regarding a project's viability and so may enhance the decision-making of investors (Moss et al., Reference Moss, Neubaum and Meyskens2015; Wu et al., Reference Wu, Wang and Li2015).

In addition to the traditional signals referred to in the literature of crowdfunding (Michelucci and Rota, Reference Michelucci and Rota2014, p. 5), it is suggested that regulation to protect investors could add one more signal that would lower the information asymmetry between a business and investors (Yum et al., Reference Yum, Lee and Chae2012): businesses attempting to raise more than AUD$100,000 in one go should only be able to do so if they raise the funds in stages. Each stage would be a milestone that, when reached, would allow the business to raise more money to achieve the next milestone in the project. This would provide additional information to investors regarding their initial investment: is the business meeting its milestones on time? If it is, it may attract more investors or encourage existing investors to increase their stake in the company. On the other hand, if milestones are not met, questions will be raised regarding the reasons behind the delay. Evidence of delays may deter new investors from investing in the business. Such milestones may limit fraudulent activities in the sphere of CEF and may also limit the losses of investors.

This education campaign to boost financial literacy could be conducted jointly by ASIC, as part of its financial literacy programme, and the intermediaries in CEF, since they play a gatekeeper role between businesses and investors. In addition, an approach similar to the Italian system might be adopted, so that investors are required to complete a questionnaire demonstrating their understanding of the risks and the factors to consider when investing in CEF. It is to be hoped this will raise investors’ awareness of investments in general and so enhance financial literacy.

Investors’ p rotection: lastly, investors still need a regulatory policy that protects their interests. This is particularly important, since CEF is relied on when SMEs wish to raise a small amount of money from a large pool of investors. In instances where misleading or fraudulent conduct by businesses or intermediaries occurs, investors have few resources available to them: it is unlikely that individual investors would have invested enough money in a project to justify bringing a legal action against the business or the intermediary. A class action may also be unlikely, as the gains for lawyers running such a case are limited (Pesok, Reference Pesok2014, p. 149). Consequently, ASIC must take an active role in monitoring and regulating CEF. This may be necessary to send a message to businesses that they will be held accountable if they are involved in misleading or fraudulent conduct through CEF, irrespective of the fact that the losses to individual investors may be relatively small.

However, from the regulator's perspective, this may be problematic, as ASIC has a limited budget. Accordingly, the full-scale audit of ASIC that is currently taking place (Thompson et al., Reference Thompson, Shapiro and Eyers2015) should consider improving the regulator's budget to enable it to achieve its objectives in protecting consumers, even in the CEF sphere. ASIC should additionally be equipped with administrative enforcement powers that would allow it to act quickly to stop a fraudulent scheme from taking place.