New Zealand implemented relatively liberal equity crowdfunding regulations in 2014. This was a bold approach. Equity crowdfunding markets around the world were either non-existent or in their infancy, so there was scant precedent to inform policy makers. And there was widespread concern about whether retail investors would properly understand the risks of investing in private growth companies.

The equity crowdfunding regulations allow for each company to raise up to $2m from retail investors in any 12 month period. The key change in the regulations was to remove the requirement for a regulated "product disclosure statement" when offering shares to retail investors. This change drastically reduced the cost of making a public offer, and therefore opened up the wider equity capital market to cash-hungry early stage growth companies. Over $25m has been raised by such companies in the 21 months since the first offer was launched on 11 August 2014.

New Zealand's equity crowdfunding framework has provided a fertile regulatory environment for the market to get on its feet. Hats off to the policy makers involved. New Zealand is already cited globally as a good example of how such a market can be established. But after 21 months of trading, we've now had enough time in the market to identify aspects of the regulation that are restricting the potential of the market. The key aspects are:

  • The $2m limit.
  • Restrictions regarding a secondary market.
  • Restrictions regarding subsequent rights issues.
  • Restrictions regarding the offer of convertible securities.

This article focuses on the current $2m limit.

The $2m limit

We talk to many companies that are looking to raise between $2m and $10m. The economics are difficult for a raise of this size in New Zealand - it's expensive to engage an investment bank and lawyers to put together a product disclosure statement for such a small public offer. And there's not enough value in the deal for a broker, so there's no established distribution channel to place the shares with investors.

Since a public offer is prohibitively expensive, these companies are forced to consider private funding channels. Given their stage of growth, they are generally too developed to appeal to angel networks, but not developed enough to appeal to VC funds. So they end up looking for local high net worth investors or offshore investors. The capital raising process ends up being expensive and lengthy, and there's significant opportunity cost as management focus is diverted away from growing the business.

Equity crowdfunding marketplaces have the potential to serve these companies well, but the $2m retail investor limit restricts the impact that can be made.

A company can raise more than $2m if the balance comes from "wholesale investors". For example Squirrel recently raised over $3.4m through Snowball Effect, with up to $1.97m allocated to retail investors and the balance from wholesale investors. However the $2m limit significantly reduces the size of the investor pool for the balance of funds required over $2m.

Is there good rationale for maintaining the $2m retail investor limit?

One knee-jerk reason is to limit the exposure of retail investors to each company. However each retail investor is currently able to invest as much as they like in each offer. They are highly unlikely to invest more than $2m in an offer, and if they did, they would automatically be classified as a wholesale investor and could invest as much as they like. So that rationale falls flat.

The $2m limit was a way of policy makers saying "here is a lighter regulatory regime to improve access to capital, but larger companies are still required to comply with the normal expensive process". I'd suggest a couple of key reasons behind this. The first is that regulators could contain the damage if the new equity crowdfunding marketplaces failed to get traction or fraudulent activity emerged. The second is that $2m was seen as a sensible place to start because it addressed a part of the capital market that is widely acknowledged as being underserved. These reasons made sense when the new regulations were introduced.

It's also widely acknowledged that companies raising $2m - $10m are underserved.

Companies in this part of the market are generally more established, and therefore generally lower risk. Given the later stage of development, these companies are also generally closer to an "exit" or "liquidity event", or at least can describe their longer term liquidity intentions with greater clarity. The typical retail investor is actually better suited to investing in these expansion stage companies than they are to earlier stage companies that are raising less than $2m.

Now that the equity crowdfunding market has shown its potential for efficient capital raising, it's time for the $2m limit to be increased to address another significant hole in New Zealand's equity capital market. $10m is a sensible limit to enable the next phase of development of the market.