Race To Top When Equity Crowdfunding Platforms Have Prescribed Gatekeeping Responsibilities: A Comparative Analysis of Equity Crowdfunding (ECF) Regulations
Providing small companies alternative ways to access capital has become especially important today, owing to the impact of the COVID-19 pandemic on small businesses. Equity Crowd-sourced Funding, also known as Equity Crowdfunding (ECF), is a source of financing for small companies, whereby such companies can offer shares to the public through an online crowdfunding platform without having to comply with exhaustive securities regulations. Without ECF, equity investing in promising small companies is an option available only to a small group of professional investors such as angel investors and venture capitalists.
In our article, Could New Zealand's Equity Crowdfunding Regulations Be the Model for the Developing World? (recently published in New Zealand Universities Law Review and the winner of the 2021 Best Paper Prize of the Corporate Law Teachers Association (CLTA)), we compare the ECF regulations of the United States, United Kingdom, Australia, and New Zealand. We find that New Zealand and the United Kingdom have had the highest ECF investment per capita, but only the latter has had a significant number of failed crowdfunded companies. Neither the United States nor Australia has had much success in attracting ECF investment per capita.
What is unique about the New Zealand system is that a strong and defined gatekeeping role is given to the crowdfunding platforms. This approach appears to lower compliance and supervisory costs for fundraising companies and regulators respectively. In turn, platforms which are successful in their gatekeeping role develop a reputation for bringing successful companies to the market, making their service more appealing to the ECF market.
Given the success of New Zealand’s approach, we argue that ECF regulations could prescribe more robust duties and gatekeeping responsibilities for platforms—as opposed to regulating platforms as mere facilitators and prescribing extensive responsibilities for small companies. From a policy perspective, regulating platforms in this manner is less costly and more efficient than other models of regulation. New Zealand’s ECF regulations have low compliance costs because private actors (ie platforms) organise and monitor the market without the direct involvement of the state. It is not desirable to subject ECF offers to the costly mandatory securities disclosure obligations that are traditionally prescribed for listed companies. Imposing compliance with heavily regulated securities disclosures would be burdensome for small companies and it could discourage them from using ECF. Setting up a system where regulators oversee platforms who in turn organise and monitor the ECF market participants simultaneously reduces supervisory and compliance costs for regulators and for fundraising companies respectively.
Arguably, in an environment where all platforms are required to perform a gatekeeping function, a platform’s reputation will be an important factor ensuring a ‘race to the top’. Platforms with failed companies would soon lose the interest of crowdfunders and, in turn, a shrinking pool of crowdfunders will deter companies from using such platforms, as opposed to those who have been more successful in hosting high-growth companies. However, in the absence of regulations mandating gatekeeping, platforms must compete to attract companies to use their services against other platforms who might invest less resources in gatekeeping. There would be the danger of a ‘race to the bottom’. Regulations that set clear gatekeeping responsibilities for platforms therefore serve to level the playing field and create accountability. In an environment where gatekeeping is prescribed, all platforms are obliged to invest resources in gatekeeping and platforms that do the best in this context excel. This way, companies decide on the most suitable platform to raise capital, while regulators ensure platforms indeed race to the top by monitoring the prescribed duties that lie on platforms.
It is worth noting that New Zealand has developed an effective regime for ECF in the absence of an in-depth venture capital market. Having a relatively small venture capital market means that small companies did not have many alternatives to access capital. The approach in New Zealand exemplifies how countries with a modest venture capital market, a dearth even more significant in developing economies, can successfully develop ECF as an effective alternate source of capital for small companies.
Therefore, broader responsibilities on platforms for gatekeeping, disclosure and grooming as set out in this article would be valuable in establishing a safe and efficient ECF market.
Jonathan A Ande is PhD Candidate at Deakin Law School.
Zehra G Kavame Eroglu is the Director of the Master of Professional Accounting and Law & Lecturer of Corporate Law and Finance Law at Deakin Law School.
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