Crowdfunding is fast becoming a viable option to raise capital with less risk relative to conventional funding options, but South African businesses considering this option should be aware of local concerns.
Last month new regulations in the US came into effect when the SEC made it possible for non-accredited investors to put money into early-stage startups. For the first time, people earning less that $200000 can invest in companies they think will make it big, with rules specific to crowdfunding.
While the US now has specific legislation Daniel Witz, a partner at WCIS Attorneys, says that crowdfunding is still in its infancy in South Africa.
“As the popularity of this form of collective investment rises, South African regulatory bodies will need to specifically address this form of funding,” he says.
According to Witz, crowdfunding in South Africa is not illegal but given the lack of regulation the potential risks are high.
“Unlike the United States, there is no explicit mention of crowdfunding in any legislation in South Africa, and at this stage no draft legislation has been proposed in Parliament,” he says.
“The Reserve Bank of South Africa doesn’t allow you to simply send money to someone without reason, where the recipient doesn’t provide goods or services in exchange for the payment,” says Witz.
He points out that there is a potential loophole to get around this: just provide something to the funders in exchange. Non-profit organisations also benefit from an exception.
“The ‘goods and services’ rule doesn’t apply to non-profit organisations. A registered non-profit organisation can run a campaign for donations to be applied to a specific project,” says Witz.
“An issue that donation-based crowdfunding faces in South Africa is whether such platforms could constitute ‘banks’ that receive deposits as defined in the Banks Act. As long as the investor receives goods or services in exchange for the payment, and does not receive funds that were accepted or obtained merely from other participating investors, then the crowdfunding platform would not be acting as a bank, as defined in the Act.”
This means that crowdfunding campaigns where funders will receive the product being developed, as is very common on Kickstarter or Thundafund, would qualify.
The South African Revenue Service is also attempting to promote investment via the Income Tax Act, which plays a role in equity-based crowdfunding in South Africa.
“Section 12J allows for deductions from the income of certain, qualifying investors in respect of expenditure actually incurred for shares in a venture capital company,” says Witz.
“If crowdfunding platforms can be registered as venture capital companies in terms of Section 12J, then any funds invested in the crowdfunding platform may be allowed as a deduction for tax purposes.”
In order to qualify, platforms must have the management of investments in developing companies as their primary objective, and must be licensed in terms of section 7 of the Financial Advisory and Intermediary Services Act No. 37 of 2002. The platform also cannot be deemed to be performing an “impermissible trade”, as defined in the act.
“The National Credit Act No. 34 of 2005 (NCA) could potentially cover debt-based, or peer-to-peer crowdfunding,” says Witz.
“The NCA defines a credit provider as a party who extends credit under an agreement whereby the credit provider undertakes to pay the consumer an amount of money and defer repayment and charge a fee for such arrangement.”
“You can also consider equity-based crowdfunding projects which would likely be facilitated through offers of securities (eg shares) to the public by private companies,” he continues.
“In terms of section 100 of the Companies Act No.71 of 2008, when unlisted securities are to be offered to the public, such an offer must be accompanied by a detailed prospectus. The content and registration of prospectuses must be in compliance with Chapter 4 of the Companies Act,” he says.
“Creating a special purpose vehicle (SPV) with a share capital, which acquires the total investment proposal once the project achieves its target amount could achieve the goal of equity-based crowdfunding. Investors would receive preference or normal shares in the SPV which would be proportionate to their investment. For a few rands, you get yourself a little stake in the company you’re backing, instead of the usual coffee mug.”
An interesting recent experiment is that crowdfunding mining operations in Canada, with obvious opportunities for similar in South Africa.. Chad Williams, the president and CEO of Red Cloud Klondike Strike Inc, believes that crowdfunding is the future of raising venture capital for mining. Red Cloud began working on crowdfunding approximately 18 months ago and it took 14 months to get Canadian regulatory approvals for it. The Red Cloud platform has about 500 users and Red Cloud intends to devote effort to marketing to the millennial age group.
Regularising crowdfunding will be a laborious task for South African regulatory bodies and will take a considerable amount of time as they need to strike a balance between the protection of investors and the promotion of capital formation.
“Nevertheless, crowdfunding is a novel and exciting vehicle to promote entrepreneurship and for start-ups to gain access to much needed funding. Crowdfunding projects also offer incubator and/or mentorship environments in order to assist the entrepreneurs in building their business or launching their project and ultimately assisting the fund seekers in reaching their goals” says Witz.
While the regulatory environment might dissuade platforms that facilitate crowdfunding for others, startups looking to run their campaigns directly have many options to consider and crowdfunding no longer appears to be limited to a few specific spheres of business.