By Paul R S Hocking

There is a bit of clamour for the government to raise the investment cap from the current $2 million per company in any 12 month rolling period to as much as $10 million.  But is this what the market really needs?

At the same time as we debate this topic some, including offshore academics studying our equity crowdfunding market, are suggesting that the lack of caps on the amounts individual investors can invest in any one company or the amount invested in aggregate in any 12 month period is unsatisfactory.

However the truth is that without the cap on individuals and the ability for issuers to run hybrid capital raises with wholesale investors (particularly individuals who fall into this definition and thereby are akin to high net worth investors and angels) the need to raise the cap becomes somewhat moot.  It begs the question, will our SME sector really suffer when retail investors (ie those who are not wholesale investors and who are investing via a crowd offer) can only invest up to $10m?  I think not.

The lack of the retail investor cap seems to infer that our regulators respect the fact investors, once adequately warned about the risks, are adult enough to make their own decisions.  A very mature stance by our legislators and regulators in no uncertain terms.

If there is real concern in relation to investor well-being it should be about access to a secondary market.  In considering a secondary market pundits need to remember what a market is intended to deliver.  Its not about an exit from a bad investment or quitting ahead of the intended liquidity event.  Primarily a market for anything, whether shares or turnips, will enable price discovery to occur and once price discovery sets a price at which investors will transact in the product being offered then willing buyers and willing sellers can buy and sell to the extent market liquidity allows.

A secondary market is not about investors exiting per se.  It’s about striking a value for the shares and thereby the company and this can either encourage people to sell or to buy.  And buying is important.  The crowdfunded company may not return to the market.  It may have raised the money it needs to step up to the next level which might see a hastening of, for example, a trade sale.  That liquidity event may generate the return to the crowd investors without giving any others a look in.  But if the company is succeeding some other investors may wish to get on the band wagon and a secondary market gives them an opportunity to do so.

However, a secondary market needs rules of engagement and it needs a measure of infrastructure around things like settlements and share registers.  Importantly it also needs attention given to the free flow of information about the companies so that asymmetric markets don’t develop.  And in New Zealand we will need to face up to the requirements of the Financial Markets Conduct Act around licencing of market operators and regulated markets.  Because of the risks attaching to markets for those transacting on those markets we have developed laws around continuous disclosure and insider trading.

Having structures designed to deliver well founded markets with appropriate rules and oversight costs money and invariably it is the issuer who must fund these but crowd funded companies are by definition short of funds other than for their underlying purpose.  If commentators are serious about secondary markets perhaps they should consider a trade levy on transactions so the buyers and sellers rather than the issuers fund the market structures.

Perhaps the alternative is to have limited trading windows, such as immediately after results announcements when it can be presumed all market sensitive information is in the market but most/many of the investors will need help in valuing the companies.  Who will provide such valuations or undertake research on the companies.  If left to buyers and sellers then quite quickly we will see skilled investors taking advantage of the less skilled.  This would not be an intelligent outcome for the equity crowdfunding sector.

So the upshot is, before we expand the investment parameters we should look at secondary markets first but this will require a bit of work to balance the needs of an effective and efficient market with the costs of delivering it.