Are start-ups about to become the next small cap stocks? – OPINION

It’s a question worth mulling over as a result of the government’s much-vaunted ‘Innovation Statement’, which amongst its recommendations opened up start-ups to a much larger pool of equity.

In case you missed it, the Turnbull government yesterday outlined a $1.1 billion spend over four years to foster innovation.

One of the key planks was an ambitious plan to attract more small-scale capital for start-ups which may fly under the radar of existing venture capital of angel investors.

The government pointed to a report done by PricewaterhouseCoopers back in 2013 on the start-up sector, which found that 4500 Australian start-ups miss out on funding altogether.

It also found that access to funding is one of the main prohibitors in start-ups getting off the ground.

It may very well be that the next big thing is being brewed in a garage somewhere, but unless that start-up understands how to access capital investors, they’re not going to win any investment.

However, the government is aiming to turn mum and dad investors who may not be averse from having a punt on small cap equities into those who may not be averse from having a punt on start-ups.

Compared to other nations around the world, Australians in general are obsessed with investing in listed stocks. This comparison is especially true when measured against the US, where investing in private companies is easier.

So what’s the carrot?

The government is attempting to lure finance from everyday Australians in two ways:

Number one, it is offering a 20% tax offset for investors rather than a deduction.

For example, if somebody invests $100,000 in a start-up, their tax will be reduced by $20,000 straight off the bat.

If it were a deduction however, it would come off the investor’s taxable income and would not equate to the full $20,000.

Secondly, it is providing a 10 year exemption on capital gains tax on the initial investment if the investor holds onto their investment for three or more years.

So, if an investor invests $100,000 for shares in a start-up and sells them for $500,000 five years later, the initial $100,000 will be free from capital gains tax.

For investors looking for potential rapid upside in exchange for greater risk, these two things may help swing attention away from small-cap equities and toward start-ups.

Investors will also be eligible for a 10% tax offset for capital invested in ‘Early Stage Venture Capital Limited Partnerships’ under proposed legislation.

Eligible companies must have expenditure of less than $1 million and income less than $200,000 in the previous income year.

Crowdfunding

The government also announced that it would allow start-ups to access capital from crowd-sourced equity funding platforms.

Usually, to access CSEF platforms companies need to be public. There’s nothing in particular stopping a start-up from becoming a public company except the burden of having to do things like file annual reports and hold annual general meetings.

For many start-ups who are a one-man band, this can be rather onerous instead of being a simple proprietary company.

Under laws being drafted however, a start-up will be exempt from having to file audited annual reports and holding annual general meetings for five years.

This means start-ups will be able to access CSEF platforms, grab the capital, and then in five years when the company is more established get to filing annual reports and holding AGMs.

Access to CSEF platforms has been in vogue of late.

Crowdfunding advisor Oscar Jofre told the International Mining and Resources Conference in Melbourne recently that companies looking at raising cash via brokers were leaving of a lot of cash on the table.

“You think when you take a deal to a broker, that it’s actually being distributed to everybody. It is not,” Jofre said.

“In fact...in the last ten years the mining sector, the private placements that have been done, have only been distributed to the one per cent of those investors qualified to invest.

“The rest just aren’t getting a shot at it.”

A flood on the cards?

It’s way too early to call whether or not start-ups will eat into the retail investment pool available to small-cap equities.

It could very well be the case that the new funding arrangements will open up a new source of capital, as those who may not have thought about investing in small caps look at start-ups.

In any case, a lot of the changes need to go through parliament before they get off the ground, and there’s no guarantees there.

But it does open up another path to funding for early-stage investments.

The scope of what qualifies as a ‘start up’ under the scheme is yet to be fully defined, but it’s unlikely a driller looking for $1 million in capital to drill targets in West Africa is going to qualify.

From this point of view, it’s hard to see a direct competition breaking out between small cap equities and start-ups for retail finance.

But, it does open up another interesting paradigm in the smaller end of the market.