Early Stage Innovation Company (ESIC) Legislation Needs A Zapdos

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Pokemon Go

It would be a rare event in Pokémon Go to find a Zapdos and complete your quest for a comprehensive inventory to proudly display to the public.

In a similar vein, the ESIC legislation in force from 1st July this year, needs to take on board a couple of special amendments to make it easier for investors to back early stage companies.

In a macro sense, while we support the efforts to give tax incentives to investors to invest into such high risk and fledging companies, the federal government should move to amend the Corporations Act allowing Pty Ltd companies to have 500 non-employee shareholders rather than the current outdated 50. Compared to overseas, where most progressive economies enable private companies to have thousands of shareholders, we, for no real reason, limit investor participation to 50!

Given ESIC’s are risky investments the secret is to have (say) 200 people invest (say) $5,000 each and enable the company to achieve their funding ambitions without having to roll over to a few Sophisticated Investors who demand unrealistic control conditions.

In more of a micro vein the following tweaking should occur:

  1. Investors should be able to make the decision whether they opt for the tax offset OR not apply the tax offset to their own position and that way be able to claim the capital loss should the venture fail. Many investors know that investing into such early stage ventures is very risky and the prospects of failure are high, most investors would rather be able to claim the capital loss should it fail rather than a tax offset on the way in.
  2. Retail investors should know that if they invest (say) $75,000 they can still claim the 20% of $50k and not be denied any claim as currently interpreted.
  3. While the tax law provides for ESIC tax offsets to flow through a trust to beneficiaries, it does not provide for distributions of disregarded capital gains on ESIC shares not to trigger the application of CGT event E4. CGT event E4 arises where a unit holder receives certain non-assessable distributions of trust income for an income year and the distribution exceeds the trust’s (taxable) net income for that year. The unit holder’s cost base of units is reduced by the amount of the non-assessable distribution and a capital gain arises to the extent that the amount exceeds the cost base.  Consequently, distributions of disregarded capital gains on ESIC shares may result in capital gains for the unit holder. This seems to be a surprising oversight that needs urgent attention.
  4. We believe if a company does a ESIC round of funding say this year of $1m and then spends it on eligible expenditure and then wishes to do a follow on round, rather than being denied as they no longer would qualify under the expenses test, there should be a follow on higher rev / exp hurdle so that investors on the second round can still get a tax offset otherwise the issue price of shares is likely to be lower on the second round (due to no tax offset) than the first round which goes against all capital building strategies and looks bad from a pricing point of view.
  5. We believe a group such as a chartered accounting firm or RTO should be able to issue ESIC certificates or opinions re a company’s eligibility to help investors know there is rigour around the ESIC assessment process.

Perhaps with the above tweaks incorporated the ESIC legislation will then be complete and can proudly be shown to the public! A rare aspiration!

About Jeff Broun

Jeff is an experienced corporate finance executive, non-executive director and company secretary. He is CEO of crowd backed public company Fat Hen Ventures Ltd, executive director of Equity Crowdfunding Australia Pty Ltd, and the WA convenor of the Crowd Funding Institute of Australia.

Jeff works with early stage companies, venture capital and equity crowd backed funding ventures.