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Investors not yet ready for secondary market in crowd-funded equities, platforms say

Wednesday 12th July 2017

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Licensed stock market operator NZX is abandoning its plans to develop a market for small and medium-sized companies, but crowdfunding platforms say they're yet to see enough demand to build a secondary market for the share sales they facilitate. 

The public market operator's NXT and New Zealand Alternative Market, known as the NZAX, will be absorbed into the main board in the third quarter due to limited uptake by companies and generally low levels of trading activity, or liquidity, despite the expanding assets of KiwiSaver funds in need of viable investments and the government's partial privatisations several years ago which added a new lease of life to the stock market. 

The launch of equity crowdfunding in August 2014 was intended to provide a new avenue for small firms to raise funds that wasn't available through the larger capital markets, and has largely been seen as a success. However, that demand, which has seen 30 successful deals through the country's two major platforms - Snowball Effect and Equitise - hasn't whetted investor appetite to buy and sell those shares after the offer, even if some potential investors missed out. 

Peter Thomson, head of digital at Snowball, says investors should be looking at crowdfunding startups as a long-term proposition, but occasionally circumstances change and people need to sell. The country's biggest crowdfunding platform operates a halfway measure in that it will either connect the investor with the company or directly to an interested buyer. Two of its recent offers - Designer Wardrobe and Zeffer - ended up with a waiting list of people who would have liked to invest but missed out. 

Both Snowball and its closest rival Equitise have tested the waters for a secondary market but ruled it out due to the lack of demand. 

"Our general take is we will always look to help where we can, to put companies in touch with any buyers or sellers. Given where the market is at and what we have been witnessing, we haven't had the requirement, there just hasn't been sufficient demand," Equitise co-founder and director Jonny Wilkinson said. "That is a function of the maturity of the market and the life cycle of some of the companies involved, it's something that will come through over the years and we might try to provide it."

In the UK, which is the most developed crowdfunding market, London-based platform Seedrs launched a secondary market earlier this year. Trading is open for a week from the first Tuesday of every month, and buying is restricted to existing investors. So far, 2.5 million shares have been traded between 349 buyers and sellers, worth about 770,000 pounds overall, the platform says.

Snowball's Thomson, who has previously worked for Seedrs as chief marketing officer and for New York-based SeedInvest as head of digital marketing, says one challenge of a secondary market is setting a fair price. Seedrs uses a valuation policy that takes account of the price a company most recently sold its stock as well as ongoing performance information.

While many people who have sold their shares under the current system have been happy to sell them for what they originally paid, or for the price of the most recent round, that's not a sustainable basis to build a secondary market, Thomson said.

Part of setting a fair price is access to financial information. If it's three years since a company has raised capital, much of the information publically available from its prospectus may be out of date. The Seedrs model isn't open to new, uninformed investors, seeking instead to skirt disclosure obligations by only allowing trading by existing investors already familiar with a company. Many small start-ups are wary of having to make new disclosures about their performance.

"That gives you a window into why everyone's so nervous about all of this," Thomson said. "This is a philosophical thing: from the investor's perspective, you should be looking at buy and hold. From the company's perspective, if you're the CEO of one of these companies, the last thing you want is a stock price that's going up and down every month and people arguing about your financial statements. You want to be busy running the business, not worrying about your share price or quarterly reports."

"You don't want all of the bad of the public market," he said. "These companies are too small, they don't have a whole team of corporate investor relations people, it's often just an operational team and they don't have the capability to do all of that additional reporting."

Equitise's Wilkinson agrees - for small companies, maintaining compliance can be costly and distracting, he says. In 2015, Equitise promoted a trans-Tasman secondary market in partnership with Auckland-based Syndex. Wilkinson said the technology wasn't there so the market didn't eventuate, but "if we had investors screaming for it", the platform would look at offering a technology based solution. 

Garth Stanish, director of capital markets at the Financial Markets Authority, says the regulator has no preconceptions about how a secondary market would operate, and companies wouldn't necessarily end up with huge disclosure obligations. Platforms with existing crowdfunding licences would need to apply to the FMA in order to operate a secondary market, but none have yet done so.

"We have very broad discretion in terms of what we'd look at if we did get an application," Stanish said. "If someone did come to us, as an overall thing we'd have to make sure the market itself was transparent - whether there were clear rules which set out the parameters of what buyers and sellers could do."

Stanish said New Zealand could end up with a model like Seedrs, and it was very likely any market would have limited trading windows so that companies weren't put under pressure for continuous disclosure.

"For example, in a situation where there was only one trading day a month, I suspect you would have some sort of cleansing notice. Any company trading would have to say, before the trading window, there's nothing else out there that investors should know," Stanish said. "You want that equality of information, you don't want the asymmetry where people who are in the know have a great advantage over others. I suspect that will be the sort of proposition we get."


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