Equity funding normally means ownership of the means of production. In this talk it is extended to mean ownership in the output of the means of production. This provides a better way to Crowd Fund investments. The approach provides lower risk Investments than is available with normal equity funding. It is also a cheaper and lower risk approach for the Company than traditional loans.
The idea behind most early stage equity funding is to invest in a portfolio of startups and to expect that some (most) will fail but those that succeed will pay for the ones that fail. This approach is high risk because even if a winner is picked it is often difficult to realise the full potential of the investment because of the uncertainty surrounding ownership and the rewards from ownership. What is proposed here is an investment model using Direct Crowd Funding. A description of how this can work for any infrastructure can be found at https://kevinrosscox.me/2014/06/26/crowd-sourcing-infrastructure/. Here I concentrate on its use in early stage investments.
Instead of funding an investment with equity we Crowd Fund by PrePurchasing output from the investment before the product is built. A music album can be purchased before it is produced etc.
Crowd Funding of an enterprise can be achieved by abstracting PrePurchases of Output to be any saleable output resulting from the Investment. PrePurchases are investments where the value of the output received increases over time at some rate. This is achieved by the purchaser receiving goods in the future at a Discounted Price. Assume an investor puts in $100 with a Discount rate of 10%. In two years time the investor can purchase goods with a value of $120 with their $100 PrePurchase. The PrePurchase amounts are transferrable and can be sold together with the Discount. PrePurchases can increase in value by the rate of inflation so preserving their value.
With modern computer and communications facilities, keeping track of PrePurchase amounts and who owns them, is a relatively simple process because a PrePurchase is simply an advanced sale. The regular billing, accounting and tax procedures for sales are used for PrePurchases.
For early stage startups the Discount Rate can be high – say 30%. As the business attracts customers so new sales will have a much lower discount. It is anticipated that investment funds for stable businesses will be about 10%. As the Discounts applied to new sales drops so the investment value of high Discount PrePurchases increases. To an investor who wishes to hold PrePurchases a 30% Discount has greater value than a new PrePurchase at a Discount of 10%. The difference in value will depend on how long the investor wishes to retain the investment but it can give the investor an immediate Capital Gain if the higher Discount PrePurchases are sold.
PrePurchases being available to purchase goods and services from the Company means that the investments are liquid. This is not the case with direct equity investing.
PrePurchases are treated as unsecured liabilities on the Company Balance Sheet. If they are used with the discount then there are no tax consequences. If they are transferred then the increase in value is treated as a Capital Gain.
Using this approach means that investors with high Discount Rates are more likely to keep their funds in the Company.
If a Company is sold, the PrePurchase liabilities are transferred to the new owner and so the investor is protected from losses caused by ownership changes. If new capital is needed then the investor is protected from dilution effects.
The legal and tax rules around PrePurchases are well known because they are the same as any purchase agreement where delivery of goods is delayed.
The approach is especially attractive to long term investors like superannuation funds, pension funds or government funds for Industry.
Staff can be given bonuses by issuing them with the entitlement to obtain PrePurchases at some time in the future. This does not incur a tax event at the time of entitlement and is the same as other entitlements such as termination payments. The tax event takes place when the entitlement is acted upon.
PrePurchases with Discounts is another method of Crowd Funding that turns all buyers of product or services into investors in the output of the Company. This means PrePurchase investors, buyers, employees, shareholders all have the same incentive to produce a profit on the output of goods and services.