MCIS: A NEW CAPITAL RAISING OPPORTUNITY FOR MUTUALS.

Discretionary mutuals are often driven by the desire to join together for a common purpose, but they can be expensive to establish. A recent legislative change has now created a new opportunity for mutuals to raise start-up capital through Mutual Capital Instruments.

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What are Mutual Capital Instruments (MCIs)? 

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Recent changes to the Corporations Act mean that qualifying mutuals can now issue MCIs to investors. This is a new way for mutuals to raise capital while still meeting the requirements, including the ‘principles of mutuality’ for preferential income tax treatment.

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Up to now, mutuals haven’t really had a choice but to fund their capital requirements including establishment costs outright. Often this is done by subsidising these costs through increased member contributions or membership fees in the first few years of operation. This cost can be upwards of $120,000 with licensing, legal and administrative expenses.

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MCIs now provide an alternative allowing the introduction of a new ‘investor class’ with limited participatory rights. MCIs can be equity or debt instruments.

MCI holders do not have equivalent rights or access to the benefits that are provided to members of a mutual but they are entitled to receive dividends or distributions. MCI holders do have voting rights, but irrespective of how many MCIs they hold they only get one vote. The interests of the members continue to be given priority. MCI holders also cannot access surplus funds held by the mutual and their dividends are paid after all expenses including claim provisions.

How does a mutual issue MCIs? 

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A mutual has to meet 4 requirements before it can issue MCIs. It must:

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• Be a public company – this can include a company limited by guarantee but excludes mutuals structured as a trust;

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• Not have voting shares on a prescribed financial market – this includes the Australian Stock Exchange, the Sydney Stock Exchange (previously the Asia Pacific Stock Exchange) or the National Stock Exchange of Australia. It can hold voting rights in MCIs though;

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• Be registered under the Corporations Act – this means it can’t be a charity or co-operative registered under State or Territory legislation; and

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• Have a constitution that confirms its intention to be an MCI under the Corporations Act – if it doesn’t, the constitution of the mutual will need to be amended.

As MCIs are a security, ASIC’s disclosure obligations do apply. This means that a prospectus must accompany any offers made to the public. However, start-ups and small mutuals can make offers as part of a seed capital raise and avoid costly disclosures if they are proposing to raise capital from sophisticated or wholesale investors, venture capitalists or financial institutions. A simpler offer document, like an information memorandum, can be used for those types of offers and this allows mutuals to access funds faster.

When and where to use MCIs? 

MCIs may give some discretionary mutuals a more flexible option than using subordinated debt arrangements or raising capital through a related company like the mutual manager (using a share offer or crowdfunding) and this can be helpful where the stakeholder group is focussed on seeking investments from sophisticated and wholesale investors. But those investors must be willing to forego liquidity preference rights and ‘first in, first out’ rights, which are hallmarks of a traditional VC-backed round.

How can you take advantage of this opportunity?

If you’re an existing mutual, you will need to change your constitution to issue MCIs. The legislation includes a simplified procedure to do this that you can use until 4 April 2022. After that you’ll need to change your constitution by the rules contained in that document.

If you’re establishing a mutual, your constitution must include the right to issue MCIs before it’s adopted by the initial member. It’s also important that the members, the Board and the MCI holders understand the process behind the ranking of debt to the MCI holders when it comes to surplus and winding-up rights.

If you need advice on preparing for a capital raising or would like more information about how to use MCIs, please get in touch. We’d be happy to help.

Charmian Holmes and Julie Hartley

June 2019