In a short time, crowdfunding has caught the imagination of many entrepreneurs and become an important new fundraising technique. Through crowdfunding an issuer can aggregate substantial amounts of capital by seeking small contributions from many different people. Many start ups, small businesses, charities, artists and others now look to a variety of crowdfunding platforms to raise capital. To date however, in most jurisdictions these platforms have been limited to some sort of donation, reward, pre-purchase of products, or peer to peer lending model.1
Equity crowdfunding, the sale of securities through the use of crowdfunding techniques, has had a bumpier ride to reality. Some jurisdictions, such as Australia, have had some sort of equity crowdfunding for a number of years. There was early momentum around equity crowdfunding in the United States when the JOBS Act 2 came into force in 2012 but much of the early excitement has waned with the drawn out process of its implementation. Canadian securities regulatory authorities have been actively studying equity crowdfunding models for some time as well. To date however, with very few exceptions, equity crowdfunding has not been possible in Canada due to regulatory restrictions. This could change very soon.
In the past couple of years there has been a great deal of discussion and speculation about the nature and scope of possible regulatory changes in Canada to allow for equity crowdfunding. Recent developments suggest we are now much closer to a time when equity crowdfunding and other more flexible means for raising capital for early stage businesses in Canada will be a reality. Recent orders, proposals and notices issued by various Canadian securities administrators provide some clarity to the regulatory framework we can expect for equity crowdfunding:
- Saskatchewan was first off the mark. On December 6, 2013 the Financial and Consumer Affairs Authority of Saskatchewan adopted an order permitting limited equity crowdfunding for Saskatchewan-based startup businesses.3
- On March 20, 2014, the securities regulatory authorities in
Quebec, Saskatchewan, New Brunswick, Manitoba and Nova Scotia
published proposals4 for two new prospectus exemptions
related to crowdfunding:
- one for start-up crowdfunding based on the Saskatchewan model (the "Start-Up Crowdfunding Exemption") aimed more particularly at providing an alternative source of capital to non-reporting issuers at a very early stage of development, and
- the other more broadly applicable integrated crowdfunding exemption (the "Integrated Crowdfunding Exemption") available to both reporting issuers and non-reporting issuers.
- On the same day, the Ontario Securities Commission published a proposal5 for four new prospectus exemptions, including an offering memorandum exemption, an expanded exemption for friends, family and close business associates and an equity crowdfunding exemption substantially similar to the Integrated Crowdfunding Exemption referred to above.
- Again on the same day, the British Columbia Securities Commission issued a notice6 seeking comments on a proposed start-up crowdfunding exemption substantially similar to the Start-Up Crowdfunding Exemption. It takes the view that a form of equity crowdfunding is already permitted in British Columbia with the use of the existing offering memorandum exemption.
These proposals together are expected to allow Canadian businesses, especially start-ups and early stage businesses, to access capital from a potentially large number of investors using online portal platforms that would be registered with securities regulators. The proposed exemptions would, subject to certain conditions, allow both reporting and non-reporting issuers to raise money by distributing securities through online portals.
The Integrated Crowdfunding Exemption
The framework for the IntegratedCrowdfunding Exemption which is proposed for Quebec, Saskatchewan, New Brunswick, Manitoba, Nova Scotia and Ontario has two main components: (i) the requirements that an issuer must meet in order to distribute securities under the exemption, and (ii) a set of funding portal registration requirements. Under the IntegratedCrowdfunding Exemption, an issuer (whether reporting or non-reporting) would be allowed to distribute securities without a prospectus through a registered crowdfunding portal provided certain conditions are satisfied:
Issuer and Offering Conditions
- The issuer must be incorporated or organized in Canada and have its head office in Canada, and a majority of its directors must be residents of Canada.
- The exemption is not available to an issuer that is an investment fund, a non-reporting real estate issuer or an issuer without a written business plan.
- While an issuer is limited to securities of its own issue, the exemption permits the use of a broad range of types of securities to be offered including: (i) common shares, (i) non-convertible preference shares, (iii) securities convertible into common shares or non-convertible preference shares, (iv) non-convertible debt securities linked to a fixed or floating interest rate, (v) units of a limited partnership and (vi) flow-through shares under the Income Tax Act (Canada).
- A maximum of $1.5 million can be raised under the exemption, including any amounts raised in reliance on the exemption during 12 months immediately preceding the current offering.
- An offering document must disclose a minimum offering size and specify whether there is a maximum offering size.
- An offering cannot be completed unless: (i) the minimum offering is fully subscribed, and (ii) at the time of completion of the offering, the issuer has the financial resources to achieve the next milestone in its written business plan or, if no milestones exist, to carry out the activities set out in the business plan.
- There are specific restrictions on solicitation and advertising, including the following: (i) offering materials must be made available to potential investors on the portal's website and cannot be posted on any other website, (ii) offering materials must be delivered to the regulator at the same time that they are posted on the portal's website, (iii) investors can be directed to the portal's website by paper notice or through social media, (iv) marketing materials are limited to the offering document, documents described in the offering document and any term sheet or other summary (including a video).
- The issuer must abide by certain point of sale disclosure obligations by providing a streamlined disclosure document that includes basic information about the offering, the issuer and the portal.
Investor Rights and Conditions
- The proposed exemption provides for certain investor protection measures including the following: (i) an investor can invest no more than $2,500 in a single investment and no more than $10,000 under the Integrated Crowdfunding Exemption in a calendar year, (ii) investors must sign a risk acknowledgement form confirming that they meet the investment limits, understand they may lose their entire investment and understand the other specified risks that are set out in the form, and (iii) the investor has a right to withdraw within 48 hours prior to the disclosed offering deadline.
- If a comparable right is not provided by the securities legislation of the jurisdiction in which the purchaser resides, the issuer must provide a contractual right of action for rescission or damages in the event of a misrepresentation in any materials made available to the purchaser.
Continuous Disclosure Obligations
- There are certain specific ongoing continuous disclosure and book and record-keeping obligations for both reporting and non-reporting issuers. For example, a non-reporting issuer must disclose annual financial statements that are audited if the issuer has achieved the prescribed financial threshold, or reviewed by an independent public accounting firm if the issuer has not achieved the financial threshold. Reporting issuers must provide ongoing continuous disclosure in accordance with securities law requirements.
Portal Registration Requirements
Investments made in reliance upon the proposed Integrated Crowdfunding Exemption will have to be facilitated through a funding portal registered as a restricted dealer, a new category of registrant to be designated by applicable securities regulatory authorities. Registered portals and applicable senior officials will be subject to certain proficiency requirements and other general registrant requirements. More significantly, registered portals and every applicable registered individual may only act as an intermediary in connection with a distribution of securities made under the crowdfunding prospectus exemption and may not register in any other dealer or adviser category. This would significantly limit additional capital markets activities that a registered portal might otherwise undertake in respect of issuers and investors.
The Start-Up Crowdfunding Exemption
A form of the Start-up Crowdfunding Exemption is already available to issuers and investors based in Saskatchewan. As proposed, this exemption would be extended to Quebec, New Brunswick, Manitoba and Nova Scotia, and as noted above, it is also under consideration in British Columbia. The exemption would allow a non-reporting issuer to distribute securities without a prospectus through a crowdfunding portal so long as the issuer complies with certain conditions, including the following:
Issuer and Offering Conditions
- The issuer must not be a reporting issuer or an investment fund and must have its head office located in one of the participating jurisdictions.
- The scope of securities that can be sold under this exemption is fairly broad and consistent with the Integrated Crowdfunding Exemption other than flow-through shares which cannot be offered.
- The issuer may only use the exemption twice a year and each offering may only raise up to $150,000 with each offering remaining open for no more than 90 days.
- The offering document must disclose a minimum offering size and specify whether there is a maximum offering size.
Investor Rights and Conditions
- No investor can invest more than $1,500 per offering.
- At the point of sale, a standardized disclosure document must be provided that includes basic information about the offering, the issuer, the use of funds and the portal. This information need not include financial statements of the issuer.
- An investment cannot be completed before each of the investors has confirmed online that they have read and understood the issuer's offering document and the specified form of risk warnings required under the exemption.
- There may be limited or no right of action for rescission or damages in the event of a misrepresentation in any materials made available to the investor.
Continuous Disclosure Obligations
- There is no requirement for ongoing disclosure above the issuer's corporate or other governance statute, although issuers may decide to provide ongoing disclosure to their shareholders.
Portal Requirements and Procedures
Under the Start-Up Crowdfunding Exemption, it is still a condition that all investments made in reliance upon the exemption be made through a funding portal. However, there is no obligation for the portal to be registered as a dealer with an applicable participating securities regulatory authority. The portal must nonetheless comply with certain requirements and procedures in conjunction with each offering:
- Offering materials can only be made available to potential investors on the portal's website and must be delivered to applicable securities regulatory authorities at least 10 days before the distribution.
- The head office of the portal must be located in a participating jurisdiction and its promoters, directors, officers and control persons must be Canadian residents.
- The portal must deliver a complete portal information form at least 30 days prior to beginning to facilitate distributions.
- The portal may not provide investment advice to investors nor hold, handle or have access to investor funds.
- The portal must make the offering document of the issuer and the important risk warnings separately available to investors electronically online and ensure that the investors confirm online that they have read and understood the issuer's offering document and the risk warnings required under the exemption.
- The portal must ensure that all funds are held in trust for investors until the issuer raises the minimum amount required to close the offering.
The Consultation Process
The applicable participating securities regulatory authorities are seeking feedback on each of the proposed exemptions generally, as well as on specific questions that have been provided. In each case, the comment period ends on June 18, 2014.
1 See here for an article outlining some of the opportunities and challenges for P2P Lending: http://www.gowlings.com/KnowledgeCentre/article.asp?pubID=3051&lang=0
2 See the Jumpstart Our Business Startups Act, Title III – Crowdfunding.
3 General Order 45-925 Saskatchewan Equity Crowdfunding Exemption.
4 & Proposed Multilateral Instrument 45-108 Crowdfunding and related companion policy, proposed blanket orders and other documents.
5 Proposed amendments to National Instrument 45-106 Prospectus and Registration Exemptions, proposed amendments to OSC Rule 45-501 Ontario Prospectus and Registration Exemptions as well as Proposed Multilateral Instrument 45-108 Crowdfunding and related companion policies and other documents.
6 BCSC Notice 2014/33.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.