Last month, an article on this blog summarized the recent amendments to the accredited investor exemption which came into effect May 5, 2015. Ordinarily a company cannot issue securities unless it has filed a prospectus. In certain circumstances, such as those described in the accredited investor exemption, a company can sidestep this requirement. This exemption assumes that accredited investors have a certain degree of financial literacy in order to assess an investment without a prospectus and that, if the company's situation takes a turn for the worse, the investor's future financial prospects will not be devastated.
One of the aforementioned amendments requires a corporation to acquire a Risk Acknowledgment Form from investors before distributing securities. This form states (in bold letters) "WARNING! This investment is risky. Don't invest unless you can afford to lose all the money you pay for this investment." With such a conspicuous disclaimer, it seems one purpose of the amendments was to make sure investors appreciated the risk involved.
Recently, the securities regulators of British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia announced they had introduced, or intended to introduce, a "start-up crowdfunding exemption". Like the accredited investor exemption, this relieves the issuer from having to file a prospectus.
The goal of crowdfunding a project is to raise funds to pursue a certain project. This phenomenon has been successful in the past where companies have had people invest in their project in exchange for the pre-sale of the product of their project or for promotional items. Alternatively, equity crowdfunding allows a business to issue securities in exchange for an investor's monetary contribution to the project.
On the one hand, the start-up crowdfunding exemption provides a corporation with an alternative avenue for raising capital which avoids the potential costs associated with preparing audited financial statements and a prospectus as well as concerns about control of the company that can arise with venture capital. On the other hand, the same concern about an individual's ability to accurately assess the risk associated with an investment arises as with the accredited investor exemption.
Although the exemption allows the corporation to issue securities, there are safeguards in place to protect investors. Precautions include having the business file a prescribed offering document online outlining its idea, limiting the maximum investment amount to $1,500 per individual and requiring the crowdfunding campaign to be made through a funding portal that meets the required conditions.
Despite these protections, the British Columbia Securities Commission cautions investors that investing in a start-up or small business can be risky and that an investor could lose their entire investment. Additionally, the Commission cautions that investors may have to hold onto their securities indefinitely if they are unable to find a purchaser.
Ultimately, the investor should do some homework before investing. While the start-up crowdfunding exemption may provide investment opportunities not previously available, there are risks associated with exempting crowdfunding projects from the scrutiny of securities regulators.
The author would like to thank Corey McClary, summer student, for his assistance in preparing this legal update.
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