EQUITY CROWDFUNDING: The future of fundraising in Canada

by Taran Aujla , CrowdFundbeat Guest Editor, 

There’s a lot of hype around Equity Crowdfunding being “legal” in Canada, yet most ordinary Canadians seem to be very confused and unaware of what’s legal, what will become legal, when, and what this really means for Canadian entrepreneurs and investors.

Unlike regular crowdfunding (e.g. Kickstarter, Indiegogo) where you receive perks or rewards for the money you give, equity crowdfunding actually allows people to own a piece of the businesses they help finance.

THE RULE

Under Canadian Securities Laws, it’s illegal for privately-held companies to publicly solicit funds from the general population in exchange for securities (i.e. financial instruments that represent an ownership stake or creditor relation with a business).

In other words, if you’re a private company, you cannot publicly advertise (online or offline) the fact that you want to raise money for your business from the crowd by selling shares (or other forms of securities) to the general public.

Unless of course you:

1- “Go Public”;

2- Raise funds from Accredited Investors only or;

3- Use the new Equity Crowdfunding exception.

THE EXISTING EXCEPTIONS

1. “Going Public”

Generally, if you want to raise funds for your business from the public, you will most likely launch an Initial Public Offering (IPO) and register with a stock exchange. However, this process is extremely expensive and complex, and is not something your average Startup or Small-Medium sized business (SMB) may want to do.

2. Accredited Investor Exemption (Less than 5% of CDN Population)

Under existing Canadian Securities Laws, there is an exemption to the rule that allows private businesses to publicly issue securities to “Accredited Investors” without having to launch an IPO. Accredited investors are very wealthy people and companies, who make up less than 5% of Canada’s population. Given the recent equity crowdfunding hype, some websites are using this existing exemption to promote themselves as “Equity Crowdfunding” Portals; however, ordinary Canadians can’t invest here.

THE NEW EXCEPTION

Equity Crowdfunding Exemption (For Ordinary Investors)

Good news! Canadian Securities Commissions will soon lift the ban on general solicitation and include a new specific Equity Crowdfunding Exemption in their existing rules. This will allow businesses to issue shares or borrow money online from ordinary Canadians (non-accredited investors), who represent the “real” Crowd and 95% 0f Canada’s population.

How?

In order to use the Equity Crowdfunding Exemption, a business will be required to launch its offering (fundraising) through an authorized Canadian equity crowdfunding website, such as Crowdfuel.

Two different models of the Equity Crowdfunding Exemption will launch in Canada:

1. The Crowdfunding Exemption (let’s call this the “Large-Scale Model”) and; 2. The Startup Exemption (the “Startup Model”).

 

Canada-Equity-Crowdfunding

The “Large-Scale” Model

Although there are no restrictions as to when a business can raise funds through this model, it is designed to be used during a later stage of a business’ life-cycle (the growth or expansion stage).

As opposed to the Startup Model, the rules and requirements for using this model are much more stringent on businesses.

Current Status: This model is not yet legal in Canada and may only be allowed in some provinces by the end of 2015.

Offering (fundraising) limits: Canadian private and public businesses can raise up to $1.5M a year. The ordinary Canadian can invest up to $2,500 per business.

Type of securities allowed: Depending on their needs and legal structure, businesses can issue:

1. Shares (common or preferred); 2. Limited Partnership units; 3. Non-convertible debt securities (bonds, debentures, promissory notes) or: 4. Flow-through shares under the Income Tax Act (Canada).

Offering period (Deadline): Once you launch the Offering on an authorized Portal, you have 90 days to raise your minimum target amount.

“All-or-nothing”: An overly optimistic business wanting to raise big bucks will end up getting nothing if it does not meet its minimum target amount within the offering period. In such case, all funds raised by the business will be returned to the investors.

Documentations & Ongoing disclosure: Businesses will be required to complete & submit detailed offering documents, ongoing disclosure & financial statements, and a business plan to the appropriate securities regulators.

Right of withdrawal: Investors can withdraw 2 days before the Offering’s deadline for a full refund.

Resale restrictions: Securities purchased from a public company are subject to a 4 month hold period. Those purchased from a private company come with an indefinite hold period and can only be resold under certain exceptions.

 

The “Startup” Model

This model aim’s to fill the funding gap that often occurs in the very early-stages of a business’ life-cycle (pre-launch or infancy stage) where the average “seed” capital required is approximately $250K.

Contrary to the “Large-Scale” model, the rules and requirements imposed on Startups are much more lenient.

Current Status: This model is already legal in Saskatchewan. Several other provincial securities regulators (MB, NS, BC, QC, NB) will implement the Startup Model very soon (spring/summer 2015).

Offering (fundraising) limits: Here, the maximum amount you can raise in 1 Offering is $150,000, and you can make 2 Offerings per year, which allows you to raise up to a total of $300,000 per year. Ordinary Canadians can invest up to $1,500 per Offering in as many businesses as they wish.

Types of securities allowed: Depending on their needs and legal structure, businesses can issue:

1. Shares (common or preferred); 2. Limited Partnership units; or 3. Non-convertible debt securities (bonds, debentures, promissory notes).

Offering Period (Deadline): Under this model, each Offering will expire after 6 months from the day it goes live on an authorized Portal.

“All-or-nothing”: If you don’t reach your minimum target amount during the Offering period, all funds raised are returned to the investors.

Resale restrictions: Securities purchased from a business under the Startup Model have an indefinite hold period and can only be resold under certain exceptions.

 

Advantages of the Startup Model

It’s realistic: Considering the different limits imposed in both models, the chances of raising $150K under the Startup Exemption from ordinary investors in 6 months is much higher compared to raising $1.5M in just 90 days from people who cannot invest more than $2,500 per business.

The risk is low: Ordinary people may feel more comfortable investing a “smaller” amount such as $1,500, rather than $2,500; therefore mitigating the risks incurred by investors.

Since the requirements are significantly lower here compared to the first model, it makes it much easier and practical for a business to actually launch a successful Offering and raise the minimum target amount.

There are no on-going disclosure or financial statement requirements. Although it may be in a business’ advantage to keep its shareholders up to date. Furthermore, startups aren’t required to prepare and submit an extensive business plan, just a few basic offering documents to securities regulators.

 

Debt-Based Crowdfunding: Peer-2-Peer (P2P) Lending & Borrowing

Equity Crowdfunding is not only about selling or owning shares in a business. It’s also an alternative borrowing option for Startups and SMB’s. The new Equity Crowdfunding Exemption will also include debt-based crowdfunding, which will allow businesses to borrow money from the Crowd by issuing non-convertible debt securities such as interest bearing Bonds or Promissory Notes. This may be a more suitable option for businesses that do not want to give up equity, but would rather pay interest on loans.

Hybrid Crowdfunding: Rewards + Equity / Debt

The Perks + Rewards model of crowdfunding has shown significant success around the globe and in Canada. Just like regular crowdfunding (i.e. Kickstarter, Indiegogo), businesses will be able to add perks and rewards along with the securities they issue to investors; therefore making their offering more attractive.

Food For Thought

In 2012, the contributions of 10,000 Kickstarter backers helped Oculus, a virtual reality headset, raise $2.5M from crowdfunding. In exchange, the backers received a few perks / rewards for their contributions. A couple of years later, Facebook acquired Oculus for $2 billion… Imagine if those backers owned an equity stake in Oculus, and could have shared the wealth from Facebook’s acquisition.

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