Crowdfunding (Canada): Start-up panacea or regulatory quagmire? (Part I)

November 21, 2013

What is Crowdfunding?

Crowdfunding is a novel way of raising funds for a project, business idea or new venture by pooling small, individual contributions of capital from a large number of people through the internet using social media networks or an online platform. Ideally, an idea or venture will gain popularity with a large number of people and then leverage each person’s social network in order to gain greater exposure and raise more capital.

There are a number of different models for crowdfunding. At one end of the spectrum, there is donation based crowdfunding whereby the donor receives nothing in return; at the other end, there are crowdfunding models that involve personal loans or the issuance of equity securities in exchange for capital. This article will focus on the latter.

In the United States, crowdfunding has gained legitimacy through the introduction of the Jumpstart Our Business Startups Act (the “JOBS Act”) in 2012 which created a blanket exemption for entrepreneurs to raise funds by crowdfunding in exchange for issuing equity securities. For more information on crowdfunding in the United States, see Crowdfunding (U.S.): Start-up panacea or regulatory quagmire? (Part II).

Crowdfunding in Canada

Regulatory Approach

Crowdfunding in Canada is still in its infancy. In December 2012, the Ontario Securities Commission (“OSC”) published Staff Consultation Paper 45-710, Considerations for New Capital Raising Prospectus Exemptions (the “OSC Consultation Paper”), as part of the OSC’s larger review of the exempt market regime in Canada. Crowdfunding was included as one of the proposed prospectus exemptions in the OSC Consultation Paper.

The Consultation Paper proposed the creation of a crowdfunding exemption whereby a business would be permitted to raise up to $1.5 million on an annual basis by issuing its shares to investors. Investors, on an individual basis, would be limited to a maximum investment of $2,500 per investment and a total of $10,000 on an annual basis. In addition, the proposal included some basic disclosure that would need to be provided to investors prior to the investment and also imposed re-sale restrictions on the shares purchased.

The comment period on the OSC Consultation Period closed in March 2013. Generally, the comments received favoured a crowdfunding exemption, however, comments questioned whether investors would be appropriately protected if such an exemption was available. Despite the positive feedback, it is important to note that the OSC proposal was presented as a consultation paper and a crowdfunding exemption is still just a concept for discussion. The OSC published OSC Notice 45-712, Progress Report on Review of Prospectus Exemptions to Facilitate Capital Raising (the “Progress Report”), in August 2013. The Progress Report indicated the OSC is still actively considering a crowdfunding exemption in Ontario and will be actively working on developing a regulatory framework for crowdfunding.

Other regulators in Canada are also actively considering equity based crowdfunding exemptions, either through a specific exemption or as part of larger reform, to the offering memorandum exemptions available in those jurisdictions.

Crowdfunding in Practice

The OSC recently put the crowdfunding concept into practice by granting exemptive relief to an applicant called MaRS VX (known as MaRS Social Venture Connexion). MaRS VX, a not-for-profit entity, applied for registration as a restricted dealer and sought relief from the know your client (“KYC”) and suitability requirements in National Instrument 31-103, Registration Requirements and Exemptions (“NI 31-103”), in order to create an online portal where accredited investors could connect with Ontario based ventures who are promoting social or environmental development in the province with less than $25 million in revenue.

While the decision in MaRS VX is a step toward crowdfunding in Canada, the OSC imposed a number of restrictions that limits the scope of the decision significantly. MaRS VX will have an online portal with separate public and private areas. The portal is designed to connect accredited investors to issuers but it is prohibited from acting as a market and no transactions will be executed, settled or cleared through the portal. The private area is password protected and will only be available to accredited investors (as defined in National Instrument 45-106, Prospectus and Registration Exemptions (“NI 45-106”)) who enter a written agreement with MaRS VX and to issuers seeking capital who have agreed to comply with applicable securities laws. This requires ongoing disclosure to investors including annual audited financial statements, interim financial statements, bi-annual updates on business activities and background checks for directors and officers. The portal also limits investors to an investment of $25,000 per offering and a maximum of $50,000 aggregate investment per year unless the investor has provided a letter from a registered dealer who has reviewed the KYC requirements and suitability of the investment, or is a “permitted client” (usually a large institution) and has waived the KYC and suitability requirements. The portal will provide basic information to prospective investors who will then be directed to separate “deal rooms” on the investor’s request.

The exemptive relief granted to MaRS VX is a step towards crowdfunding in Canada. However, the relief granted expires in two years or earlier if MaRS VX materially changes its business. The OSC has emphasized that the decision has limited precedential value. MaRS VX may serve as an interesting learning opportunity for start-ups and early stage businesses, investors and securities regulators to further refine the crowdfunding model in Canada.

In addition, other crowdfunding platforms are expected to launch in Canada in the short term. These platforms will offer Canadians the opportunity to invest in early stage Canadian businesses through private placements. These platforms are expected to operate without a specific exemption from securities regulators and will rely on existing exemptions available under NI 45-106 and NI 31-103.

Crowdfunding is an exciting new area of capital raising to explore for Canadian market participants. Many new regulatory developments are expected in the near future that will change the prospectus exempt capital raising landscape for early stage Canadian businesses and enable them to raise capital in a dynamic and cost-effective manner.

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