Financing evolves to let companies capitalize on the crowd

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Vancouver Sun | Derrick Penner | April 22, 2016

Guusto video imageBefore Guusto co-founders Skai Dalziel and Joe Facciolo tried crowdfunding to raise money for the online gift-giving startup they’d spend two years building, they tried the usual venture-capital routes.

They had put their own money in, recruited some friends and family and were making the rounds of startup pitch sessions to woo potential angel investors. (They even made an unsuccessful trip to CBC’s Dragons’ Den.)

Many of the angels, though, wanted to see more of a track record from the business than they had at that point.

“It’s gruelling,” Dalziel said of the routine. “It’s non-stop meetings, networking and pitch events. The biggest challenge during that whole process is that you’re not actually working on your business, working on developing your product or selling your product.”

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Their search for financing, however, coincided with the approval of rules by the B.C. Securities Commission that allow companies to raise private capital using the techniques of crowdfunding.

Online crowdfunding, through websites such as Kickstarter, Indiegogo and FundRazr, has been used to launch hundreds of businesses by giving them a venue to preview  ideas and pre-sell products to enthusiastic early adopters.

Unlike Kickstarter though, where donors put up money to get tickets to a performance or early access to the beta version of a hot new product, equity investors buy shares in the startup they’re backing with the possibility of a return if the company takes off. Thus the name, equity crowdfunding.

No one is expecting equity to replace the so-called donations and rewards side of crowdfunding as a tool for businesses. It is more of an evolution in the overall sector that will see the two sides filling different niches.

Equity crowdfunding is viewed as putting a smaller-scale form of venture capital into reach for a class of investors who don’t qualify as accredited investors.

However, investor-protection advocates are wary of combining the hype associated with crowdfunding campaigns with the arena of startup ventures.

“There’s definitely a risk for investors in that they can’t get rid of the shares, they’re not liquid,” Dalziel said. “You can’t go to a stock exchange and trade them.”

Dalziel and Facciolo turned to FrontFundr, one of the first online portals to take on equity crowdfunding in Canada. They ran a campaign under the new rules to raise a portion of what turned into close to $50,000 in private financing.

For Guusto, Dalziel said their investors were largely already customers of their app and web-based gifting platform, and are savvy enough to know they’re hedging that the money they’ve put in will help its creators increase the business’s value for an eventual payoff.

“The two options they have would be the company grows to the point we could pay a dividend — likely three, four, five years down the road,” Dalziel said. “Or a potential exit where the company is acquired or (launches an initial public offering) onto a public market.”

However, for the amount Guusto was able to raise, Dalziel said the crowdfunding has proved to be an effective tool, and not just for the cash they raised.  “The biggest benefit was having brought in — I think we’re at 35 investors in the business now — a group of real brand champions, a group of people supporting Guusto and helping us get the message out,” Dalziel said.

Early days

It is still early days for equity crowdfunding in Canada, which has only been allowed in B.C. since the middle of last year. Alberta, Saskatchewan, Ontario, Quebec and Nova Scotia are also on board.

Generally, equity crowdfunding rules restrict the amounts companies are allowed to raise in a single financing and the maximum amount individual investors can sink into a single financing. In B.C. the limits are $250,000 per financing and $1,500 per individual investor.

Companies are also required to raise funds through specific online portals, which must post information about the companies trying to raise money, such as offering documents that generally spell out a description of the businesses, what they are selling and other sources of money.

The incipient equity side of crowdfunding only accounts for about $5 million to $10 million of that $150-million overall national estimate for crowdfunding of all types, said Craig Asano, chairman of the National Crowdfunding Association.

The NCFA counts 15 equity crowdfunding portals among the 110 crowdfunding entities across Canada, with five of those in B.C.

The equity side of crowdfunding is more established in the U.S. and Europe. It represents the evolution of the private-investment sector to an online presence, said FrontFundr CEO Peter-Paul Van Hoeken.

Van Hoeken was already setting up a brokerage to sell exempt-market, private-company investments online under the existing rules for other investors when the BCSC issued its rules for crowdfunding, which dovetailed with his own efforts.

He looks at it as an avenue for companies that have advanced beyond the idea stage and have built a product and started to do some business, but have exhausted other early stage sources of capital such as family and friends.

And it gives the company’s early customers a chance between throwing money into a company to buy something, “or becoming a co-owner, even a small part.”

Critics wary of selling hype over risk

However, the investor-protection advocate organization Fair Canada (the Canadian Foundation for the Advancement of Investor Rights), remains skeptical about mixing online promotion of startup companies with a pool of unsophisticated investors without a high level of financial literacy.

“We didn’t feel what Canadians were clamouring for and really needed was more opportunities to sink money into extremely high-risk, low-probability investments,” Fair executive director Neil Gross said.

Gross said most people struggle to save $1,500 or $2,500 to put into long-term investments such as RRSPs and the fear is too many of those people won’t distinguish the difference between that and backing a high-risk startup venture, which he characterized as “slightly regulated lottery tickets.”

Too many people might be captivated by tech-sector success stories and believe they have a chance to buy into the next Hootsuite or Shopify, Gross said, and not fully comprehend that they’re buying into things they can’t sell.

[Podcast]: What You Need to Know About Crowdfunding Right Now

Gross said crowdfunding is being introduced at the same time securities commissions have loosened regulations for raising private capital without having to register publicly, which also increase risks for investors.

“What regulators have done is set a buffet of risky propositions out and made it easier to market (them) to a broader spectrum of Canadians,” Gross said.

To date B.C. hasn’t seen a lot of uptake for equity crowdfunding, said Peter Brady, director of enforcement for the BCSC.

Guusto is the first company to use the method, but only relied on the crowdfunding rules to raise about $6,000 of its financing, Brady said. The rest came from other private sources such as accredited investors.

Brady said companies raising money through the crowdfunding rules need to file reports with the commission detailing how much money they raised and how many shares were sold, just like all other companies raising private capital.

Exempt-market investments have been a problem for the BCSC in the past with high-profile frauds such as the $65-million David Michaels case, which saw the unregistered salesman sell exempt-market private shares to seniors in money-losing firms.

To date, Brady said he hasn’t heard of anyone abusing the equity crowdfunding rules, but the companies using them will be subject to the same surveillance by BCSC enforcement staff as all other companies.

Van Hoeken said there is an onus on portals, such as FrontFundr, to do a credible job of vetting the companies that make offerings through their venue and make sure investors understand the high-risk nature of the investments.

“We perform our own due diligence,” he said, in terms of establishing what companies plan to do with the money they raise and who is involved, “and if we’re not comfortable, we won’t take them on.”

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The National Crowdfunding Association of Canada (NCFA Canada) is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders across the country. NCFA Canada provides education, research, leadership, support and networking opportunities to over 1300+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada. Learn more About Us or visit www.ncfacanada.org.

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