March 23rd, 2017
NCFA Canada Response to British Columbia Notice 2014/03 – Proposed Start-Up Crowdfunding Exemption
NCFA Canada | June 18, 2014
NCFA Canada Response to British Columbia Notice 2014/03 – Proposed Start-Up Crowdfunding Exemption: Questions and Answers
NCFA Canada 2014 Conferences and Outreach
NCFA Canada held four events across Canada (Toronto: April 16, 2014, Vancouver: May 21, 2014, Saskatoon: May 28, 2014, and Nova Scotia: Jun 19, 2014) to educate and receive feedback from various constituent groups interested in start-up capital in their communities. All of these events were held in association with strong community supporters such as the City of Toronto, the Saskatoon Chamber of Commerce, the Kolo Project, Vancouver Economic Commission, BC Technology Industry Association, Innovacorp and local angel groups. NCFA Canada and all in attendance appreciated the participation by local securities regulators in each jurisdiction at these events
In addition to holding conferences, NCFA Canada has fielded hundreds of questions from aspiring crowdfunding portal operators, issuers, investors and media by telephone, email and in person. We have participated in several federal and provincial government educational meetings with Industry Canada and Economic Social Development Canada (ESDC) and the Ontario Ministry of Economic Development, Trade and Employment.
We have worked towards building communities of crowdfunding practice across the country and have grown our national Crowdfunding Ambassadors program to over 20. We are working closely as community development partners in support of entrepreneurship with various organizational initiatives such as Startup Canada’s Financial Literacy Committee and Fundica’s cross-Canada funding road show to advance the level of Crowdfunding literacy amongst SMEs.
We have developed a significant amount of online educational content including webinars and we have published an equity crowdfunding FAQ on our website and provided articles summarizing the key elements of the proposed crowdfunding exemptions. We are also in the process of finalizing an e-book of a larger array of questions and answers on equity crowdfunding and investing in general.
Proposed Implementation Principles
To cultivate the benefits of investment crowdfunding frameworks, regulators must strike the right balance between protecting investors while ensuring efficient capital formation for SMEs. To assist with this task, NCFA Canada has developed eight (8) high-level implementation principles to be used as guidelines when considering the costs and benefits of a prospective crowdfunding exemption in Canada.
||Collaborative development||The collaborative development of a harmonized set of crowdfunding regulations to benefit Canada as a whole.|
||All sectors and industries||To be as inclusive as possible to a broad-based range of sectors and industries to encourage balanced growth in communities across the country.|
||Disclosure rules and crowd intelligence||Support transparent disclosure and crowd intelligence as a means to help government and industry prevent, identify and report potential fraud and abuse to authorities within a timely manner.|
||Innovative market adaptation||To ensure crowdfunding regulations support market evolution enabling innovation to flourish.|
||Efficient capital formation||A regulatory framework that gives SME issuers and investors (funders) the confidence that there is a robust framework in place capable of efficient capital formation, and one that is collectively supported by the eco-system.|
||No jurisdictional restrictions||Enable a vehicle to allow businesses to accept investment (and funding) from other jurisdictions on a limited basis encouraging competiveness, collaboration and cross border participation.|
||New channels and source of funds||Ensure crowdfunding regulations are designed to open up largely a new source and channel of funds by minimizing the impact and overlap with existing exempt market exemptions.|
||Investment caps and reasonable due diligence||Protect investors by limiting investment exposure, promoting education, fraud detection and implementing a fair and reasonable amount of due diligence and compliance without overly burdening the process.|
1. Is there a funding gap that prevents small and early-stage businesses from raising sufficient capital under our existing prospectus exemptions? If so, please describe where you think the gap exists and what causes it.
- Yes. Please see the above sections ‘SMEs Funding Challenge’ and ‘The Importance of SMEs to the Canadian Economy’ for reference.
2. Will the start-up crowdfunding exemption address this funding gap? Why or why not?
- We believe a start-up crowdfunding exemption in British Columbia would help small businesses to raise startup capital from within British Columbia and within all participating jurisdictions’ borders. This would help prevent the flight risk of ideas, entrepreneurs and capital fleeing elsewhere, such as to an international jurisdiction where the capital raising environment may be more supportive and easier for an entrepreneur to commercialize an idea, product or venture.
- A Canadian only start-up crowdfunding exemption may attract entrepreneurial startups that face a funding gap in other areas of Canada to migrate to one of the participating jurisdictions. The influx of new minds would help propel these jurisdictions forward.
- While the crowdfunding industry is still in its infancy, much of the success thus far can be attributed to the advancements of technology and range/reach of social media to allow like-minded investors to pool funds and transact online beyond the limitation of their own geographic boundaries. With the proposed start-up crowdfunding exemption, the number of portals, issuers and investors will in fact be constrained by the capacity and participation within the participating jurisdictions. Put differently, the concept of crowdfunding is such that it requires the power of a ‘large crowd’ to derive the maximum benefit of ideation, distribution, and pooling of capital. Ideally, we would like to see the start-up crowdfunding exemption adopted right across Canada.
3. Although the start-up crowdfunding exemption is intended to assist start-up and early stage businesses, it is not restricted to those issuers. Should we restrict the exemption to issuers that have raised less than a certain amount since their formation? Should we limit the total amount an issuer can raise under this exemption?
- Do not restrict the exemption to issuers who have raised less than a certain amount since their formation. There are a number of different funding gaps in the life cycle of businesses in Canada.
- From various conversations and extrapolated from our survey data results, we recognize that the funding gap exists for many types and sizes and businesses. Over time, it is possible to conceive crowdfunding as a source of capital for many types of issuers and not just those requiring small and limited amounts of capital. Thousands of SMEs, many of which are well run and profitable, but have no access to capital may be one of the largest beneficiary of the start-up exemption.
- Some companies requiring more significant amounts of capital (e.g., solar projects) may be deemed unsuitable investments by more conventional funding channels (e.g., banks) yet the same company may be widely supported and considered an attractive option to a different type of investor under the start-up crowdfunding exemption. In fact, serial projects by such companies may be well suited to the start-up crowdfunding exemption.
- The start-up crowdfunding exemption is also suitable for companies launching a new products or funding research and development projects.
4. Do the requirements of the start-up crowdfunding exemption adequately protect investors?
- The crowd is an integral part of investor protection in crowdfunding campaigns.
- Portals should be required to maintain investor forums after funding is complete, or else provide some easy way to move forums, including user identities and comment histories, to a new, permanent online location. Failing to do this will result in a loss of accountability and create an opening for fraud. On donation, perk and product presale crowdfunding portals, communities of supporters continue to give feedback on projects long after funding has closed, providing both a valuable resource and an important incentive for issuers to deliver.
- Crowdfunding relies on the online as well as real world identities for issuers, commenters, and backers being transparent to one another. LinkedIn, Twitter, and Facebook are all useful methods to identifying individuals and discovering and verifying expertise. Portals and should be required to have issuers and other link their online profiles on these sites to their identity on the portal.
- The rules should clarify that investors are free to share information about an equity crowdfunding investment they are interested in through their social media contacts. Ethan Mollick, a professor from Wharton University of Pennsylvania, studies crowdfunding extensively. He has found that investors play a critical role in detecting fraud. Investors look for signals of quality, and are more likely to fund projects that show signs of the ability to succeed – clear plans for future development, appropriate backgrounds, past experience, and outside endorsements. They discuss projects and their viability on the portals but also on social media sites where they can tap into the knowledge of outside experts, their extended network and the media. Projects improve because of the feedback from such discussions, fraud is made almost impossible, and the entire community of investors benefit. See: Mollick, Ethan. (2014), The Dynamics of Crowdfunding: An Exploratory Study, Journal of Business Venturing, 29 (1), 1 – 16. Or video of Ethan Mollick discussing same topic: Youtube Video Link.
5. Should we require the portal to do due diligence on issuers and their principals? If so, what level of due diligence should we require?
- Background checks on issuers, directors, executive officers, promoters, and control persons should be limited to requiring portals access free public resources online. The TSX Venture Exchange charges $500 for a domestic background search, which barely recoups their cost. International searches can cost up to $5,000 per director and take up to three months to receive all information on the director.
- We believe that undertaking an international background check on an issuer’s key stakeholders should not be required as it would impose a significant financial burden on both portal operators and issuers and provide little value in return.
- Performing a quality international background check has many challenges. Language and regulation issues lie at the heart of these challenges and are a major driver of additional costs. Most developed countries have enacted legislation to protect the privacy of personal information and the ways in which this information is collected, transmitted and utilized.
- Background verification companies have a duty of care to collect personal information in a manner which is consistent with the jurisdiction in which it is collected.
- In Canada we are guided by the Personal Information Protection and Electronic Documents Act (PIPEDA); in the US and Europe, The Fair Credit Reporting Act (FCRA), and the EU’s Directive on Data Protection govern.
- In many countries, however, laws governing background verification and personal information privacy are still under development. Additional translation and interpreter resources would have to be accessed in order to understand local protocols and to subsequently request the personal information required for the verification of the key stakeholders. The additional time required to properly perform this service across multiple time-zones would also add to the cost of verification.
6. Should we impose any additional conditions on portals that rely on this exemption?
- We do not believe additional conditions should be imposed on portals relying on this exemption.
- We believe registration as an investment dealer, exempt market dealer or restricted dealer is not required in order to protect investors. History has shown innovation in any market does not come from within the established pillars of that marketplace. Assumptions about one’s industry get in the way in seeing obvious innovations and opportunities.
- In Canada, broker dealers have been able to set-up online equity crowdfunding portals relying on the accredited investor exemption or the offering memorandum exemption since 2004. They have also been allowed to advertise on and offline. Optimize Capital Markets was the first exempt market dealer in Canada to set up an online funding portal in 2009. It remained the sole online funding portal in Canada until 2013. Even now, Optimize Capital Markets stands alone in moving to a cross-border online funding portal model. In contrast, the U.S. Securities and Exchange Commission only recently (September 23, 2014) allowed advertising under its accredited investor exemption. Since that date, accredited investor portals established by registrants and through no-action letters from registration have proliferated in the U.S. A number of these portals have raised significant capital. For example: Circle-Up – US$30,000,000; Crowdfunder - $111,700,000; EquityNet - $231, 748,700; Fundable - $114,000,000; Microventures - $36,600,000; RealtyMogul - $18,000,000; Fundrise - $10,000,000; and Rock-the-Post - $30,698,452 are all active U.S. accredited investor equity portals. (All amounts approximates in U.S. dollars and as reported on their websites on May 14, 2014.) Most of the founders of these portals come from a mixed background and not solely the finance markets. Given our different experience with the development of accredited investor portals in Canada could be waiting a long time for a vibrant start-up equity crowdfunding market to emerge if we rely solely on Canadian registrants to develop these portals.
- Crowdfunding portals are a business. They are driven by the same considerations as any other successful business: opportunity; ownership structure; funding; management; business model and relationships. Crowdfunding portals in the donation, perk, and product pre-sale market emerged without any structure or rules to guide them or protect campaign contributors. There has been less than 0.01% of fraud in this marketplace since its inception. Similarly, there has been no reported fraud on the equity crowdfunding platforms operating outside of Canada. Founders of a crowdfunding portal have high incentives to make their business as success.
- We expect there will be significant sampling and attrition among equity crowdfunding portals in Canada similar to that experienced in the mutual fund and discount brokerage businesses in the early 1990s. The better operators are likely to utilize best practices from the non-equity crowdfunding marketplace and innovate in ways we cannot anticipate at this time. This innovation should be encouraged.
- We caution there is a high risk of regulatory capture by an entrenched industry that wants to keep the status qua as it protects its economic interests. Requiring portals to register as an investment dealer, exempt market dealer or restricted dealer will not necessarily protect investors. Keeping the status quo will not benefit Canada in the short or long term as issuers and investors will seek out jurisdictions that advance their interests versus the interests of the established finance industry.
Limits on Investing
7. Under the start-up crowdfunding exemption, investors are limited to investing no more than $1,500 per offering. Because of this limit, issuers may end up having many security holders holding small numbers of securities of the issuer. Is this amount a suitable limit?
- We believe the investor investment cap of $1,500 per single investment should be raised to $5,000 or $10,000 per single investment in a calendar year. Investors also should not be subject to aggregate crowdfunding exemption investment cap. Investors should be allowed to invest in as many equity crowdfunding campaigns as they chose. 90% of the U.S. States which have adopted or are considering adopting an intrastate crowdfunding exemption have chosen a 12 month investor investment cap of either $5,000 or $10,000 per single investment, unless the investor is accredited. If the investor is accredited no investment caps are applicable. The crowdfunding prospectus exemption should follow these U.S. developing norms.
- Issuers will have a difficult time raising the capital they need if the investment cap per investor remains at $2,500 per single investment.
- As of June 16, 2014, U.K. equity crowfunding portal Crowdcube has raised CD$49,211,800 for 124 businesses. This means an average issuer raises CD$396,869 in their equity crowdfunding campaign on Crowdcube. Only six of these campaigns have over 200 investors. The majority of the successful campaigns on Crowdcube have under 100 investors despite a minimum investment threshold of as little as a CD$180, which means an average investment amount of $4,000 per investor. Canada should expect similar investment trends under the crowdfunding prospectus exemption. As such, the investor investment cap should be raised to a much higher amount.
- Accredited investors should be able to invest an unlimited amount in a crowdfunding campaign as they are allowed to invest an unlimited amount under the accredited investor exemption. The participation of accredited investors at higher levels will provide non-accredited investors with added value as they are more likely to do greater due diligence then if they were only investing the minimum threshold amount in a campaign.
8. Should we impose an investment limit based on a percentage of the investor’s net assets or net income, instead of a fixed dollar amount? Would having this type of investment limit add complexity to the start-up crowdfunding exemption?
- No. A fixed dollar amount is much easier for portals and investors to implement, verify, track and manage.
9. Should we add a requirement that issuers give investors a “cooling-off” period similar to the two-day right of rescission under the offering memorandum exemption?
- We support a cooling off period that allows investors a two-business day right of withdrawal from the date of their initial investment decision, as long as that investment is made 96 hours prior to closing date of the offering.
- The need for a withdrawal right that allows an investor to withdraw their investment within 48 hours prior to the disclosed closing date of the offering is not necessary. Campaigns under the exemption may be online for as long six months. This form of capital raising is not a high-pressure sales approach with a salesperson creating urgency and the investor lacking full information.
- The propose withdrawal period is also not workable in an all or nothing campaign unless over-subscription is allowed, as an issuer may believe they have the investors they need to complete their offering but because of the right of withdrawal they may find they are short. Issuers will have no or limited time in which to try to replace investors who have exercised their right of withdrawal. The lack of the ability to obtain certainty even when a campaign looks successful will deter issuers from using this exemption.
10. The offering memorandum exemption is not widely used by small and early-stage businesses. We have heard that the costs of complying with the financial statement requirements in the offering memorandum form may be prohibitive and we welcome suggestions on ways to adjust those requirements. Are there other issues with the offering memorandum exemption that we should reconsider in order to make it a more useful exemption for small businesses?
- We are not providing specific comments on the offering memorandum exemption (OM exemption), or the proposed OM exemption being considered by the OSC and the amendments to the OM exemption being considered by the Alberta Securities Commission, Autorité des marchés financiers, Financial and Consumer Affairs Authority of Saskatchewan, and New Brunswick Financial and Consumer Services Commission (the Amending Jurisdictions). Instead, we are offering general comments.
- NCFA Canada supports the OSC adopting the OM exemption. This exemption is currently available in every province and territory in Canada but Ontario.
- Harmonization of the capital-raising exemptions in Canada should be a top priority all Canadian securities regulators.
- Canada however will have four different OM exemptions if the Amending Jurisdictions go forward with a new version of the OM exemption under consideration.
- SMEs do not use the current OM exemption because it is too complicated and expensive as is. Making the use of the OM exemption even more complicated with more nuanced differences across Canada will make it completely unworkable for SMEs.
- To the extent possible, the substantive and procedural components of all capital-raising exemptions should be identical across Canada. We can see no reason for an Ontario only version of the friends, family and business associate exemption, OM exemption or existing security holder exemption. Adopting a version of any of these three exemptions that is substantially or even moderately different from the version adopted in other jurisdictions in Canada is ill advised.
- The OM exemption as it exists now should be the version adopted by the OSC and remain in place across the rest of Canada. No evidence has been put forward by any of the Amending Jurisdictions that the existing forms of the OM exemption are flawed or being abused. Instead, evidence seems to suggest the OM exemption is being under-utilized by SMEs. The proposed amendments to the OM exemption do no suggest the proposed changes will be ones that would make this exemption more attractive to SMEs. Instead, the amendments appear to be adding a layer of complexity and cost.
- Issuers and investors no longer conduct business or investments in a territorial bubble. Technology advances continue to change the way people conduct business. The gathering and sharing of information is almost instantaneous and global. Work is decentralized. Companies can outsource production, and back-end functions worldwide. Securities rules that artificially restrict business and its ability to raise capital efficiently hurt the Canadian economy as a whole.
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