Regulators need to heed the rise of crowdfunded ‘techquity’ markets

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The Globe and Mail | Robert Keller and Michael Motala | October 2, 2015

Crowdfunding cash in hand

Robert Keller is a senior securities lawyer with over a decade of experience in litigation and regulatory policy. Michael Motala is a political economist and law student who comments on the digital economy.

It comes as no surprise that millennials are distrustful of equity markets. The Great Recession continues to cast its long shadow on the labour market for young professionals, and in Canada at least, we are in a technical recession. Tanking commodity prices and schizophrenic stock markets reaffirm the volatility of conventional investment instruments. Squeezed out of traditional career paths, many young people have turned into tech entrepreneurs.

In an economy marked by diminishing venture-capital funds, however, this new wave of young talent is turning to crowdfunding to capitalize their business ventures.

A prominent example is Palmer Luckey, the 23-year-old virtual-reality inventor who became very rich almost overnight last year, when Facebook acquired his venture, Oculus Rift, for $2-billion (U.S.), leaving his original crowdfunders stunned. The Oculus Rift was an unlikely gamble in 2012. Yet, the success of its original Kickstarter campaign, which sought $250,000 in seed capital, exceeded its target by almost 1,000 per cent.

Related: Kickstarter backers of Oculus Rift angrily reject Facebook takeover

Some organizations are seeing the writing on the wall and are rising to the occasion. New York’s Nasdaq exchange, for instance, is hoping to capitalize on emerging tech startups in Silicon Valley with the Nasdaq Entrepreneurial Center, a non-profit offshoot that recently opened in San Francisco to help young entrepreneurs connect with experts, mentors and financial backers. At home in Canada, programs such as Ryerson’s Legal Innovation Zone and the MaRS Discovery District are also incubating young tech talent.

Mr. Luckey’s good fortune suggests that crowdfunding offers a valid capitalization model, but it is emerging in untested regulatory waters. Unlike conventional shareholders, crowdfunders generally have few established legal rights in respect of the corporate venture they help create. With equity crowdfunding, in particular, investors generally have little say over the corporate governance of their investments, and little to no recourse when startups break their promises and sell out. Yet, crowdfunding activity continues unabated.

Securities regulators are taking note of emerging peer-to-peer “techquity” markets. In 2012, the United States’ JOBS Act established a right to use online equity crowdfunding portals to raise up to $1-million, but certain restrictions were enacted by the U.S. Securities and Exchange Commission in 2013.

In Canada, regulators have taken an even more restrictive approach. Six provincial authorities issued new regulations on crowdfunding in May of this year, imposing an aggregate limit of $500,000 (Canadian) a calendar year for each startup.

Related: What startups need to know about B.C.’s new crowdfunding laws

Meanwhile, the Ontario Securities Commission (OSC) pledged it would promulgate its own regulations soon, with a higher aggregate limit of $1.5-million a startup per calendar year. Both, under the final provincial regulations and those expected from the OSC, equity instruments issued through crowdfunding are subject to strict holding periods and sales of these instruments are only allowed under very limited circumstances.

Even if a startup decides to play by the rules, however – say, by establishing a home office in Canada and using a Canadian Internet portal – it remains to be seen whether the crowdfunding limits imposed will spur investment or end up impeding the market. In the public comment process on the new OSC rules, some industry members remarked that the legal and other fees involved in complying with the new regulations could eat up a considerable portion of the capital raised in each deal. Meanwhile, Kickstarter already offers a competitive, low-cost alternative for fundraising in 18 countries around the world, with few to no legal obligations imposed on the businesses raising such funds.

Other challenges arise from the fact that Canada is still a patchwork of different securities regulations. In the 21st century, many find it hard to believe that, in an advanced economy such as Canada’s, securities regulation is still subject to a 19th-century approach to jurisdiction.

Related: Is Culture Killing Equity Crowdfunding in Canada?

Startups have to navigate different equity crowdfunding rules depending on the province in which they intend to raise funds, instead of dealing with a uniform federal market. This leads to inefficiencies, given the greater legal and administrative fees required for complying with different rules in different provinces, not to mention the frequent interjurisdictional conflicts, which only further inhibit the fundraising process.

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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 1100+ 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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