April 21st, 2017
Selling Equity and Accessing the “Crowd”: Opportunities for Canadian Issuers to Access Capital Using Rule 506(c), Regulation A+, and Online Platforms in The United States
As of today’s date, Canadian issuers have raised over C$ 290 million on online equity funding platforms in The United States. Almost this entire amount has been on one platform in the last two years, an accredited investor platform called EquityNet.com. Issuers have raised US$ 300 million on EquityNet. Canadian issuers represent over US$ 185 million of this total amount or 62%. Over 700 Canadian companies have a capital raising profile on EquityNet. Canadian issuers have also raised capital on other accredited equity funding platforms in The United States such as CircleUp, AngelList, Crowdfunder, and Fundable.
There are over two hundred 200 active equity funding platforms in the United States versus six (6) in Canada. The majority of these The United States platforms are open to Canadian and other foreign issuers. If you are a Canadian issuer (public or private) looking for capital, an equity-funding platform in The United States may be a good fit for you.
The Emergence of Online Funding Platforms in the United States
The first online equity funding platforms in the United States emerged from online private due diligence deal rooms for accredited investors whether they be angels, venture capitalists, or institutional investors. Actual online equity funding platforms started emerging in the United States in 2005. The majority of these early platforms operated (and some still operate) in a grey area as they are not registered as broker dealers or investment advisors.
The Jumpstart Our Business Startups Act (Job’s Act) was enacted on April 5, 2012. It requires the SEC to amend or adopt rules to make it easier and more cost efficient for small issuers to raise capital in the United States and, if public, meet ongoing disclosure obligations. This includes the adoption of a new equity crowdfunding rule that pre-empts state regulation (Title III equity crowdfunding), the amendment of the accredited investor exemption to allow advertising (Rule 506(c)), and the amendment of Regulation A to increase the amount that can be raised under the exemption (Regulation A+).
Proposed Title III equity crowdfunding rules were issued for comment but have not been enacted into law. The Rule 506(c) rules became effective on September 23, 2013 and the Regulation A+ rules on June 25, 2015.
It is not a requirement under Rule 506(c) or Regulation A+ for issuers raising capital under these private placement exemptions to use a broker dealer or an online funding portal. The number of online equity funding portals relying on Rule 506(c), however, has exploded in The United States since the enactment of the rule. Regulation A+ online funding portals are also now emerging, however at a slower rate, than accredited investor focused platforms.
Rule 506(c) and Regulation A+ are discussed in more detail below.
Rule 506(c) – Advertising and the Accredited Investor Exemption
Canadian securities laws, unlike the securities laws in the United States, have allowed issuers to advertise they are raising capital and are looking for investors since 2003. In 2005, National Instrument 45-106 – Prospectus Exemptions (NI 45-106) harmonized the majority of the capital raising rules across Canada, including the ability to advertise when using certain exemptions such as the accredited investor exemption in NI 45-106.
The securities laws in The United States did not allow solicitation and advertising when raising capital under Rule 506 until Rule 506(c) was enacted on September 23, 2013. Despite this limitation 90% of all exempt offerings in the United States are made under Rule 506 to accredited investors.
Rule 506 is available to issuers (private and public) located anywhere in the world when raising capital in the United States. Rule 506 allows issuers to raise capital in an unlimited amount, to an unlimited number of accredited investors, and it pre-empts state securities law requirements. Rule 506(b), the original Rule 506 accredited investor exemption, allows issuers to sell securities to up to 35 non-accredited investors in an offering. Issuers selling securities to non-accredited investors must provide them with disclosure documents with information similar to what is contained in a registered offering prospectus. The securities issued under Rule 506 are restricted securities.
Rule 506(c) permits general solicitation and advertising, but excludes non-accredited investors from participation in the offering. Issuers must also take reasonable steps to verify whether investors in the offering are accredited investors. Rule 506(b) does not require issuers to take reasonable steps to verify whether an investor is an accredited investor. Rule 506(c) also prohibits issuers as well as underwriters, placement agents, directors, executive officers, and certain shareholders from participating in the sale of a Rule 506(c) offering, if they have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws (Bad Actor Provisions). Accredited investor offerings under Rule 506(b) are not subject to these Bad Actor Provisions.
Issuers may use Rule 506(b) or Rule 506(c) when raising capital but once a Rule 506(c) offering has been started, issuers cannot sell securities to non-accredited investors.
The definition of who is an accredited investor under Rule 506 is very similar to the definition of who is an accredited investor in Canada under NI 45-106. The main difference being all dollar amounts are The United States dollars versus Canadian dollars which makes the income and financial test qualification thresholds higher.
Issuers relying on Rule 506(c) are not required to file their adverting material with the SEC before or after undertaking an offering. An exempt distribution report on Form D – Notice of Sales is required to filed electronically with the SEC within 15 days of the first sale of securities under Rule 506(b) or Rule 506(c). There is no SEC filing fee. Issuers are also required to file this Form D with all applicable state securities regulators. State filing rules and filing fees vary. Some states require issuers to file in advance when conducting a Rule 506 offering.
Comparison of United States Rule 506 Accredited Investor Exemptions
|Rule 506(b)||Rule 506(c)|
|12 Month Maximum Offering Amount||No limit.||No limit.|
|12 Month Maximum Investor Investment Limit||No limit.||No limit.|
|State Blue Sky Review||Pre-empts State blue sky laws.||Pre-empts State blue sky laws.|
|Solicitation and Advertising||Not permitted. Issuers may only approach potential investors if there is a substantive, pre-existing relationship.||Advertising in all forms permitted.|
|Eligible Investors||Accredited investors and up to 35 non-accredited investors who meet sophistication requirements.||Accredited investors only.|
|Accreditation Process||Issuer may rely on investors` self-certification via a questionnaire that they are certified.||Issuer must take reasonable steps to verify accredited investor status. Self-certification is not considered taking reasonable steps. SEC examples of reasonable steps to verify status similar to Canadian requirements.|
|Selling Agent||Issuers can sell directly, or through a registered broker-dealer or an exempt broker-dealer (ie. AngelList or FundersClub).State blue sky laws may require directors and officers selling securities to be registered prior to offering.||Issuers can sell directly, or through a registered broker-dealer or an exempt broker-dealer (ie. AngelList or FundersClub).State blue sky laws may require directors and officers selling securities to be registered prior to offering.|
|Offering Material||None required unless offering securities to non-accredited investors. If non-accredited investors included, must provide those investors with disclosure documents similar to those used in registered offerings. If issuer provides information to accredited investors, it must make that information available to non-accredited investors. Issuers must be available to answer questions from potential investors. Any information provided must not violate antifraud prohibitions.||None required. Any information provided must not violate antifraud prohibitions.|
|Filing Requirements||Issuers must file a Form D with SEC and all applicable State securities regulators.||Issuers must file a Form D with SEC and all applicable State securities regulators.|
Regulation A+ – Access to All Potential Investors
Regulation A+ allows issuers in The United States and Canada who are private start-ups to later stage companies not otherwise reporting issuers under the United States Securities and Exchange Act of 1934 to raise up to US$ 50M from both accredited and non-accredited investors. Issuers can advertise their offering in The United States when using Regulation A+. Securities issued in a Regulation A+ offering are free trading securities in the United States.
To be eligible to use Regulation A+ an issuer:
- must be organized and with their principal place of business, in the United States or Canada;
- must not be an investment company or blank check company;
- must not be issuing fractional undivided interests in oil and gas rights, or a similar interest in other mineral rights;
- must not be a reporting issuer under the 1934 Act;
- must not have its securities suspended or revoked under the 1934 Act;
- must not be disqualified under the Bad Actor Provisions disqualification rules; and
- must have filed all Regulation A+ exempt distribution reports during the past two years.
Regulation A+ is divided into two tiers each of which has different requirements. Tier 1 of Regulation A+ allows issuers to raise up to US$ 20M. Tier 2 of Regulation A+ allows issuers to raise up to $50M. Regulation A+ requires issuers prepare an offering circular similar to a Canadian offering memorandum which is vetted and qualified by the SEC before an issuer can raise capital under the exemption. Tier 1 offerings must also pass a state co-ordinated review. Tier 1 offerings do not require audited financial statement if they are not otherwise available. Offerings under Tier 2 required audited financial statements. Canadian issuers can provide these financial statements in US GAAP or IFRS GAAP.
Tier 1 does not limit investment amounts in the offering. Non-accredited investors in a Tier 2 offering are limited to investing 10% of their income or net worth per year.
Issuers can file their offering documents with the SEC on a confidential basis. They can also test the water to check if there is any interest in the offering before undertaking the expense of a Regulation A+ offering.
Tier 2 offerings are subject to ongoing disclosure obligations. Specifically, issuers must file year end audited financial statements, six month unaudited financial statements and a current report any time there is a material change.
An exempt distribution report on Form 1-Z Exit Report must be filed electronically within 30 calendar days from termination or completion of offering. Canadian issuers must also file a Consent to Process on Form F-X. There is no SEC filing fee. Issuers are also required to file exempt distribution reports with all applicable state securities regulators. State filing rules and filing fees vary.
Issuers rarely used the previous Regulation A rule to raise capital. The number of Regulation A offerings over the last ten years had fallen to five to seven offerings raising less than US$30 million per year. Since enacting Regulation A+ three months ago, the SEC has received twenty-four (24) Regulation A+ offering circulars. The first Regulation A offering under the new rules was cleared of all SEC comments on September 1, 2015.
Author: Alixe Cormick is the founder of Venture Law Corporation in Vancouver, British Columbia and a member of the Advisory Board of the National Crowdfunding Association of Canada. You can reach Alixe by phone at 604-659-9188, by email at email@example.com, on twitter @AlixeCormick or on Google+.
The National Crowdfunding Association of Canada is the leading and only nationally organized non-profit working with over 1300 social and investment stakeholders across the country, and the national voice of an industry that is fast becoming an integral part of the start-up financing ecosystem. Learn more About Us or visit www.ncfacanada.org.