Gowlings via Mondaq | W. Ian Palm and Martine Guimond | May 1, 2014

In a short time, crowdfunding has caught the imagination of many entrepreneurs and become an important new fundraising technique.  Through crowdfunding an issuer can aggregate substantial amounts of capital by seeking small contributions from many different people.  Many start ups, small businesses, charities, artists and others now look to a variety of crowdfunding platforms to raise capital.  To date however, in most jurisdictions these platforms have been limited to some sort of donation, reward, pre-purchase of products, or peer to peer lending model.

Equity crowdfunding, the sale of securities through the use of crowdfunding techniques, has had a bumpier ride to reality.  Some jurisdictions, such as Australia, have had some sort of equity crowdfunding for a number of years.   There was early momentum around equity crowdfunding in the United States when the JOBS Act ² came into force in 2012 but much of the early excitement has waned with the drawn out process of its implementation.  Canadian securities regulatory authorities have been actively studying equity crowdfunding models for some time as well.  To date however, with very few exceptions, equity crowdfunding has not been possible in Canada due to regulatory restrictions.  This could change very soon.

Overview

In the past couple of years there has been a great deal of discussion and speculation about the nature and scope of possible regulatory changes in Canada to allow for equity crowdfunding.  Recent developments suggest we are now much closer to a time when equity crowdfunding and other more flexible means for raising capital for early stage businesses in Canada will be a reality.  Recent orders, proposals and notices issued by various Canadian securities administrators provide some clarity to the regulatory framework we can expect for equity crowdfunding:

• Saskatchewan was first off the mark.  On December 6, 2013 the Financial and Consumer Affairs Authority of Saskatchewan adopted an order permitting limited equity crowdfunding for Saskatchewan-based startup businesses.³
• On March 20, 2014, the securities regulatory authorities in Quebec, Saskatchewan, New Brunswick, Manitoba and Nova Scotia published proposals for two new prospectus exemptions related to crowdfunding:
  • one for start-up crowdfunding based on the Saskatchewan model (the "Start-Up Crowdfunding Exemption") aimed more particularly at providing an alternative source of capital to non-reporting issuers at a very early stage of development, and
  • the other more broadly applicable integrated crowdfunding exemption (the "Integrated Crowdfunding Exemption") available to both reporting issuers and non-reporting issuers.
• On the same day, the Ontario Securities Commission published a proposal for four new prospectus exemptions, including an offering memorandum exemption, an expanded exemption for friends, family and close business associates and an equity crowdfunding exemption substantially similar to the Integrated Crowdfunding Exemption referred to above.
• Again on the same day, the British Columbia Securities Commission issued a notice seeking comments on a proposed start-up crowdfunding exemption substantially similar to the Start-Up Crowdfunding Exemption.  It takes the view that a form of equity crowdfunding is already permitted in British Columbia with the use of the existing offering memorandum exemption.

These proposals together are expected to allow Canadian businesses, especially start-ups and early stage businesses, to access capital from a potentially large number of investors using online portal platforms that would be registered with securities regulators.  The proposed exemptions would, subject to certain conditions, allow both reporting and non-reporting issuers to raise money by distributing securities through online portals.

Related:

• CSA Equity Crowdfunding Draft Regulation 45-108 (Request for Comments until Jun 18, 2014)

• Two Equity Crowdfunding Exemptions Taking Hold in Canada

The Integrated Crowdfunding Exemption

The framework for the IntegratedCrowdfunding Exemption which is proposed for Quebec, Saskatchewan, New Brunswick, Manitoba, Nova Scotia and Ontario has two main components: (i) the requirements that an issuer must meet in order to distribute securities under the exemption, and  (ii) a set of funding portal registration requirements.  Under the IntegratedCrowdfunding Exemption, an issuer (whether reporting or non-reporting) would be allowed to distribute securities without a prospectus through a registered crowdfunding portal provided certain conditions are satisfied:

Issuer and Offering Conditions

• The issuer must be incorporated or organized in Canada and have its head office in Canada, and a majority of its directors must be residents of Canada.
• The exemption is not available to an issuer that is an investment fund, a non-reporting real estate issuer or an issuer without a written business plan.
• While an issuer is limited to securities of its own issue, the exemption permits the use of a broad range of types of securities to be offered including: (i) common shares, (i) non-convertible preference shares, (iii) securities convertible into common shares or non-convertible preference shares, (iv) non-convertible debt securities linked to a fixed or floating interest rate, (v) units of a limited partnership and (vi) flow-through shares under the Income Tax Act (Canada).
• A maximum of $1.5 million can be raised under the exemption, including any amounts raised in reliance on the exemption during 12 months immediately preceding the current offering.
• An offering document must disclose a minimum offering size and specify whether there is a maximum offering size.
• An offering cannot be completed unless: (i) the minimum offering is fully subscribed, and (ii) at the time of completion of the offering, the issuer has the financial resources to achieve the next milestone in its written business plan or, if no milestones exist, to carry out the activities set out in the business plan.
• There are specific restrictions on solicitation and advertising, including the following: (i) offering materials must be made available to potential investors on the portal's website and cannot be posted on any other website, (ii) offering materials must be delivered to the regulator at the same time that they are posted on the portal's website, (iii) investors can be directed to the portal's website by paper notice or through social media, (iv) marketing materials are limited to the offering document, documents described in the offering document and any term sheet or other summary (including a video).
• The issuer must abide by certain point of sale disclosure obligations by providing a streamlined disclosure document that includes basic information about the offering, the issuer and the portal.

Investor Rights and Conditions

• The proposed exemption provides for certain investor protection measures including the following: (i) an investor can invest no more than $2,500 in a single investment and no more than $10,000 under the Integrated Crowdfunding Exemption in a calendar year, (ii) investors must sign a risk acknowledgement form confirming that they meet the investment limits, understand they may lose their entire investment and understand the other specified risks that are set out in the form,  and (iii) the investor has a right to withdraw within 48 hours prior to the disclosed offering deadline.
• If a comparable right is not provided by the securities legislation of the jurisdiction in which the purchaser resides, the issuer must provide a contractual right of action for rescission or damages in the event of a misrepresentation in any materials made available to the purchaser.

Continuous Disclosure Obligations

• There are certain specific ongoing continuous disclosure and book and record-keeping obligations for both reporting and non-reporting issuers. For example, a non-reporting issuer must disclose annual financial statements that are audited if the issuer has achieved the prescribed financial threshold, or reviewed by an independent public accounting firm if the issuer has not achieved the financial threshold. Reporting issuers must provide ongoing continuous disclosure in accordance with securities law requirements.

Portal Registration Requirements

Investments made in reliance upon the proposed Integrated Crowdfunding Exemption will have to be facilitated through a funding portal registered as a restricted dealer, a new category of registrant to be designated by applicable securities regulatory authorities.  Registered portals and applicable senior officials will be subject to certain proficiency requirements and other general registrant requirements.  More significantly, registered portals and every applicable registered individual may only act as an intermediary in connection with a distribution of securities made under the crowdfunding prospectus exemption and may not register in any other dealer or adviser category.  This would significantly limit additional capital markets activities that a registered portal might otherwise undertake in respect of issuers and investors.

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