Proposed Exemption For Start-Up Businesses

Investment Limits/Caps

Comments:

• We believe the limit, if applied at all, should be $5,000,000 or $10,000,000 and not $1,000,000. We believe that the $1,000,000 limit chosen by the Participating Regulators was selected based on the US $1,000,000 limit set out under Title II of the JOBS Act and the proposed US Securities and Exchange Commission crowdfunding rules. Recent activity in the US suggests a limit of $1,000,000 may put Alberta and Nunavut (and Canada if the rule was adopted in other provinces) to a disadvantage over US crowdfunding rules, particularly as this is a lifetime limit and other caps, if they exist, are yearly limits.
• Specifically, US Congressman Patrick McHenry introduced a bill to amend US Title III crowdfunding as proposed by the US Securities and Exchange Commission. The proposed Startup Capital Modernization Act of 2014, if adopted, will raise crowdfunding limits in the US federally from $1,000,000 to $5,000,000. Other changes will also make the US federal crowdfunding exemption more attractive to issuers and investors.
• A number of the intrastate crowdfunding exemption adopted or under consideration have also chosen a higher limit than $1,000,000. See: NASAA Intrastate-Crowdfunding-Exemptions-08-01-2015.
• Current data from existing early stage equity crowdfunding portals in Europe and accredited investor equity crowdfunding portals in the US seem to indicate the mean offering size of existing campaigns are trending upwards past $5,000,000 as issuers and investors are becoming more comfortable with this form of raising capital and investing. In 2014, 30% of equity funding for SMEs in the UK came from equity crowdfunding. In 2015, that number is projected to be around 50%. Similar patterns can be seen in each jurisdiction in Europe. Equity crowdfunding is still evolving and a higher limit would allow for that future growth. A higher limit would also ensure Canada offers equal crowdfunding opportunities as exists in the US
• We believe an issuer’s raise should not be aggregated with amounts raised by an affiliate of the issuer or an issuer engaged in a common enterprise with the issuer or with an affiliate of the issuer (“issuer groups”). A parent or subsidiary company may be involved in a completely different line of business or be the research arm of the organization. New developments and opportunities may be stifled by treating these entities as one for the purpose of this exemption.

The Proposed Start-Up Business Exemption would prohibit an issuer from accepting an investment from an investor of more than $1,500 in a single investment under the exemption, and no more than $3,000 in respect of an issuer group in a calendar year if the distribution is conducted without a registered dealer. The Proposed Start-Up Business Exemption would prohibit an investor from investing more than $5,000 in a single investment under the exemption, and no more than $10,000in a calendar year if the distribution is conducted with a registered dealer. Do you agree with these limits?

Are investors generally able to withstand the loss of a$1,500 investment?

Do you agree with allowing a higher limit when a registered dealer providing suitability advice is involved? Why or why not?

Comments:

• 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 without the use of registered dealer, but on a funding portal.
• Issuer groups, as started previously, should not be aggregated or treated as one on the Start-Up Business Exemption.
• Investors should be allowed to invest in as many equity crowdfunding campaigns as they chose in a calendar year.
• 90% of the US 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 an investor is accredited no investment cap should be applicable. The Start-Up Business Exemption should follow the developing norms in the US and UK.
• Issuers will have a difficult time raising the capital they need if the investment cap per investor remains at $1,500 per single investment.
• As of December 17, 2015, UK equity crowfunding portal Crowdcube has raised approximately C$264,116,442 for 332 businesses. This means an average issuer raises C$795,531 in their equity crowdfunding campaign on Crowdcube. The average number of investors per pitch is 185, despite a minimum investment threshold of as little as a C$180. The average investment per investor on Crowdcube is $3,923. The Participating Regulators should expect similar investment trends under the Start-Up Business Exemption. As such, the investor investment cap should be raised to a much higher amount.
• Accredited investors should be encouraged to invest in or along side a Start-up Business Exemption campaign. The participation of accredited investors at higher levels will provide non-accredited investors with added value as the investment group are more likely to do greater due diligence than investors only investing the minimum threshold amount in a Start-Up Business Exemption offering or investing as an accredited investor independent of the Start-Up Business Exemption investors.

• Given time, encouragement, and support the Start-Up Business Exemption and Canada’s other crowdfunding exemptions will prove to be a useful tool to SMEs looking to raise capital.
• Technology is evolving such that having a large number of security holders is not as problematic or as expensive as it was even two years ago.
• Equity funding portals in other jurisdictions are split on how they handle this issue of a large number of security holders. The majority of portals have chosen to adopt a direct ownership structure, whereby individual investors are independently responsible for their shares; while others have chosen a nominee structure, in which the company behind the equity funding portal manages the investors’ shares on their behalf. Ultimately, having a large number of security holders is proving to be a non-issue.
• The Participating Regulators should not be quick to determine that the Start-Up Business Exemption is of no interest to SMEs if a large number of SMEs do not immediately use this exemption or portal operators are not quick to offer securities under this exemption.
• Canada has been slow to adopt the start-up crowdfunding exemption available in BC, MB, NB, NS, QU, and SK and the use of funding portals in general utilizing the accredited investor and offering memorandum exemption.
• Other jurisdictions such as the UK, Europe and the US also had a slow start to the use of their funding portals. The use of these portals however have doubled or tripled year after year over the past four years in these jurisdictions. We expect a similar evolution of the use of funding portals will occur in Canada as investors and issuers become aware of and educated about this form of raising capital and investing.

Disclosure Requirements

• Successfully funded issuers should provide shareholders with an annual snapshot of unaudited financial statements, and brief business update summarizing historical performance and future plans.
• Issuers should be required to maintain a basic share registry on their own website or a third party service provider.
• Portals or third party service providers, should also remain the central, publically accessible centers for all reports and amendments by issuers. Portals should be required to keep this material permanently on their site and make this information accessible to the public. This not only provides a central location for information about an issuer, it also incentivizes portals to be accountable for issuances on their sites.   The names and businesses of fundraisers are also permanently diarized and assessable to future potential investors and regulators.
• Other than the foregoing there should be no other ongoing disclosure requirements. Issuers relying on the start-up exemption should be treated identical to issuers raising capital under the friends and family and accredited investor exemptions as much as possible.
• Audited financial statements cost $5,000 to $200,000 for small and medium sized enterprises ("SME"). Reviewed financial statements are only slightly less expensive to prepare. This is often an unnecessary cost.
• Financial statements for true start-up companies provide little useful information. What is more important at this stage of a company’s life cycle is how much cash a company has on hand, how much they are burning through each month and how much they need to reach their next significant milestone. Investors also want to know whether the money being raised is to be used in consumption or production. Consumption and paying off prior debt is negative, while production is effort in building value in the company.
• The need for reviewed and audited financial statements suggests a certain level of complication in an issuers business.   When you are an early stage company, very little is complicated and most entries are outflows.
• Once a company is making sales, audited financial statements provides greater value to investors and the company.
• The majority of corporate statutes in Canada require issuers provide audited financial statements unless all of the shareholders consent in writing to waiving this requirement each year. A single investor could refuse to provide written consent forcing a company to obtain audited financial statements.

• Marketing material should not be required to be filed with Participating Regulators.
• If the purpose of filing all marketing material related to an online offering with the Participating Jurisdictions is to mitigate any potential misrepresentations made by an issuer group related to their offering, then this information could be required by the portal to maintain and made available to the Participating Jurisdiction upon request.
• Marketing material and content online is constantly evolving and is likely to include videos and social media messaging – it would seem that the Participating Jurisdiction would be required to hire additional oversight program resources just to stay on top of the collection and review of this material with vary little benefit.
• Unless marketing materials become standardized as part of the offering we encourage the Participating Jurisdiction to work with dealers and funding portals to make this information available.

Investor Protection

• There is no need for eight (8) different risk acknowledgements under National Instrument 45-106 – Prospectus and Registration Exemptions and related multi-lateral instruments. Not only is this frustrating to issuers it is equally frustrating and confusing to investors.
• The Participating Regulators should look at harmonizing its Start-Up Business Exemption risk acknowledgement with either the integrated crowdfunding risk acknowledgement, start-up crowdfunding risk acknowledgment, accredited investor risk acknowledgement or the Participating Regulators’ offering memorandum risk acknowledgement. Creating another risk acknowledgement is creating too much of a regulatory patchwork necessitating issuers engage a lawyer to figure out what rules and forms apply to their proposed offering.
• Instead of spending money on new staff reviewing whether an issuer has filed the correct risk acknowledgement form, Participating Regulators should encourage and provide financial support for market education. Industry best practices and standards need to be developed and offered to all funding participants by way of online media including tutorials, videos, podcasts, articles and whitepapers. These types of ongoing initiatives will go a lot further in reducing investor risk than making investors sign different risk acknowledgement forms.
• Industry associations, and financial and academic institutions, should offer industry recognized non-mandatory courses to those interested in pursuing crowdfunding education via course work.

Portal Registration

• The Start-Up Business Exemption will have limited use if portals are required to be registered as a dealer or exempt market dealer. The Participating Regulators should take the approach of the jurisdictions which have adopted the start-up crowdfunding exemption and create a new non-dealer portal category.
• We believe registration as an investment dealer, exempt market dealer or restricted dealer is not required in order to protect investors.   Further, 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.
• Very few funding portals are operational in Canada under the start-up crowdfunding exemption. Only one exempt market dealer (EMD) is currently offering securities under the start-up crowdfunding exemption. This EMD also offers securities relying on the accredited investor and offering memorandum exemption. The other funding portals who are registered as exempt market dealers are focused on raising capital for more established issuers and for traditional private market products (real estate, mortgage investments, and funds).
• There are 184 IROC dealers in Canada. 25 fewer than June 2011. A number of IROC firms have indicated they intend to close their doors in 2016 (Jacob’s Securities, Octagon Capital Markets, RBS Capital Markets, and Salman Partners) or have merged with competitors (Jones, Gable & Co. Ltd. merged with Leede Financial Markets; Burgeonvest Bick Securities merged with Industrial Allied Securities; and Pope & Co. merged with Europacific) all since November 2015. Fewer of these firms are catering to SMEs and are instead focused on selling managed products. There are no funding portals established by an IROC member despite diminishing returns in their traditional markets, and it is highly unlikely an IROC member will establish a funding portal in the near future.
• EMDs overwhelming favor selling securities that offer their clients yield and which have a clear exit. SMEs are seldom in a position to provide yield or have a clear exit. In Canada, 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. Established EMDs have not rushed to create funding portals relying on any of the exemptions available to them to sell securities.
• EMDs are not interested in establishing funding portals as it would require deal transparency and the potential loss of control over their book of business (investors) which is at the heart of their business.
• 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 US 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 US A number of these portals have raised significant capital. For example: Circle-Up – $150,000,000 ($30,000,000 - May 2014); Crowdfunder – $312,900,000 ($111,700,000- May 2014); EquityNet - $ 200,000,000+ ($ 231,748,700- May 2014 – EquityNet is no longer reporting actual amount raised on its platform); Fundable – $218,000,000 ($114,000,000 –May 2014); Microventures – $80,000,000 ($36,600,000 - May 2014); RealtyMogul – $57,000,000* ($ 18,000,000 - May 2014 - RealtyMogul is no longer reporting amount raised on its platform and this is an estimate from deals closed) are all active US accredited investor equity portals. (All amounts approximates in US dollars and as reported on their websites on December 17, 2015.) Intrastate crowdfunding portals are starting to emerge in the US as well. On November 19, 2019, Anya Coverman, the Deputy Director of Policy, for the North American Securities Administrators Association (NASAA) reported at the Securities and Exchange Commission Government-Business Forum on Small Business Capital Formation that over 100 issuers have raised capital to date under the various intrastate equity crowdfunding exemptions. Most of the founders of these accredited and intrastate crowdfunding 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, we could be waiting a long time for a vibrant Start-Up Business Exemption funding market to emerge if we rely solely on existing Canadian dealers to develop these portals.
• Funding 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. Funding 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 funding portals operating outside of Canada. Founders of a funding portal have high incentives to make their business as success.
• We expect there will be significant sampling and attrition among equity funding 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 funding marketplaces and innovate in ways we cannot anticipate at this time.   This innovation should be encouraged.
• Again, requiring portals to register as a registered dealer, EMD 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.

Cross-Country Capital Raises

• Issuers in Alberta and Nunavut raising capital currently look to Ontario and British Columbia in addition to their home province. Alberta residents also have strong ties with Saskatchewan and likely approach residents in that province if those investors fall under one of the existing investor exemptions available.
• Issuers ideally would prefer that the Start-Up Business Exemption was harmonized and available across Canada. Investors will be attracted to different types of businesses based on their knowledge of the industry and their relationship to management. Criteria for investing therefore may not depend on proximity to the business or a pre-existing relationship to management.
• Also keep in mind SMEs do not see a border when doing business. Approximately 9% of SMEs in Alberta and 11% of British Columbia and the Territories export goods and services to other countries. The number of exports across provincial and territorial borders is even higher. The individuals and companies these SMEs do business with, inside and outside of their home jurisdictions, may be interested in investing in these SMEs. SMEs raising capital will want to be able to offer their securities under the Start-Up Business Exemption or similar exemption in each province or territory where a user of their product or service resides. Someone who uses a SMEs product is much more likely to understand the business and want to be an equity owner and not just a consumer.
• The whole purpose of accommodating equity crowdfunding and exemptions such as the Start-Up Business Exemption is to enable SMEs to reach out to a wider investor community by using the internet and other electronic means, whereby geographic boundaries become irrelevant.

• Harmonization between the Start-Up Business Exemption and MI 45-108 and/or with Multilateral CSA Notice 45-316 Start-Up Crowdfunding Exemption should be a top priority of the Participating Regulators.
• The Start-Up Business Exemption will be much more useful if it can be utilized with other jurisdictions private placement exemptions with as little regulatory friction or excessive fees by legal, accounting and selling dealer agent fees as possible. Private placements that are unduly complex as a result of having to rely on different exemptions in different jurisdictions that require different documents and have conflicting rules on how capital may be raised will be avoided if there is a simpler solution.
• Any such harmonization should be made in favour of expanding the rules as much as possible to allow the markets versus regulators to ultimately determine the optimal offering size, documents necessary to encourage investment, and investor investment limits.

Offering Memorandum Exemption

• See answer in item 9 above.

• ASC Blanket Order 45-515 Exemption should remain as an exemption in Alberta.
• Multilateral CSA Notice 45-311: Exemptions from Certain Financial Statement-Related Requirements in the Offering Memorandum Exemption to Facilitate Access to Capital by Small Businesses resulted in a number of provinces adopting a blanket order, local policy, or other instrument to facilitate capital raising for SMEs. ASC Blank Order 45-515 is how Alberta implemented this harmonized interim local order. The original harmonized interim order expired on December 20, 2014. A number of provinces, including Alberta, extended this harmonized interim order to December 20, 2016. Very few SMEs were every aware that this exemption even existed.
• As this exemption is available in a number of different provinces it provides an opportunity for SMEs to create one document that it can use to sell securities across Canada without the use of a funding portal or registered dealer if it so chooses. This exemption does not have any ongoing disclosure requirements (as of today's date) and is essentially the same in every jurisdiction making it much easier to manage than meeting the requirements of a different exemption in each province SMEs may be thinking of selling securities.

Other Comments

• It is disappointing that Canada is about to have four (4) different versions of the offering memorandum, three (3) different SME equity crowdfunding exemptions, eight (8) different risk acknowledgement forms; and a number of different exempt distribution reports and continuous disclosure requirements across the country depending on which exemption a private SME uses to raise capital. Most of these differences do not serve the goal of creating fair and efficient capital markets in Canada or protecting investors. It must be obvious to the Participating Regulators and other Canadian securities regulators they are increasing the complexity SMEs face when raising capital, not simplifying that process, or protecting investors.
• SMEs do not use the current offering memorandum exemption because it is too complicated and expensive. There is a risk that by choosing to implement the Start-Up Business Exemption in only two jurisdictions in Canada and not adopting one of the two different equity crowdfunding exemptions available in seven of the other provinces of Canada that the Start-Up Business Crowdfunding will not be used. The adoption of the Start-Up Business Exemption and two different crowdfunding exemptions makes raising capital more complicated and expensive in the minds of many SMEs. It may also curtail Canada wide offerings by SMEs under any of these exemptions due to an inability to co-ordinate the more nuanced differences of these rules when more than one version of these exemptions is involved. This will make the Start-Up Business Exemption and the various equity crowdfunding exemptions, exemptions SMEs avoid unless highly motivated.
• To the extent possible, the substantive and procedural components of all capital-raising exemptions should be identical across Canada. We like the idea of sampling various SME and equity crowdfunding exemptions, but this sampling does carry a cost to SMEs and Canada’s economy as a whole. A benefits versus cost analysis should be weighed very carefully before a variation under an existing rule is undertaken as a new rule versus an amendment or carve-out of one of the existing forms of that rule. There are a number of things we like about the proposed Start-Up Business Exemption that do not exist in either the start-up crowdfunding exemption or integrated crowdfunding exemption but we are concerned about the loss of harmonization across Canada of these various SME targeted exemptions.
• Issuers and investors no longer conduct business or investment 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.