NCFA Canada | Alixe Cormick | July 6, 2016

Forward: The National Crowdfunding Association of Canada (NCFA Canada) does not offer legal advice, and nothing in this post should be construed as offering advice legal or otherwise. You are strongly encouraged to consult a securities attorney regarding any equity crowdfunding opportunity you are considering as an entrepreneur, investor, or funding portal.

Overview of Equity Crowdfunding Regulations

Why is equity crowdfunding regulated in Canada and not other forms of crowdfunding?

Equity crowdfunding involves the issuance of securities whereas the other forms of crowdfunding do not. Almost every country in the world regulates the selling and issuance of securities. Studies have shown that countries with strong securities regulation, extensive disclosure requirements and strict enforcement mechanisms have significantly lower costs of raising capital than countries lax in these areas.

In Canada, securities and those offering securities to the public must be registered unless there is an exemption available from registration and/or the preparation of a prospectus. This includes securities offered in a crowdfunding campaign. The underlying policy for the need for registration and the preparation of a prospectus ensures investors obtain the information they need to make an informed decision and issuers are put on notice they will be held accountable for this disclosure and any misrepresentations, manipulation or fraud in the offering.

Canadian securities regulators also conduct "merit review" through securities laws and their application by not allowing companies whose organization, plan of business or material contracts are deemed "unfair, unjust, inequitable or oppressive" or whose investment offered does not "promise a fair return". History dating back to the 13th century and King Edward of England has shown these types of securities laws are necessary to avoid unscrupulous sales representatives fleecing the public by hocking worthless investments.

Three policy assumptions underlie the various exemptions from the need to register and prepare a prospectus when selling securities:

• The class of securities is low risk (ex. government and bank bonds);
• The investor can participate in the offering due to his or her wealth, sophistication or pre-existing relationship to the insiders of the issuing company (e.g. accredited investor exemption and close friends, family and business associate exemption); or
• A lesser level of disclosure is warranted given the risk, size of the company and the ability to impose suitability investment caps (e.g. the offering memorandum exemption and related eligible investor requirements).

Entrepreneurs will need to rely on an exemption from the registration and prospectus requirements of Canadian securities laws if they intend to issue securities through crowdfunding.

What is the status of equity crowdfunding in Canada?

Canada now has two crowdfunding specific exemptions: the Start-Up Crowdfunding Exemption (May 14, 2015 – BC, SK, MB, QU, NB, and NS), and the Integrated Crowdfunding Exemption (Jan. 25, 2016 - MB, ON, QU, NB, and NS, with SK pending).

As of February 15, 2016, there are six portals which list Start-up Crowdfunding Exemption deals. Five of these funding portals operate on reliance of the Start-up Registration Exemption for Start-up Crowdfunding portal operators. One of these funding portals is a registered dealer.

There are no portals which are currently authorized to list deals under the Integrated Crowdfunding Exemption, but this is not a surprise as the rule only came into force on Jan. 25, 2016. We anticipate registered dealer funding portals will be the first to offer securities under this exemption as they need only file a Form 33-109F5 Change of Registration Information to indicate they plan on offering this service as part of their business. Restricted dealer portals operating on reliance of the Integrated Crowdfunding Exemption will have to go through a more robust review before being authorized.

Entrepreneurs can also conduct equity crowdfunding campaigns in Canada relying on other exemptions from the prospectus and registration requirements of Canadian securities laws such as the accredited investor exemption, and offering memorandum exemption (both exemptions available across Canada). There are eight online funding platforms offering deals relying on these two exemptions. One of these funding portals is a restricted dealer and seven are registered dealers.

Reporting issuers in Canada, can also raise capital under the Existing Security Holder Exemption (available across Canada under various blanket and local orders) and the Investment Dealer Exemption (BC, AB, SK, MB and NB) through an online funding platform operated by an investment dealer. There are currently no funding platforms operated by investment dealers in Canada.

View Summary Table of Equity Crowdfunding Regulations in Canada What's [expand title="Answer" swaptitle="Close"]

The chart below illustrates where equity crowdfunding is today in Canada from a regulation and operational status. Not everyone will agree that all of these forms of raising capital online are equity crowdfunding. This is a debate that will unfold as raising equity online evolves over the next five years.

[1] See section 1.1 of National Instrument 45-106 – Prospectus and Registration Exemptions (NI 45-106) for the full definition of who is an accredited investor. Definition in table only sets-out requirements for an individual to be considered an accredited investor. Section 2.3 of the Companion Policy to NI 45-106 provides guidelines on how to apply the financial tests to determine if someone is an accredited investor.

[2] See section 2.9 of NI 45-106 for the offering memorandum exemption and section 3.8 of the Companion Policy to NI 45-106 for guidelines as to various matters concerning using the offering exemption. See also Multilateral CSA Notice of Amendments to National Instrument 45-106 Prospectus Exemptions Relating to the Offering Memorandum Exemption.

[3] See: AB Blanket Order 45-15 Exemption from certain financial statement requirements of Form 45-106F2 Offering Memorandum for Non-Qualifying Issuers, 2014 ABASC 499; SK General Order 45-922 Exemption from Certain Audit and Financial Statement Related Requirements in the Offering Memorandum Exemption; and 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. Each of the adopting jurisdictions have adopted the policy in different formats.

[4] See Start-up Crowdfunding Registration and Prospectus Exemptions. Each of the adopting jurisdictions have adopted the policy in different formats. Go to one the participating jurisdiction's Start-up Crowdfunding webpage for links to information bulletins and all forms related to equity crowdfunding under the Start-up Crowdfunding Exemption.

[5] See Multilateral Instrument 45-108 - Crowdfunding. Each of the adopting jurisdictions have adopted the policy in different formats. Go to one the participating jurisdiction's Integrated Crowdfunding Exemption webpage for links to information bulletins and all forms related to equity crowdfunding under the Start-up Crowdfunding Exemption.

[6] See Multilateral CSA Notice of Publication and Request for Comment Proposed Multilateral Instrument 45-109 Prospectus Exemption for Start-up Businesses.

[7] See article “Changing Your Mind: Part I – Two Day Cancellation Right under the Offering Memorandum Exemption” by Alixe Cormick and Brian Koscak for a chart on which provinces have a statutory or contractual cancellation right.

[8] AB, NB, NS, QU and SK will not be amending their version of the offering memorandum until April 30, 2016. Until that date eligible investors in AB, SK and QU do not have any caps on their investment amount and non-eligible investors who obtain advice regarding suitability from an eligible investor do not have an investment cap. See Multilateral CSA Notice of Amendments to National Instrument 45-106 Prospectus Exemptions Relating to the Offering Memorandum Exemption.

[9] Multilateral CSA Notice 45-317 - Amendments to Start-up Crowdfunding Registration and Prospectus Exemptions. In BC restricted dealers under the Integrated Crowdfunding Exemption may not offer securities under the Start-Up Crowdfunding Exemption.

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The Start-up Crowdfunding Exemption

What kind of businesses can raise funding under the Saskatchewan crowdfunding exemption? [expand title="Answer" swaptitle="Close"]

Any business resident in a participating jurisdiction (BC, SK, MB, QU, NB, NS) that is not a reporting issuer or an investment fund can raise funding under the Start-up Crowdfunding Exemption. [/expand]

Can businesses resident outside of a participating jurisdiction raise funding under the Start-up Crowdfunding Exemption?

[expand title="Answer" swaptitle="Close"]

No. Only businesses resident in a participating jurisdiction (BC, SK, MB, QU, NB, NS) may raise capital under the Start-up Crowdfunding Exemption. [/expand]

How much capital can I raise for my company through the Start-Up Crowdfunding exemption? [expand title="Answer" swaptitle="Close"]

You can raise up to $250,000 per offering under this exemption. Your company, and all promoters, directors, officers and control persons related to the company, may not use this exemption more than twice in a calendar year. This means your group can raise an aggregate total of up to $500,000 in a calendar year utilizing this exemption in two separate offerings for either the same issuer or two separate issuers. There cannot be any concurrent offering by you or any other company for the same project under this exemption.

You can however, rely on other private placement exemptions such as the accredited investor or offering memorandum exemption during the year to raise additional capital if required. [/expand]

What type of securities can I offer investors under the Start-Up Crowdfunding exemption? [expand title="Answer" swaptitle="Close"] You can offer common shares, preferred shares, debentures, convertible debentures, bonds, partnership units, limited partnership units, promissory notes and any other security instrument other than derivative type securities. [/expand]

Who can invest in a Start-up equity crowdfunding campaign? [expand title="Answer" swaptitle="Close"]

Anyone resident in a participating jurisdiction (BC, SK, MB, QU, NB, NS) and over the age of eighteen (18). [/expand]

How much can I invest in a company using the Start-up crowdfunding exemption to raise funds? [expand title="Answer" swaptitle="Close"]

You may invest up to $1,500 in an offering under the Start-up Crowdfunding Exemption. You can invest in an unlimited number of different equity crowdfunding offerings, as there is no limit imposed under the rule. [/expand]

If I participate in a Start-Up crowdfunding offering and later move outside of the province of a participating jurisdiction, will I lose the securities I purchased? [expand title="Answer" swaptitle="Close"]

No, you will not lose the securities sold to you in a Start-up Crowdfunding offering if you later decide to move outside of a participating jurisdiction province. What is important is that you were resident of a participating jurisdiction at the time the securities were sold to you. Where you live subsequent to that sale does not matter. You will still own those securities. [/expand]

As an entrepreneur, what must I do or provide to rely on the Start-Up crowdfunding exemption? [expand title="Answer" swaptitle="Close"]

To use the Start-up Crowdfunding Exemption you must:

• Use an online funding portal to sell your securities;
• Prepare an offering document using the format, and providing the information in, Form 1 - Start-up Crowdfunding - Offering Document;
• Not pay a commission or other amounts to your promoters, directors, officers, control persons, employees or agents for the offering (you may however pay a fee or a commission to the online funding portal); and
• Report your sales in each participating jurisdictions where you sold securities and the jurisdiction where your head office is located on Form 45-106F1, or Form 45-106F6 if in BC, within 30 days of the offering’s close and file a copy of the offering document; and
• Provide a confirmation notice to each investor who purchased securities including the following information:

• The date of subscription and the closing date of the distribution;
• The quantity and description of securities purchased;
• The price paid per security; and
• The total commission, fee and other amount paid by the issuer to the funding portal in respect of the start-up crowdfunding distribution.

All of the Start-up Crowdfunding forms are set-up to be easily understood without the need of the assistance of a lawyer or other professional to complete them. These forms are short and require only the minimum information necessary for accurate disclosure.

The participating jurisdictions expects that issuers and portals will expand on the minimum disclosure necessary as investors request more information and best practice norms emerge organically from the equity crowdfunding community. [/expand]

What are the requirements for an online funding portal to be recognized in Participating jurisdiction to offer Securities under the Start-up Crowdfunding Exemption? [expand title="Answer" swaptitle="Close"]

Funding portals offering securities of issuers under the Start-up Crowdfunding Exemption may be operated by either:

• funding portals operated by persons relying on the start-up registration exemption;
• funding portals operated by restricted dealers under the Integrated Crowdfunding Exemption; or
• funding portals operated by registered dealers

A funding portal intending to rely on the start-up registration exemption must deliver certain forms to regulators at least 30 days before starting operations. These forms are:

• Form 3 Start-up Crowdfunding Funding Portal Information Form (8 page PDF Form); and
• Form 4 - Start-up Crowdfunding – Funding Portal Individual Information Form for each promoter, director, officer and control person of the owner of the portal (8 page PDF Form).
• other documents regulators may request

Documents that may be requested include organizing documents of the funding portal (articles and certificate of incorporation or partnership agreement), business

registration numbers, and documents that support the funding portal’s process and

procedure for handling of funds and meeting other conditions of the Start-up

Crowdfunding Exemption.

Portals who are licensed to operate under the Start-up Crowdfunding Exemption are not subject to the “know your client” and “client suitability” rules imposed on registered dealers. They are however subject to certain other requirements such as:

• the head office of the portal is in Canada;
• a majority of the portal’s directors are Canadian residents;
• the portal is not registered under Canadian securities legislation;
• The portal cannot be related to businesses making offerings through them;
• The portal must ensure that both the issuer and the investor have an address in a participating jurisdiction;
• The portal must not allow an investment until the investor acknowledges it is accessing the website of a funding portal that is not registered under Canadian securities legislation and provides no advice about the suitability or the merits of an investment, and that they have read and understood the offering document and risk warning available on the funding portal;
• The portal must not provide advice to potential investors;
• Funds received for an offering through the portal must be held separate from the funding portal's property, in trust for the investors until the close or abandonment of the offering;
• The portal must not release funds to the issuer until the minimum amount to close the offering has been reached; and
• The portal must provide the issuer with each investor's name, address, telephone number, email address and the details of the purchase within 15 days of closing the offering.

Portals may receive a fee or a commission based on the amount raised for their services. [/expand]

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Source:

Alixe Cormick is the founder of Venture Law Corporation in Vancouver, BC. Alixe concentrates her legal practice in the areas of initial public offerings, follow-on offerings, reverse takeovers, capital pool corporations, qualifying transactions, mergers & acquisitions, secondary listings and exempt market financings (more).