Canadian Business | Murad Hemmadi | Dec 7, 2015

When Palmer Luckey needed money to develop his virtual reality headset, the Oculus Rift, he turned to crowdfunding. Over a month-long Kickstarter campaign in 2012, 9,000 backers put up US$2.4 million; a year and a half later, Oculus VR was acquired by Facebook Inc. (Nasdaq: FB) for US$2 billion. If the US$300 many of those online supporters pledged had bought them equity instead of an early version of the Rift, they would have netted a $43,500 payout, by some estimates.

Equity crowdfunding, the offering of shares of (typically startup) companies on crowdfunding platforms akin to Kickstarter, has been legal in Europe, Australia and Israel going back as far as 2010, but it’s only now catching on in North America. Saskatchewan was the first province to formally recognize this web-enabled alternative to traditional venture capital or private equity fundraising in 2013.

Regulatory changes set to take effect on Jan. 25, 2016, will legitimize equity crowdfunding in Ontario, Manitoba, Quebec, New Brunswick and Nova Scotia. Accredited investors will be able to invest up to $25,000 per company (up to a $50,000 yearly total), while non-accredited investors will be restricted to $2,500 per investment (and a $10,000 cap in Ontario).

British Columbia adopted rules in May capping individual investments at $1,500. The provinces restrict the kinds of companies that can seek funding and how much they can raise. Those looking to set up online portals where issuing companies can list their offerings will also be required to register with regulators and fulfil certain gatekeeper functions, like doing background checks on issuers and reviewing disclosures.

See:

• Data on Equity crowdfunding performance in the UK

• Alberta and Nunavut Securities Regulators Publish Proposed start-up Business Exemption for Comment

For retail investors, crowdfunding offers a way to diversify one’s portfolio into private equity, normally the preserve of institutional investors and high-net-worth individuals, says Don McDonald, president of Waverley Corporate Financial Services. “I think most people are probably underweighted in private equity,” he adds. Waverley licenses the SeedUps and InvestX platforms in Canada, which allow users to invest in fledgling and established private companies, respectively. (The company uses existing memorandum and accredited investor exemptions, and McDonald says it is unlikely to make heavy use of the new equity crowdfunding regulations.)

Since private company valuations are not strongly correlated to the swings in public equity markets, crowd holdings can provide diversification to investors who already have conventional stock and bond portfolios, he says. “You could even view it as a bit of a hedge.”

Still, it’s a high-risk asset class. Investors would be wise to approach crowdfunding campaigns the same way they do the long-standing market for exempt securities. Most companies seeking funding are in the startup stage, and the failure rate of such enterprises, statistically speaking, ranges between 75% and 90%. “If you’re thinking about investing in crowdfunding, limit your exposure to something that you’re comfortable losing,” says Michael Pieciak, chairman of the corporate finance section committee of the North American Securities Administrators Association. The asset class also has limited liquidity. “There’s no secondary market for trading in crowdfunding,” notes Pieciak. “If you need to access the cash in an immediate way, then you are in sort of a bind. You can’t go to the stock exchange and trade the shares in for dollars.”

See:  Early bird registration open for 2nd Annual Canadian Crowdfunding Summit in Toronto (March 3)

Another issue is the lack of transparency. Notwithstanding regulators’ intrusion into the market, the requirements for financial and governance disclosure are nothing like those for publicly traded companies. You can’t expect to find third-party analysis of the venture, and your financial adviser likely won’t be much help either. McDonald suggests sticking to companies in sectors you understand well.

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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 1300+ 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 ncfacanada.org.