Disrupting Private Equity: A Canadian’s Perspective

What is Crowdfunding?

Crowdfunding is the practice of funding a project by raising a series of small amounts of funds from a large sum of people over a medium such as the Internet. Websites like Kickstarter and Indiegogo are popular websites that allow users to campaign by proposing their project and solicit funds for the initiative. These campaigns can vary from feature film projects, musical productions, to inventions and now business ventures via equity crowdfunding. The four most common forms of crowdfunding are:

(a) the donation model, which is the crowd donating to a project or venture in exchange for nothing of tangible value;

(b) the reward model, which is the crowd donating to a project or venture in exchange for some tangible reward, perk or benefit;

(c) the pre-purchase model, which is the crowd donating to a project or venture in exchange for a future tangible reward, such as a consumer product; and

(d) the securities-based model, which the crowd investing in an issuer and its business in exchange for the issuer’s securities, which are often equity securities but may include other types of securities, including debt securities.

Source: Ontario Securities Commission, Companion Policy 45-108CP Crowdfunding

Equity crowdfunding in Canada allows privately held businesses to raise capital from a pool consisting of a large number of investors through an online portal registered with the securities regulatory authorities. Canadian businesses could raise up to $1.5 million during a 12-month period in select jurisdictions. The crowdfunding regime is aimed primarily at start-ups and small- and medium-sized enterprises based in Canada.

The Evolution of Crowdfunding in Canada

I work with and advise Ontario businesses so let us begin by breaking down what it would take for an Ontario business owner looking to explore equity crowdfunding. The first step would be to understand the regulatory framework for going down this path. Any plan to raise capital in exchange for equity or debt via a crowdfunding platform is subject to regulation by the Ontario Securities Commission (the “OSC”), the provincial equivalent to the US Securities and Exchange Commission (“SEC”). Every province and territory has their own securities regulator that falls under the oversight of the Canadian Securities Administrators (“CSA”).

Next the business owner would select the right crowdfunding portal to list their offering. Effective January 2016, the OSC introduced exemptions to allow private businesses to raise capital through online crowdfunding portals registered with the securities regulatory authority, in this case the OSC. Some examples of online crowdfunding platforms approved for Ontario include the following registered exempt market dealers:

**Disclaimer – I have no interest or financial incentive to promote any of the firms listed above. They have been provided for example purposes. 

Additional information regarding the requirements and restrictions of crowdfunding can be found at NCFA Canada – Equity Crowdfunding Regulations.

Besides regulatory requirements, companies and investors alike are subject to crowdfunding portal specific requirements above those required by the OSC. For example, FrontFundr expects a minute book, articles of incorporation; shareholder agreement, central securities register, and detailed business plan including risk assessment. SeedUps on the other hand requires an Offering Memorandum be submitted rather than a robust prospectus. The funding portals are required by law to check directors and officers of the Company for previous securities and disciplinary enforcement, criminal record, bankruptcy, and court record. To date, the funding portals have not disclosed what the related fee/commission to manage the capital raise is. (Estimated to be between 5-10% of total funding amount) The forms of capital eligible to be raised through these platforms include common equity, preferred share equity, debt (notes or bonds), or limited partnership units.

The next step for an interested company is to develop a crowdfunding-offering document that will qualify for a prospectus exemption and permit the company to raise funds through a registered crowdfunding portal. Firms can attempt to prepare the offering document themselves, using the following framework provided by Form 45-108F1 – Crowdfunding Offering document. Otherwise retaining a consultant, lawyer or financial advisor with the relevant experience can improve the probability of a successful campaign.

Investor’s Perspective

Accredited investors[1] will be subject to the following limits, $25,000 per investment, an annual limit of $50,000, and no limit if the investor qualifies as a permitted client[2]. Non-accredited investors (average investor) will be subject to the following limits, $2,500 per investment, and an annual limit of $10,000. The company would have requirements mandated by the OSC to participate in this exempt market as an issuer of securities. This includes requirements to provide investors with annual financial statements, annual notice regarding the use of the proceeds raised under the exemption, and notice in the event of a discontinuation of the issuer’s business, a change in the issuer’s industry or a change of control of the issuer. Please note issuer, business owner, and company have been used synonymously in this report.

The RDM Take

Equity crowdfunding represents the next step in the capital raising process. It creates an agile method for business owners to raise capital that can fund working capital or other capital projects, thereby reducing delays often experienced when courting and partnering with venture capitalists. The process also creates visibility as the company can be promoted and spoken about by participating investors through social media. The trade-off the business owner forgoes is the experiential advice offered by the venture capitalist, which could lead to more rapid business growth. Previously raising funding through crowdfunding could also improve your chances of securing private investment in the future.

The risks involved are not to be taken lightly for either company or investor. The company will be saddled with higher legal and accounting costs required to provide investors with legally required disclosure. In turn, this will apply negative pressure on the firm’s cash flows, possibly leading to slower business growth. Companies have to prepare for the added responsibilities that come along with equity crowdfunding. Crowdfunding too quickly and lacking the right personnel for example can lead to added costs. Certain details of the firm’s operations will be publicized which could be detrimental for firm’s with intellectual property (patents, trade secrets) that are more valuable when kept secret

The investor risks losing their entire investment as the investment into start-ups and small and medium enterprise have a higher risk profile, than traditional publicly traded securities. (Such as public stocks and bonds) The investor will also be committed to their investment and lack the same kind of liquidity (ability to cash in on investment) that traditional private securities have.

This is only the tip of the iceberg. The days of relying solely on your local investment banker to raise capital are in the past. This sharing economy application allows companies and individuals to connect with one another without relying on the traditional agents that have governed access to capital until now.

As Uber provides the de facto alternative to taxi transit, equity crowdfunding can become the de facto alternative to private company investing.

[1] According to the OSC, an accredited investor is an individual who alone or with spouse owns financial assets of $1 million or more before taxes but net of related liabilities, or whose net income before taxes exceeded $200,000 in both of the last two years and expects to maintain that same level of income this year.
[2] A permitted client is an investor with net financial assets exceeding $5 million.

unnamed-147x200David A. Pickett is the Finance Director for RDM Management Group and a former equity research associate from a large Canadian Broker Dealer. He studied his MBA at McMaster University's DeGroote School of Business with a focus in Finance and Business Valuation and his interests include history, business, baseball, and board games.