Several Canadian securities regulators, including those in Nova Scotia and New Brunswick, have been busy formulating a structure to make it possible to purchase and sell securities through crowdfunding. Crowdfunding has become a popular way to raise start-up funds through websites like Kickstarter, which allow large numbers of individuals to contribute relatively small amounts to development and production costs for particular projects in exchange for rewards or products after the project comes to fruition.
Crowdfunding Exemptions
Securities laws do not permit the distribution of securities without a prospectus unless there is an exemption available. Common exemptions include those available to employees, family, and close friends of the issuer, the accredited investor exemption available to high net worth individuals, and the option to produce a simplified offering memorandum in lieu of a prospectus in certain circumstances.
A new exemption for crowdfunding became law in Nova Scotia, New Brunswick, Ontario, Quebec, and Manitoba on January 25, 2016, when Multilateral Instrument 45-108 came into effect. MI 45-108 allows potential issuers to crowdfund investment by listing equity, convertible and non-convertible debt securities, limited partnership units, and flow-through shares in an online portal, raising capital through small distributions to many investors.
In May of 2015, the first crowdfunding exemption, the Start-up Crowdfunding Exemption pursuant to Multilateral CSA Notice 45-316, became available in certain provinces including those now enacting MI 45-108. Available only to businesses that are not reporting issuers, this exemption limits the amount of capital that can be raised per round of funding to $150,000, with two rounds permitted per year ($300,000 annually). Any one investor is limited to a maximum investment of $1,500 per round ($3,000 annually).
MI 45-108 introduces a second crowdfunding exemption. Open to all issuers, the annual limit on capital raised is higher: $1,500,000 per year. Investment limits are also raised to $2,500 per investor per round. If the investor in question is an accredited investor in Nova Scotia or New Brunswick, this limit is raised to $25,000 per round.
Restrictions and Obligations
Of course, with the heightened ability to raise capital come increased restrictions and obligations. Notably:
1. The online portal through which investment is solicited must be registered with and approved by the relevant provincial securities regulator. The requirements for a funding portal are discussed in more detail below.
2. The issuer's promotional materials may only be made available through the portal. Social media and other advertisement may be used to direct potential investors to the portal, but reposting the materials directly on the business website or social media feed is not permitted.
3. Ongoing disclosure requirements are imposed after the distribution closes. On an annual basis, the business must disclose financial statements and a report on the use of any proceeds of the distribution. It must give immediate notice to investors of any discontinuation of business, change in industry, or change of control.
Implications of Having Many Shareholders
In addition to the legislative restrictions, there are practical considerations that may dissuade some businesses from making use of the equity crowdfunding exemptions. The low individual contribution limits mean that dozens to hundreds of investors will be required to raise the maximum amounts. Assuming that equity securities are distributed, this means that the business now has dozens to hundreds of shareholders, which is a complicated, costly, and time-consuming situation to manage for any private corporation, and is especially so for a start-up or small company. When a corporation's shareholder number exceeds fifty, it is a cause for concern because of the potential for additional compliance requirements under corporate and securities laws.
Regulation
Crowdfunding portals are subject to regulation as well. They are intended to serve a gatekeeper function, and must review issuers' crowdfunding offering materials to ensure that they are complete and accurate. They are also obligated to conduct background checks on the directors, officers, and promoters of any corporation seeking to distribute securities through the portal. To ensure that these responsibilities are taken seriously, the portal must be registered with the relevant provincial securities regulators as either an investment dealer, exempt market dealer, or restricted dealer. Prospective issuers should also conduct due diligence on their portal of choice, as many of the portals will also be new businesses.
Conclusion
The latest crowdfunding exemptions are an interesting attempt by securities regulators to respond to the demand that crowdfunding participants be able to receive equity in the companies they support. However, the realities of both CSA Notice 45-316 and MI 45-108 will require thoughtful planning on the part of any business seeking to raise capital in this manner.
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