After a long wait and much anticipation, securities regulators in five Canadian provinces have announced a new crowdfunding regime. It includes two components, a crowdfunding prospectus exemption and a registration framework for funding portals. This new capital raising regime will be available in Ontario, Quebec, Manitoba, New Brunswick and Nova Scotia.
Unlike the earlier start-up crowdfunding exemption that is only available to non-reporting issuers in select provinces, this new crowdfunding is comprehensive and is available to both reporting issuers and non-reporting issuers. While not restricted to larger issuers, the new crowdfunding regime is aimed primarily at small and medium-sized businesses looking to raise capital online from a large number of investors.
Crowdfunding Prospectus Exemption
There are many requirements an issuer will need to meet to take advantage of the crowdfunding prospectus exemption in raising capital. Key elements include the following:
- Simple securities only: an issuer may only distribute eligible securities which consist of common shares, preference shares, securities convertible into common shares or preference shares, non-convertible debt securities linked to a fixed or floating interest rate, limited partnership units and flow-through shares.
- Limits on capital raised: an issuer may raise no more than $1.5 million in any 12 month period in reliance upon the crowdfunding prospectus exemption. However, this restriction will not limit an issuer from raising capital in reliance upon other prospectus exemptions during the same period.
- Issuer restrictions: to take advantage of the exemption an issuer must be incorporated or organized in Canada and have its head office in Canada, a majority of its directors must be resident in Canada and its principal operating subsidiary, if any, must be incorporated or organized in Canada or the United States. The exemption is not available to investment funds.
- Investor limits: for a non-accredited investor there is a limit of no more than $2,500 per investment and for accredited investors the limit is $25,000 per investment. An investor in Ontario is subject to an additional restriction on the aggregate amount that may be invested in any calendar year, being $10,000 for a non-accredited investor and $50,000 for an accredited investor, with no investment limit applicable to a permitted client (an accredited investor with net financial assets in excess of $5 million).
- Funding portal: an issuer must distribute securities through a registered funding portal and may not use more than one funding portal.
- Offering document: all material information about an issuer's offering must be contained in a prescribed form of crowdfunding offering document, that is made available solely through the registered funding portal.
- Additional marketing materials: in addition to the prescribed form of crowdfunding offering document, an issuer may make available a term sheet, a video and other materials summarizing the offering document provided these materials are only made available through the registered funding portal. An issuer may not advertise or solicit investors directly or indirectly other than to inform them of the proposed distribution of securities and refer them to the registered funding portal.
- Liability for misrepresentations or untrue statements of a material fact: a reporting issuer will be subject to statutory or contractual rights for rescission and damages if its offering document or additional marketing materials contain a misrepresentation. A non-reporting issuer will be subject to similar obligations if its offering document or additional marketing materials contain an untrue statement of a material fact.
- Right of withdrawal: an issuer must provide each investor with a right to withdraw a subscription to purchase securities within 48 hours by notification to the funding portal.
- Risk acknowledgement form: all investors must complete a risk acknowledgement form confirming they have read and understand the risk warnings and information in the offering document.
- Hold period: securities issued in reliance upon the exemption will be subject to a four-month hold period if the issuer is a reporting issuer and to an indefinite hold period for a non-reporting issuer.
In addition, non-reporting issuers that take advantage of this new crowdfunding prospectus exemption must meet certain ongoing disclosure requirements which include providing annual financial statements and notices disclosing use of proceeds, and in New Brunswick, Nova Scotia and Ontario, notices of specified events such as a discontinuation of the issuer's business and a change of control of the issuer.
Registered Funding Portals
The new crowdfunding regime establishes a registration framework for funding portals (an online platform that allows potential investors access to crowdfunding offering materials). Funding portals must be registered with applicable Canadian securities regulatory authorities under the category of investment dealer, exempt market dealer or restricted dealer. Investment dealers and exempt market dealers that register as funding portals must meet applicable existing registration obligations under securities legislation, including know-your-client, know-your-product and suitability obligations. A funding portal registered under the category of restricted dealer will be subject to additional limitations.
Regardless of its category of registration, a funding portal must:
- fulfill certain gatekeeper responsibilities prior to allowing an issuer access to its online platform, including review of disclosure in the issuer's crowdfunding offering document and other materials; and
- review information and obtain background checks on an issuer and its directors, officers and promoters, and deny an issuer access to the funding portal in certain circumstances.
Comparison with the Start-up Crowdfunding Exemption
The start-up crowdfunding exemption adopted by six provinces on May 14, 2015 remains in place. There are a few notable differences between the new crowdfunding regime and the existing start-up crowdfunding exemption:
- There are limitations on where the exemptions are available:
- Both the start-up crowdfunding exemption and the new crowdfunding regime will be available in Quebec, Manitoba, New Brunswick and Nova Scotia.
- In Ontario, only the new crowdfunding regime will be available.
- In British Columbia and Saskatchewan, only the start-up crowdfunding exemption will be available (provided in Saskatchewan the new crowdfunding regime has been republished for an additional 60 day comment period)
- The new crowdfunding regime will be available to both reporting issuers and non-reporting issuers, unlike the start-up crowdfunding exemption which is available only to non-reporting issuers.
- The new crowdfunding regime provides a higher offering limit, up to $1.5 million in any 12 month period as compared to a limit of $500,000 under the start-up crowdfunding exemption.
- Under the start-up crowdfunding exemption there is a limited dealer registration exemption for funding portals, whereas under the new crowdfunding regime all investments must be made through a registered crowdfunding portal.
- There are no ongoing disclosure obligations under the start-up crowdfunding exemption.
Compliance and Investor Protection
Even with the announcement of the new crowdfunding regime, there is still significant concern expressed about the need for a focus on investor protection. Much of the delay in implementation can be attributed to concern by regulators over how to address investor protection concerns.
With an expanded pool of retail investors able to access exempt market offerings, securities regulatory authorities have expressed a need for additional vigilance. The Ontario Securities Commission, for example, has announced plans to develop a compliance and oversight program to monitor distributions under not only the new crowdfunding regime but other exempt distributions as well. Issuers, dealers and investors who participate in the crowdfunding marketplace should anticipate active oversight by securities regulatory authorities to ensure compliance.
In some provinces, ministerial approvals are required for the implementation of the new crowdfunding regime. Provided all necessary approvals are obtained, the new regime will come into force on January 25, 2016.
Other Recent Notable Crowdfunding Developments
The Alberta Securities Commission and the Nunavut Securities Office have also published for comment a prospectus exemption to facilitate capital raising. This exemption would allow a start-up or early stage business to raise up to $1 million using an offering document and is being designed to work with the start-up crowdfunding exemptions.
The proposed regulations for Canada's Capital Markets Regulatory Authority are expected to include both the new crowdfunding regime and the start-up crowdfunding exemptions.
After long delay, the Securities and Exchange Commission approved new crowdfunding rules under the JOBS Act in the United States. The US crowdfunding rules are not available to Canadian or other foreign companies.
Crowdfunding is a growing global phenomenon. In parts of Europe, in Australia and elsewhere in the world crowdfunding is becoming more and more common as a viable financing option for start-ups and small and medium-sized businesses to raise capital. While securities regulatory authorities in Canada have expressed support for new and innovative technologies that can benefit both issuers and investors there has also been a reluctance to move quickly - a stance that is consistent with what we have witnessed in the United States. With the adoption of the new crowdfunding regime we anticipate a growing momentum. After much hype in the recent past, we expect 2016 will bring a meaningful expansion of crowdfunding activity in Canada.