There is no doubt that small and mediumsized enterprises (“SMEs”) and businesses in the startup phase (also known as early- stage businesses) face multiple challenges when seeking financing. Not only must they identify investors who are prepared to take the risk of investing in their projects, they must also ensure that they comply with the rules on raising capital imposed by the securities regulators.
Under the rules in force in Quebec and the rest of Canada, for a corporation to raise capital, unless it has an exemption, it must retain the services of a firm registered in an appropriate category with the Canadian Securities Administrators, and must also prepare and provide the purchasers with a disclosure document known as a “ prospectus”.
This procedure is generally too onerous and demanding for SMEs and startups, not to mention the obligations these companies would have after the financing to prepare and distribute continuous disclosure documents, such as financial statements, management’s discussion and analysis and press releases.
Thus, SMEs and startups are often limited to raising funds from business associates, family (“love money”) and accredited investors — which are generally persons with a net income before taxes exceeding $200,000 or net assets of at least $5,000,000.
SMEs and startups also have the option of soliciting funds from a broader range of investors without having to prepare a prospectus through the use of an offering memorandum. The offering memorandum is a disclosure document similar to a prospectus but which is more simple to prepare and less costly. This financing alternative seems generally to be overlooked and underused by SMEs and startups. The lack of use of the offering memorandum is likely due to the accompanying regulatory requirement of preparing audited financial statements drawn up in accordance with the IFRS. This type of financing appears to be much more popular in the Canadian West.
However, in this regard, on December 20, 2012, the Autorité des marchés financiers (“AMF”) issued an interim local order allowing SMEs and startups that are not otherwise reporting issuers, as defined in the securities legislation, to distribute their securities by means of an offering memorandum without having to include audited financial statements drawn up in accordance with the IFRS.
Thus, it is henceforth possible for these corporations to issue an offering memorandum without having to prepare audited financial statements. Moreover, the unaudited financial statements accompanying the offering memorandum may even be drawn up in accordance with the Canadian GAAP applying to private issuers.
However, to take advantage of this easing of the regulatory requirements, the issuer must limit the total amount of all of its offerings made under this rule to $500,000 and limit the aggregate acquisition cost per purchaser to $2,000 per 12-month period preceding the offering (and not $2,000 per issuer). A warning must also be added to the offering memorandum clearly informing any purchaser of the fact that the financial statements are not audited and are not drawn up in accordance with the IFRS, and of the limits on the investment threshold.
It should also be noted that, under the Quebec legislation, the use of an offering memorandum by a corporation to raise funds is subject to translation requirements. Thus, for purposes of soliciting financing in the province of Quebec, the offering memorandum must either be written in French or in both French and English.
Conscious of the financing needs of SMEs and startups, at the same time as the AMF was announcing the easing of the rules on the contents of the offering memorandum (which is slated to apply for a maximum period of two years), the AMF also launched a consultation on equity crowdfunding.
Equity crowdfunding consists of raising capital from a large number of investors, who are not necessarily accredited investors, by means of an electronic platform in return for the issuance of securities. Some jurisdictions such as the United States (under development since April 5, 2012), England and Australia have adopted rules authorizing equity crowdfunding.
These rules generally provide that corporations may only raise a modest amount through this type of financing. Similarly, the amount investors may invest is also small. At present, this type of financing is prohibited in Canada unless one has an exemption or issues a prospectus.
The main objective of equity crowdfunding is to facilitate access to capital at a reduced cost. However, this objective is difficult to reconcile with recent developments in the regulation of Canadian securities markets aimed at protecting investors.
Indeed, in carrying out their mission to protect investors, Canadian authorities have continued to increase the regulatory requirements (disclosure, compliance, proficiency, etc.), which also has the effect of increasing the operating costs of the various participants in the financial markets.
Some financial market stakeholders are concerned about the risks of an exodus of innovative Quebec corporations and talent which could be tempted to move south to the U.S. to finance their projects, where they would benefit from a more streamlined and less costly financing environment. The Canadian Securities Administrators will have to meet the challenge of finding the difficult balance between the financing needs of SMEs and startups and the protection of investors.