As one more step in the current overhaul of Canada’s exempt market, securities regulators in British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia (the Crowdfunding Jurisdictions) have each adopted substantially harmonized registration and prospectus exemptions that permits non-reporting issuers to raise capital from large groups of investors.
The crowdfunding exemption consists of two elements: a prospectus exemption (the Prospectus Exemption) permitting issuers to distribute securities without a prospectus; and a registration exemption (the Registration Exemption) permitting an online funding portal to assist with the distribution without being registered as an investment dealer under securities laws. Previously, crowdfunding was only permitted in Canada in the absence of a distribution of a security.
Both of the Prospectus Exemption and the Registration Exemption are effective immediately, and are currently scheduled to expire on May 13, 2020.
Interestingly, even though it was one of the jurisdictions that initially advanced a proposal to adopt a prospectus and registration exemption for crowdfunding, Ontario is not one of the Crowdfunding Jurisdictions. We understand that Ontario is proposing to proceed with its own prospectus and registration exemptions that will differ from the exemptions provided in the Crowdfunding Jurisdictions. If adopted, this lack of harmonization may increase investor and market confusion.
While normally Ontario’s lack of involvement would restrict the practical use of a new capital raising exemption, given crowdfunding is intended for non-reporting issuers we do see this as a powerful new way for smaller companies to be able to successfully raise the capital necessary to push their enterprise to the next stage of development.
This new crowdfunding exemption, when grouped with the recent restriction of the $150,000 minimum amount exemption to only non-individuals and the adoption in certain jurisdictions of a new suitability exemption, demonstrates a trend that securities regulators are attempting to respond to issuers’ need for streamlined access to capital, and are relying heavily on registered dealers for investor protection rather than disclosure requirements.
We also expect that a separate set of rules that permit crowdfunding for reporting issuers will follow in due course in the Crowdfunding Jurisdictions.
In order to rely on the Prospectus Exemption, the issuer must not be a reporting issuer anywhere in Canada and must be distributing a limited type of its own securities, being any of: (i) a common share; (ii) a non-convertible preference share; (iii) a security convertible into a common share or non-convertible preference share; (iv) a non-convertible debt security linked to a fixed or floating interest rate; or (v) a unit of a limited partnership.
The distribution must occur through the facilities of a funding portal, either using the Registration Exemption described below, or through the facilities of a registered dealer. If a registered dealer is operating the funding portal, they must provide confirmations to the issuer that the registered dealer is operating its funding portal in accordance with certain specified conditions.
The issuer must have a head office in one of the Crowdfunding Jurisdictions. An issuer may only use the Prospectus Exemption twice in any calendar year, and each of those distributions is limited to a maximum of $250,000 in capital. Each investor is limited to a maximum investment of $1,500 per distribution. A distribution period may only remain available for a period of 90 days.
The issuer must prepare an offering document (the Offering Document), which describes the issuer, its intended use of proceeds from the distribution and the minimum amount that the issuer has to raise before it is permitted to close the offering. The Offering Document must meet certain form requirements.
The issuer must provide each investor with a contractual right to cancel their purchase order within 48 hours of their initial subscription or, if the Offering Document is amended before the distribution, within 48 hours of the amendment.
All of the securities issued using the Prospectus Exemption will be subject to restrictions on resale referred to as a seasoning period. Accordingly, they cannot be resold without a prospectus, another prospectus exemption, or 4 months after the issuer becomes a reporting issuer.
The Registration Exemption permits non-registered persons to operate a funding portal specifically for the Prospectus Exemption without having to be registered under securities laws as a dealer.
In order to operate a funding portal using the Registration Exemption, the entity must have a head office in Canada and have a majority of its directors resident in Canada. 30 days before facilitating its first distribution using the Prospectus Exemption in a particular jurisdiction, the funding portal must have provided the securities regulator in a Crowdfunding Jurisdiction with certain prescribed information about itself and about its directors, officers and control persons. Securities regulators have the discretion to request additional time and also to shut down the funding portal if it considers the funding portal’s business to be prejudicial to the public interest.
The funding portal is not permitted to provide any advice or recommendation to purchasers with respect to the suitability or merits of any of the investments being offered on the funding portal.
A funding portal is not permitted to charge a commission, fee or other amount from any of the investors, and accordingly it will only be recompensed for its services by the issuer. It must have a website through which the funding portal can receive payments from investors for their subscriptions, host Offering Documents and risk acknowledgements (in a specified form – the Risk Acknowledgment) for the distributions, and disclose the name, jurisdiction of residence, and contact information for each of the principals of the funding portal.
The funding portal must keep the purchaser’s assets in trust, separate from its own assets. If a purchaser exercises its right to cancel its purchase, the funding portal must refund all of the purchaser’s funds to the purchaser within 5 business days of the exercise.
The funding portal has an obligation to ensure that both the issuer and the purchasers are resident in jurisdictions where the Prospectus Exemption is available, as well as to ensure that every purchaser has confirmed they have read and understood the Offering Document and the Risk Acknowledgment.