As we have previously discussed, the Ontario Securities Commission recently proposed a crowdfunding prospectus exemption aimed at facilitating greater access to capital through the exempt market, particularly for start-ups and small and medium-sized enterprises (SMEs). The exemption is one of four new prospectus exemptions proposed for Ontario.
Under the crowdfunding exemption, both reporting and non-reporting issuers and their affiliates would be able to raise up to $1.5 million per year. Investors would also be limited to investing no more than $2,500 in a single investment, and no more than $10,000 in a year under the exemption.
While the proposed exemption would certainly make it easier for smaller companies to raise capital, as we stated in our comments to the OSC, the following are some proposed restrictions the OSC may want to reconsider to ensure that access to the exemption is not unduly restricted.
For example, issuers relying on the exemption would be required to be be incorporated or organized in Canada. While a requirement that a business have its principal place of business in Canada would serve the objective of assisting Canadian start-ups and SMEs with raising capital, a requirement for incorporation or organization in Canada arguably fails to provide a sufficient or relevant nexus.
There are many reasons why a business may be organized outside of Canada while still being a “Canadian” business. For example, many “B Corps” (corporations certified to meet certain standards of social and environmental performance, accountability, and transparency) incorporate or organize in other jurisdictions, predominantly Delaware, where legislation currently exists where it is possible to incorporate a B Corp or that is more favourable to B Corps than the Canada Business Corporations Act or other Canadian corporate statutes. These are the types of entities that would benefit the most from, and make the most use of, the crowdfunding exemption.
It should also be noted that the requirement that a majority of the directors of the issuer be resident in Canada imposes a restriction above and beyond current Canadian corporate law. For example, the Canada Business Corporations Act only requires that 25% of the directors of a corporation be resident in Canada (the same residency requirement is mandated by the Business Corporations Act (Ontario)). In other Canadian jurisdictions (i.e., British Columbia and Québec) there are no such residency requirements.
The crowdfunding exemption also prohibits the completion of an offering unless the issuer has “financial resources sufficient to achieve the next milestone in [its] written business plan, or if no milestones, to carry out the activities set out in the business plan”. It remains to be seen whether this requirement would achieve any significant investor protection given than the milestones may not be significant or represent any minimum level of achievement by the issuer.
While the proposed investment limits provided in the crowdfunding exemption would serve to protect investors, it may make sense to exclude accredited investors from such limits. Investment limits should also not extend to anyone who would be able to purchase securities through another prospectus exemption.