In an effort to encourage crowdfunding, the Canadian Securities Administrators (“CSA”) of the country’s provinces and territories, with the exception of Ontario and British Columbia, issued a harmonized interim local order on December 20, 2012 that provides exemptions from certain requirements set forth in Form 45-106 F2 - Offering Memorandum for Non-Qualifying Issuers (“Form 45-106 F2”) of Regulation 45-106 respecting Prospectus and Registration Exemptions (“Regulation 45-106”). These more flexible rules seem to reflect the United States’ Jumpstart Our Business Startups Act (“JOBS Act”), a law that was adopted to stimulate funding and job creation south of the border. Will the CSA’s harmonized interim local order help Canada achieve this goal?
What is Crowdfunding?
With crowdfunding, small amounts are collected from many individuals on the Internet through, for instance, social networks. The money can be used to finance an artist, philanthropic project, political party, scientific research, start-up business or SME. Currently, securities regulations limit contributions to donations and product pre-orders. The harmonized interim local order targets not these types of contributions, but investments that are used to acquire an interest in enterprises.
New Exemption Regime and Canada’s Situation
In Canada, an enterprise that wants to issue securities must provide subscribers with a prospectus that contains full, true and plain disclosure of all material facts relating to the securities in question. Regulation 45-106 sets forth some exemptions from this requirement. For example, an issuer may be exempted from the prospectus requirement if it submits an offering memorandum that complies with the requirements of Form 45 106 F2. This memorandum must describe the company and give details, among other things, of its activities, products or services, capital structure, securities offered and risk factors that might affect the investment. In addition to this memorandum, the exemption also requires the filing of audited financial statements prepared using the Canadian generally accepted accounting principles (“GAAP”) that apply to enterprises which, under the International Financial Reporting Standards, are publicly accountable.
The harmonized interim local order, which will remain in force until December 14, 2014, will make the offering memorandum exemption available to a wider number of enterprises. The CSA, well aware of the costs of using this exemption, has decided to exempt from certain requirements those enterprises (i) that raise amounts under the harmonized interim local order exemption never exceeding $500,000 and (ii) whose investments do not exceed $2,000 per investor per 12 month period. In some cases, and provided certain other conditions are met, the issuer will be exempted from:
- the audit of its financial statements or other financial information; and
- the requirement for financial statements to be prepared using the Canadian GAAP applicable to publicly accountable enterprises.
The Ontario Securities Commission published a notice of consultation on December 14, 2012 dealing, among other things, with crowdfunding. Then, on February 12, 2013, the British Columbia Securities Commission published a notice of consultation on crowdfunding. For more information on this subject, please consult our bulletin: Multilateral CSA Notice 45-311 - Exemptions from Certain Financial Statement-Related Requirements.
Under Regulation 31-103 respecting Registration Requirements, Exemptions and Ongoing Registrant Obligations, to operate a funding portal one must register as a dealer. To date, there is no exemption from the requirement to register as a dealer or an advisor in the context of funding portals. This is not simply an administrative requirement, considering that market intermediaries must have the training and experience needed to register. Market intermediaries must also abide by brokerage rules, namely they must know their client, their client’s investor profile and risk tolerance, and know the financial products offered. Market intermediaries must make their recommendations with the investor’s investment objectives and risk tolerance levels in mind, better known in the common law provinces as the “suitability rule”. This might have the effect of dissuading anyone from creating a crowdfunding portal.
Situation in the United States
In the United States, the JOBS Act was adopted on April 5, 2012. This means enterprises there may soon be able to solicit investors without having to register with the Securities and Exchange Commission (“SEC”) (until they have 2,000 shareholders), although they will be required to do so through an intermediary (a portal) that must be registered with the SEC. Companies will not be allowed to use this type of funding to raise more than US$1 million (less any other amount raised under other exemptions) per year, and investors will be limited as to the amounts they may invest:
- investors whose annual income or net asset value is less than US$100,000 may invest either US$2,000 or 5% of their annual income or net asset value;
- investors whose annual income or net asset value is equal to or greater than US$100,000 may invest more than US$100,000 or 10% of their annual income or net asset value.
These rules are not yet in force. The new regulation providing the framework for crowdfunding has still not been developed by the SEC, which has failed to meet several of the deadlines that were initially set.
Advantages and Inconveniences
With crowdfunding, an unconventional idea or project can find funding, be marketed and, incidentally, garner a certain amount of publicity. However, the entrepreneur will have to have an efficient communications plan in order to answer the questions and allay the fears of investors and the public. What is more, intellectual property protection could suffer, since a good idea risks being copied and developed quickly by competitors with deeper pockets. While crowdfunding may be interesting to start-up companies and SMEs, there is a risk that it will attract a large number of more or less sophisticated investors with a small interest in the enterprise, which could limit future funding options. Potentially, it could be more difficult for this type of enterprise to attract a business angel or investors in a later phase of its development. There are also concerns over the risk of fraud and abuse. Lastly, investors must understand that these types of investments are not liquid, and that they will probably have wait for the enterprise to be sold or go public before they can sell their shares.