On January 25, 2016, five provinces implemented rules aimed at facilitating small investments made through online portals, a practice known as “equity crowdfunding”. As we discussed in a previous Insight, securities regulators anticipate that the regime will be of greatest use to small and medium-sized businesses, including both reporting and non-reporting issuers.
The five provinces that are implementing the new rules are Manitoba, Ontario, Québec, New Brunswick and Nova Scotia, and are referred to herein as the “participating provinces”. The rules can be found in Multilateral Instrument 45-108 Crowdfunding (MI 45-108).
In connection with these changes, the provinces that have adopted the Start-Up Crowdfunding Exemption described below have made minor amendments to that exemption, so as to conform to MI 45-108.
Background to the new crowdfunding rules
Any offering of securities must either be qualified by a prospectus or be exempt from the prospectus requirement. In addition, if the offering involves an intermediary—such as a broker or a dealer—that intermediary must either be registered in such capacity or be exempt from the requirement to register.
MI 45-108 introduces a prospectus exemption for equity crowdfunding in the participating provinces, subject to a number of conditions. There is no associated registration exemption, which means that any funding portal involved in an offering under the exemption must be registered. The MI 45-108 prospectus exemption will be available to both reporting and non-reporting issuers or, in non-technical parlance, to both public and private businesses.
The MI 45-108 prospectus exemption should be considered in light of an exemption (the Start-Up Crowdfunding Exemption) implemented by six provinces in May 2015 (as described in another previous Insight), and amended January 25, 2016 (as discussed below). Those provinces—being British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia—adopted exemptions from the prospectus and registration requirements for equity crowdfunding transactions to supplement other prospectus exemptions used by online platforms in Canada, such as the accredited investor exemption. In contrast to the new crowdfunding prospectus exemption under MI 45-108, the Start-Up Crowdfunding Exemption is available only to non-reporting issuers. The interplay between the MI 45-108 prospectus exemption and the Start-Up Crowdfunding Exemption is discussed further below.
Amendments to the Start-Up Crowdfunding Exemption
Funding portals should note minor concurrent changes to the Start-Up Crowdfunding Exemption. These changes, which are set out here, slightly revise the wording of the acknowledgment that investors must make before entering a portal that is using the exemption. The changes also: (i) clarify the applicable filings that a portal may make with the securities regulators; and (ii) note that in certain cases a portal will not provide investors with suitability advice in respect of their investments. The latter two changes will impact the wording of the engagement agreement between an issuer and a portal.
Details of the MI 45-108 prospectus exemption
The principal conditions of the MI 45-108 prospectus exemption are summarized below.
The limits on investment under the MI 45-108 prospectus exemption focus on both investors and issuers. Investors will be limited to $2,500 per investment and, in Ontario, $10,000 per calendar year (all figures CA$), unless they satisfy certain asset and income tests. Those that meet such tests and are therefore considered “accredited investors” may invest up to $25,000 per investment and, in Ontario, $50,000 per calendar year. In Ontario, investors who meet even higher thresholds—qualifying them as “permitted clients”—are not subject to an investment limit.
An issuer, together with any other person in the “issuer group,” can raise a maximum of $1.5 million per 12-month period. “Issuer group” includes affiliates of the issuer.
Issuers using the MI 45-108 prospectus exemption must provide investors with an offering document containing prescribed information about the issuer and the offering including, among other things:
a. Financial statements, which must be audited if the issuer has completed a financial year; and
b. A statement that investors will be able to rescind their investment or sue for damages in the event of a misstatement in the offering document or other materials associated with the investment.
Investors will be required to sign a form acknowledging that the investment is risky.
Advertising and solicitation
An issuer using the MI 45-108 prospectus exemption must not advertise a distribution of securities, though it may inform prospective purchasers of its intention to distribute securities and refer the person to the applicable funding portal.
After completing a distribution under the MI 45-108 prospectus exemption, issuers will have to continue to provide investors with certain information about the business. Reporting issuers must observe their existing disclosure obligations. Non-reporting issuers will have to make annual financial statements “reasonably available” to investors within 120 days of the issuer’s year-end, together with a description of the use of proceeds. In Ontario, New Brunswick and Nova Scotia, a non-reporting issuer will also have to notify investors of certain issuer events, namely a discontinuation of its business, a change of its industry or a change of control.
Requirements for funding portals
A distribution under the MI 45-108 prospectus exemption must be made through a single funding portal, which must be registered as a dealer. The offering document and any other permitted materials must be posted only on that portal’s online platform.
Funding portals are subject to a number of requirements, including those applicable to other registered dealers. Other rules include a prohibition on advertising or general solicitation of investors; a requirement to conduct certain background checks on the issuer and its key individuals; and an obligation to terminate a distribution if it appears that the business of the issuer is not being “conducted with integrity”.
The MI 45-108 prospectus exemption is available only to issuers incorporated or organized in Canada, and having their head office and a majority of directors located in Canada. In addition, if the issuer has a principal operating subsidiary it must be incorporated or organized in Canada or the United States. The exemption is not available to investment funds, it cannot be used to offer complex securities, and proceeds of a distribution may not be expended to invest in, merge with or acquire an unspecified business. Issuers must maintain certain records for a period of eight years following the distribution.
Impact of the MI 45-108 prospectus exemption
The conditions to the MI 45-108 prospectus exemption, summarized above, are fairly onerous, particularly in light of the applicable investment limits. In order to gauge the frequency with which it may be used, two other recent developments in securities law should be borne in mind.
The first is that, as noted above, the MI 45-108 prospectus exemption complements the Start-Up Crowdfunding Exemption available in certain provinces. As such, non-reporting issuers may conduct a distribution under both exemptions in Manitoba, Québec, New Brunswick and Nova Scotia; a concurrent distribution in Saskatchewan and British Columbia under the Start-Up Crowdfunding Exemption; and another concurrent distribution in Ontario under the MI 45-108 prospectus exemption, assuming all conditions are satisfied. The investment limits under the Start-Up Crowdfunding Exemption are also low, at $1,500 per investor and $250,000 in aggregate, but the addition of those amounts may increase the viability of a distribution under the MI 45-108 prospectus exemption.
The other development relates to the offering memorandum prospectus exemption, which has recently been adopted in Ontario and amended in several other provinces, and which we described in a recent posting. The obligations of an issuer under that exemption are roughly similar to the obligations under the MI 45-108 prospectus exemption, while the investment limits are considerably higher. In addition, the offering memorandum exemption will apply across Canada, if with some variation. Those facts may persuade issuers interested in raising funds from the “crowd” to conduct offerings by way of the offering memorandum exemption, rather than the exemptions that are specifically designed for equity crowdfunding.