Selling Shares through Crowdfunding

One of the most important recent developments in financing for small businesses has been the rise of crowdfunding. Crowdfunding is when a bunch of people make small investments in a company through a crowdfunding portal (such as Kickstarter or Indiegogo), in exchange for some sort of reward, like an amount of the product the company makes. The pooled money is used to grow the business. Unfortunately, selling shares – aka “equity” or stock – through crowdfunding has been, and still is mostly illegal in Ontario.

Most small companies are “private issuers”, and “non-reporting companies” – which means that they can’t sell shares to the general public – including crowdfunding. To sell equity to the general public, the corporation has to jump through a whole bunch of regulatory hoops, and make detailed disclosure documents available to investors. Disclosure typically includes an offering memorandum or prospectus, and audited financial statements – which are time consuming and expensive to prepare. There are strict rules about the type and size of offering, what kinds of disclosure must be prepared for prospective shareholders, and who can participate in the offering. All of that, however, is about to change.

The Ontario Securities Commission (“OSC”), the watchdog that regulates the public trade of shares of companies, has just released its proposed rules for a “Crowdfunding Exemption”. They hope to allow small companies to raise capital through crowdfunding without saddling small businesses with expensive disclosure and reporting requirements. The tough part is how to protect investors, and make sure they get enough information to make an informed decision on whether or not to invest.

The Crowdfunding Exemption tries to strike this balance by requiring some limited disclosure from the issuing companies issuing the shares, placing strict regulations on crowdfunding portals, and limiting how much individual investors can contribute. A few of the highlights:

Requirements of Issuing Companies

  • May only raise $1.5 million through crowdsourcing in a calendar year
  • Must be a Canadian company, with its head office in Canada, and a majority of its directors must be resident Canadians
  • May be a public or private company
  • Must disclose the minimum offering amount, and whether or not there is a maximum
  • Offerings must be completed within 90 days
  • Must meet the minimum offering amount, and have the resources to execute its business plan in order to be successful
  • Equity may only be issued in the form of common shares, non-convertible preferred shares, non-convertible debt securities linked only to fixed or floating interest rates, securities convertible into common shares, units of a limited partnership, and flow-through shares under the Income Tax Act
  • May only advertise through a crowdfunding portal, its own website and social media , or with limited marketing materials.

Investor Protection

  • Maximum of $2,500 per investment, and $10,000 per calendar year, per investor
  • At the time of investment, the company must provide an outline of basic information about the company, the fundraising platform, and one year of financial statements
  • Investors must sign an acknowledgement of risk, confirming investment eligibility, and consenting to the possibility that they may lose the entire investment
  • Investors have a two day “cooling off period” to cancel the investment, in case of buyer’s remorse
  • Issuing company must continuously disclose its cash and annual financial statements, and maintain accurate records of the use of crowdfunded money
  • Four month ban on re-selling the shares of a public company, and an indefinite freeze on resale of shares of non-reporting issuers

Crowdfunding Portals

  • Must be registered with the OSC as a restricted dealer, similar to registering as a securities dealer
  • Must do background checks on issuing companies, and their directors, officers, promoters, and control persons
  • Must understand the general structure, features, and risks of securities offered, review and vet information to ensure compliance with the OSC rules, prevent fraud, and provide investor education materials
  • Can’t provide any investment recommendations or endorsements, solicit purchases or sales of securities on behalf of a client of their platform, or invest in or underwrite any issuing company

The OSC proposed rules are open for comment from investors, issuers, and portals until June 18, 2014. It’s expected that the comments will be considered, the rules tweaked, and the Crowdfunding Exemption will come into force shortly afterwards. The most vocal feedback so far has been that the limits on individual investors are too low, and the startup costs for portals to register are too high, and will make it more expensive for their clients. Regardless of the tweaks, equity crowdfunding will be a revolution in small business financing that will make big money available to companies that never would’ve been able to afford to access it before.

If you’re having trouble sleeping at night, you can find a full version of the OSC’s proposed changes as part of the jauntily titled “Introduction of Proposed Prospectus Exemptions and Proposed Reports of Exempt Distribution in Ontario” – at Appendix D – Pages 131-224. It’ll put you right out, I promise.

 

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