What’s a cooperative?

There are a lot of different models available to people to set up their businesses, but one of the most underused is the cooperative model. Frankly, I find it odd that so few startups consider using a co-op, given the shift towards people-centric companies, corporate social responsibility, social enterprise, crowdfunding, and the sharing economy. In many ways, co-ops are ideal for these types of ventures, since the primary aim of a cooperative is to benefit its members. It’s up to the members to decide what “benefit” means, so co-ops are often about more than just maximizing profits.

Perhaps unfamiliarity breeds avoidance. The co-operative corporation is an odd beast, and far less common than corporations, partnerships, and proprietorships. A lot of folks don’t even know the co-op exists as an option. Hell, a lot of business lawyers I know have never touched the things, and just gloss it over in the “other” category when talking about business structures. Its weirdness makes it difficult to understand. Co-ops are a mash-up of business and not-for-profit corporations, with partnership-esque decision-making, which are sort of public companies, and report to a separate branch of government than every other business in Ontario.

the-people-dont-know-their-true-power-tc-cartoon-sad-hill-newsIt’s high time we blew the dust off the ol’ girl, and maybe you won’t think co-ops are so weird and scary after all. You might even start to think that your business would do well as a co-op, in which case, we should talk.

There are a LOT of possible variations in co-ops, so I’ll stick to the basics in this article. The goal is to give you an idea of the broad strokes, and I’ll leave the details for later articles. I’m going to talk about:

  • What a co-op is
  • Advantages and disadvantages
  • Types of ownership
  • Types of co-op
  • The basics of financing a co-op, and
  • The basics of decision making

So what is a Co-op Anyway?

Co-operatives are democratically-run businesses governed by those who use their services – their members. Co-ops generally rely on member participation to make the wheels turn. Members pool their money, goods, or services, have a say in decision making, and share in the profits or losses of the co-op’s business. Members can be human people, corporations, and not-for-profits.

cooperative-movementAs we’ll see below, a co-op can be set up with shares, like a business corporation; or without, like a not-for-profit. Co-ops with shares can sell them to members and the general public to raise capital. Co-ops without shares may operate as not-for-profits, and apply for charitable status.

Decision making is one-member, one-vote, so each member has an equal say. Members can be broken down to stakeholder groups, where each group’s votes may be weighted differently, kind of like in a partnership.

Once they reach 35 shareholders or lenders, co-ops become somewhat like a public company, and have to distribute information about the business and its finances to potential investors. The annual financial statements of a co-op must be audited, to ensure that the co-ops accountants are preparing the statements by accounting norms. Ontario co-ops are regulated by the Financial Services Commission of Ontario, rather than the Companies Branch

Advantages

  • Egalitarian – while corporations can allow their stakeholders to participate in ownership through stock option plans and the like, such plans are often carefully controlled to prevent those stakeholders from controlling the company.
  • Democratic – each member has an equal say.
  • Cheaper to set up and run than stock option plans or large partnerships – though the rules governing co-ops can be a bit tedious, many of the rights and responsibilities are written in the law, rather than being custom creations
  • Shared resources – members can get access to more and better equipment or facilities, increased negotiating power when buying/selling, shared marketing costs, etc.
  • Networking and education – members have access to people who face similar challenges, and make contacts up and down the supply chain.
  • Limited liability – a co-op is a “person” in the eyes of the law, which takes on its own liability. Members and shareholders personal assets are protected, and they only stand to lose what they invested.
  • Flexibility – co-ops have a huge array of options on goals, structure, financing, decision-making, and services.
  • Double or triple bottom line – benefits to the members aren’t limited to a share of the profits.

Disadvantages

  • Startup costs – are typically higher than for simple incorporations or partnerships. It takes more legal and accounting work to get ’em off the ground.
  • Offering statements are required to raise money – which takes time and money to prepare, and there are ongoing disclosure requirements.
  • Annual financial statements must be audited – which adds an extra annual operating expense.
  • Decision making can be slow and difficult – especially when there are a lot of members, or stakeholder groups with different interests. Think of how much of a pain in the ass the membership meetings of a condominium can be…
  • Unfamiliarity – because there are relatively few co-ops, compared to other business forms, government and foreign entities may have a hard time wrapping their heads around how to deal with you.

Membership Shares, or Members?

You have two options when incorporating a co-op – ownership through shares, similar to a regular ol’ corporation – or control by members, similar to a not-for-profit corporation. Choosing between the two usually comes down to two things:

  • Whether the co-op’s purpose is to operate like a business and turn a profit, or to provide a service on a break-even or non-profit basis; and
  • How much capital is needed to get started and run the co-op. The greater the need for capital, the more likely it is you’ll lean towards shares.

Consult with your lawyer and accountant before choosing which way you’ll go.

Shares

Shares are just a bunch of rights in the co-op. Most of these rights centre on control (voting), profits (dividends), and ownership (right to a share of the net profit if the business is sold or wound up). Every co-op with share capital must issue at least one type of “membership shares”. Each membership shareholder gets one vote at members’ meetings to do things like electing the directors, setting the rules (bylaws) of the co-op, choosing an auditor, approving annual financial statements, and major business decisions like selling or dissolving the co-op. Different types or membership shares may have slightly different rights.

You also have the option of creating and selling different types of “preference shares” to raise money. Like a regular business corporation, you can get pretty creative with the rights that the preference shareholders have, like priority on dividends, to be bought out or redeemed, to be paid part of the proceeds of liquidation, to receive information, and to receive a portion of the net profits of the co-op each year as a patronage return.

Members

For co-ops without share capital, there are only members, who fill much the same role as membership shareholders, above. The biggest consequence of this type of co-op is that its only financing options are membership fees, loans from members to the co-op, and loans or other debt from outside sources.

Multi-Stakeholder Co-ops

In these bad boys, members are organized into stakeholder groups, depending on what they contribute to the co-op. Each stakeholder group has certain rights as a group, such as appointing directors to the board, or to receive a lower or higher share of the co-op’s profits.

Types

There are four basic types of co-op in Ontario

  • Worker-owned

    Exactly what it sounds like. Only workers can be members of the co-op, and at least 75% of employees of the co-op must be members. An example would be Toronto’s Co-op Cabs, where each taxi license holder is a member of the co-op, and gets a share of the net profits of the company rather than revenues from their specific cab.

  • Consumer

    Businesses, often in retail, which are owned by their customers for their mutual benefit. Resources are pooled to buy in bulk, then the savings are passed on to the members. The most common are credit unions, green energy, insurance, and grocery stores. I’ll lump housing co-ops in here too.

  • Producer

    Producers of a certain product, or a certain category of goods band together to share common expenses like warehousing, equipment, shipping, and marketing. Most people have seen farmers’ co-ops, which often have warehousing and large equipment, as well as buying farm supplies in bulk. Producer co-ops could work for any business from lumber, to crafts, to booze.

  • Multi-stakeholder

    Here, many different groups of interests recognize that they’re all in the same boat, and band together for common gain. These groups could include workers, producers, service providers, consumers, and supporters of a certain cause. Health care and social services are common areas for this form. There’s a big push towards sustainable food co-ops right now, bringing together farmers, land owners, seed banks, grocers, and restauranteurs.

Dolla Dolla Bills Y’all

A co-op model can allow a business to take a fundamentally different path than a regular corporation. The directors of corporations are voted in by shareholders to maximize the value of the shares. Co-ops exist for the benefit of their members, which can far broader than simple monetary gain. That’s not to say that a co-op can’t turn a profit. It’s just up to the members as to how far up the priority list profit falls. The rules on how money comes into and flows out of a co-op are different than regular corporations too.

Money In

Besides profits from the sale of goods, the most common fundraising method is membership fees – an annual fee that members must pay to stay members. In most cases, this isn’t a large sum. Co-ops can also charge fees for use to members or the public – like an hourly rate for use of equipment and facilities, or for sales leads they generate for their members.

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Debt Financing

As with any business, a co-op can borrow money, known as debt financing, from a variety of sources. Co-ops can, and often do, require their members to loan money to the co-op, which is common in agricultural co-ops where production is cyclical. They need the cash up front to float the year’s operations, and the loans are paid back when the harvest comes in. They can force members to re-invest profits earned from the previous year as member loans as well.

Co-ops can borrow from banks, government, and other private lenders, same as any other business. They can also apply for government grant funding.

Equity Financing

Co-ops with share capital can raise money by selling preference shares. The magic number is 35, meaning that if there will be 35 or more people who own securities (shares and debt) when the sale is done, the co-op has to file an “offering statement” with the Financial Services Commission. This is similar to, but less demanding than, what a corporation must do before “going public”. The goal of the offering statement is to ensure that the investors know what they’re investing in. The exact requirements vary depending on the co-op, but the result must be a full, true, and plain disclosure which answers any reasonable question an investor may have. There are a few exceptions which mean you don’t have to file one for small numbers of investors, and small amounts raised.

Money Out

Aside from paying operating costs, wages, tax, and debt, there are rules about how the profits of the co-op are paid out. What’s left after operating expenses are paid, but before tax, is called the “surplus”.

A co-op can set aside some or all of its surplus to create a “reserve fund” of retained earnings for its future expenses, and it can pay out the surplus through dividends and patronage returns.

Dividends

Dividends are paid out of a co-op’s after tax income. The member or shareholder is taxed on the dividend (not as regular income), meaning some tax credits are available to them.

The maximum dividend allowed on membership shares is the prime lending rate +2% per year. There’s no cap on dividends to preference shareholders, so the rate of dividend is what’s set out in the Articles of the co-op.

Dividends may be paid in more shares of the co-op as well, which allows the business to reinvest the profits, and increase the equity holdings of the shareholders.

Patronage Return

This posh sounding term is the profit share a member is entitled to based on how much business they’ve done with the co-op. This is the main way in which members receive their profits. Patronage returns are paid out of the pre-tax income of the co-op, and are taxed as income for the member.

Different rules apply to different types of co-op, but the way patronage returns are calculated is set out in the bylaws. Worker co-ops, for example, pay patronage returns based on hours worked, or total compensation paid each year. Producer co-ops may account for the relative profits earned from different products contributed to the co-op (a ton of strawberries may turn a higher profit margin than a ton of potatoes. No offence to potatoes.)

Non-members may also be paid a patronage return, so long as the return for non-members is the same or less than what’s paid to members.

Decision Making

As with a corporation, co-ops have three levels of decision-making – members, directors, and officers.

Members

Each member, or membership shareholder, has one vote at meetings of the members. Members have to attend a meeting in order to vote – they can’t send a proxy to vote in their place.

Most votes are decided by a simple majority of votes, after a resolution has been discussed. The key decision members are called upon to make is to elect the board of directors, or removing them if need be. They also approve audited financial statements, and vote on resolutions proposed by members.

Members have a say in other major decisions, which require a 2/3 majority to pass. These include changing the articles of the co-op, adopting new bylaws, and approving the sale or merger of the co-op.

5% of members can call a meeting, or propose member resolutions. 10% of members can force a directors’ meeting to pass a new bylaw or resolution.

Directors

Elected by the members, the directors have a fiduciary duty to run the co-op in the best interests of the members. All directors must be members of the co-op, and there must be at least three directors on the board. The board is responsible to set the strategic direction of the co-op, and appoint the officers to manage its day-to-day affairs. They vote on things like approving new members, budgets, major contracts, and expansion plans.

Officers

Appointed by the directors, officers oversee operations, and supervise the lower-levels of leadership. Officers are employees of the co-op, and except for the President and chair of the board, they don’t have to be members. The duties of the different offices are listed in the Cooperative Corporations Act. Most co-ops will delegate a certain amount of decision-making power to officers, such as the ability to sign contracts up to a certain amount, to hire and fire employees, and to do the co-op’s banking.

Conclusion

So, there you have it, co-ops in a nutshell. This is by no means a complete guide to co-ops in Ontario, but I hope it proves to be a useful starting point. If you’re looking at starting a business or non-profit, take a good, give co-ops due consideration.

There are a ton of good resources out there for information gathering, including a whole series of guides from the FSCO, and the Ontario Co-operative Association that can help you to get started.

As always, I’m happy to help you birth your cooperative business baby. Reach out.

 

Mike Hook
Intrepid Lawyer
mike@intrepidlaw.ca
@MikeHookLaw

Beware the Entrepreneurship Industry

This may be a controversial post. You’ve been warned. This post is from my point of view as an advisor to small business. I realize that I occupy a place in the “industry” landscape, and that like the bigger wheels in the machine, I too turn a profit from providing services to small business. As a lawyer, however, I have a duty of loyalty to my clients – called a fiduciary duty. It isn’t optional, it’s the law. This means a bunch of things – to be competent and diligent in my work, to act in my clients’ best interest, honesty, and to keep your information confidential. Most of the other people you’ll come in contact with in the business world don’t have such a duty – and therein lies the risk that we call “doing business.”

I’ll get to the point.

I’ve noticed a trend towards the industrialization of entrepreneurship these days, and the more I think about it, the less comfortable I am with it. When I say “industry”, I’m talking about making labour systematic. The same business model that created the assembly line to make business more “economically efficient” is now being applied to entrepreneurship. There’s big money to be made. Investors and big business have realized that in many cases it’s more economically efficient to buy innovation than to innovate.

But how do you groom small, innovative businesses into ones that will slip neatly into the world of big business, and global financial markets as they grow? The answer is to industrialize entrepreneurship. As this system gains momentum, there’s an explosion of organizations which provide ready-made solutions to most of your small business needs.

Most of these organizations exist to make money….

… off of you…

… and none of them owe you a duty of loyalty.

I’m not saying that these organizations are out to get you. There are plenty of amazing collaborators out there. All I’m saying is that a healthy dose of caution, and an unhealthy dose research before getting into bed with them is in order. Any time you give up equity (shares) in your company it’s like taking on a business partner. They invest time, money, and resources in making your company grow. With the money comes the expectation of profit. You, as the one with the business or idea, will want to be assured that your partners will pull their weight, and that you’ll have a way out if they don’t. In return, there are some pretty thick strings attached to the investment. They’re gamblers in a way. Gamblers with a much bigger stack than you, more experience in these kinds of deals, and an uncanny ability to lawyer plucky little startups into the ground if they feel wronged. Choosing the wrong horse to hitch your wagon to could cost you your business.

In this article, I’ll talk about two of the big growth sectors in the entrepreneurship industry – high risk investors, and growth programs. I’ll deal with high risk investors first – angel investors and venture capital. Then I’ll move on to the growth programs – incubators and accelerators.

High Risk Investors

The starting point to understanding high risk investors is to understand the basic business proposition from the investor’s point of view. Angel investors, and to a greater extent, venture capital, are betting on the success of your business. In return, they demand returns commensurate with that level of risk. Particularly for VC, they may invest in ten companies, and only get a return on one – meaning the one that hits, they’ve got to make all the money back that they invested in all ten, plus a healthy profit margin – otherwise they’ll be out of business. That means they’re going to do almost everything in their power to make sure that they get their money back. This includes attaching strict, investor-friendly terms to the financing. This also includes using their networks and contacts to spur growth. They’re putting a lot of eggs in your basket, and approach the deal accordingly.

Angels

An angel investor is a wealthy person or group of investors who are willing to pony up startup capital for businesses that they think will succeed. Some angels specialize in raw startups, while others are only interested in companies that have already reached a certain critical mass. While the term “angel” might make them seem benevolent, they’re planning on making money off of your work. Their investment buys a part of your company – between 10-50% typically – and often gives the investor a say in how the business is run. They think they can make money on your idea – and if you don’t do it for them, they may take the reins and do it themselves. Angels see the end-game too, where they can realize the return on their investment. Cashing in. This often means selling the business – either to a third party or by taking the company public. If your end game is different, you may have found the wrong angel. If selling isn’t their goal, they might intend to grow your company in a way that benefits their other business interests.

Angel investment is attractive because as soon as they’re on board, it’s in the angel’s interest to use their connections and experience to help the business. A good angel can open up supply or sales channels that were previously out of reach, guide you through tough negotiations, and provide mentorship to help you develop your business skills. On the other hand, an angel whose intentions aren’t so angelic could take control of the business, fire you, and force you to sell them your shares at a discount. If they have a bad reputation in the business community, you could be tainted with that as well. I’ve seen all of these things and more. Do your homework, and get advice before, during, and after negotiations with angel investors.

Venture Capital

Venture capital is a different beast altogether. VC is usually a fund where many professional investors, serial entrepreneurs, large companies with innovation budgets pool their money together. The fund is managed by specialists who look for high-growth, high-potential businesses to invest in. Usually they’re looking for an “adolescent” business, rather than a raw startup, will invest for several years, and expect a return of around 10 times what they invested over that time. VC will usually get paid out first – often within 1-2 years – and take a percentage of ownership of the company. Venture capital is usually a one-way ticket to an initial public offering, and your investors will do what they must to ensure they get a return. They’ll appoint board members to shepherd their investment, and often have a good deal of say in hiring for key positions. They may replace you as the CEO if they have someone who’ll do better. The investment will usually be a high-interest loan, and secured with shares in the company which will pay the VC back first if the company goes belly-up. The exit plan almost always involves taking the company public. VC is more complex than that – but the important take-away here is that it’s very, very pricey money.

VC is attractive because, if it works, you get rich when the company is sold or taken public. VCs will lend based on their valuation of the idea, rather than their ability to secure their investment on the assets of the company, like a bank would. The downside is, once the VC comes on board, the business ceases to be your baby. Your interests aren’t aligned – the VC is looking out for their investment, not for the best interests of you, the company, or the employees. Most venture capital funds focus on building up the pool of money they manage, rather than mentoring and guiding the business – they’ll often appoint outside board members to represent their interests. The strings attached are large, and tied tightly.

Dealing with High Risk Investors

High risk investors can take your business to the next level in a hurry, and are sometimes the only viable option to fund your research and development. This is especially true for businesses built on ideas, rather than physical assets. Be very, very careful about who you’re dealing with, and understand the deal that you’re making before you sign on the dotted line. Do your research. Get legal and accounting advice. Shop around, and keep these in mind when you’re exploring your options:

  • First, foremost, and always remember – if they’re willing to fund you, then you have something they want. You have leverage in negotiations, and should only take a deal that works for your company.
  • What’s the business/industry background of the people you’re dealing with? What other companies have they worked with, and what results did they get? Talk to those companies, and get a no-bullshit assessment.
  • Who will be appointed to your board? How many other boards do they serve on?
  • Who are their advisors – accounting, legal, etc – and do they come as a package deal? Are they encouraging you to get independent advice before signing?
  • What’s their exit plan? Does it mesh with your vision for the business?

If the investor can’t give you a good answer to those questions, or stands in the way of you finding the answers on your own, run away as fast as you can.

Predatory investors can be hard to spot… until it’s too late. I’ve got a bunch of horror stories from people in my network who jumped at what looked like a good deal… and when they landed, the investor owned the company, and the founder ended up with only a fraction of the value they’d built. They’re smart people who make their living by getting other people to do the grunt work for them… and unscrupulous investors know how to cover their bases. Be cautious, and put in the time and effort to understand them, their goals, and what they expect of you before committing.

Growth Programs

Incubators & Accelerators

These two get lumped together because they fulfill roughly the same role at different stages of a company’s growth. They are, at their core, great business models, and can do a whole lot to nurture the development of your company, and your business skills as a founder. The basic premise is that they’re in the business of investing in startups. An established business person, or group of ‘em, will bring in a company, or group of ‘em, and invest in the company in hopes that it will grow. Most will invest a combination of money, marketing, office space, production and design support, mentorship, and access to their personal networks. They’ll set a pretty rigorous training schedule in business skills, which members are required to go through. In return, they take a piece of your company.

Incubators are typically a long-term involvement, around 2-3 years’ worth, with no set schedule for growth. Most will bring in companies of a similar type into a common working space in hopes that ideas will flourish. Often, incubators will put their own management teams in place – directors and officers – once the grunt work to bring the idea to fruition is complete. Incubators typically take up to 20% of your company for the role they play in incubating your idea.

Accelerators are usually a set business development program to spur rapid growth – hence the name. The program takes place over 3-6 months, and is aimed at companies that have reached a certain stage of development. That program typically involves a couple of “funding rounds” from VC, and may also involve tacking directors and officers of their choosing on to your management team, or full-on replacing the founders in those roles. Accelerators usually take less than 10% of your company for their services.

Who Sails the Ship?

The most value in a growth program is the network that comes along with it. When done right, incubators and accelerators can provide value that’s almost unparalleled. You can get specialized advice and training that will help you to understand and speak the language of business, interpret financial statements, and refine your pitch. Most valuable is the access you get to their well-established business network of advisors, mentors, financiers, and other graduates of their program. That cuts both ways, however. When you climb aboard that train, you’re committing to doing business the way they teach you to do business. While some incubators and accelerators have altruistic intentions, many more are an elaborately constructed way to make money off of your efforts, or to cherry-pick talented business people for their own organizations. It’s a business farm, and you’re the cash crop.

For example, law and accounting firms view successful incubators and accelerators as a way to get new clients. I’m one of them, as an advisor at Ryerson’s DMZ, and a mentor at HumberLaunch. I’ve met several clients that way. Strangely, in the cash strapped world of startups, my competition is largely huge national law firms. These firms will offer cut-rate startup packages, as a loss-leader.  They take a hit on their fees in the short term, in hopes that you’ll grow enough by the time the discount period runs out that you’ll have enough in the bank to pay their rates. That business development strategy means that they’re looking to minimize their short term losses incurred by giving away their services. This can mean standard-form business agreements that aren’t customized to your situation and business. The work is pushed to junior lawyers, law students, and clerks to “cut their teeth” on. A free client’s phone calls are returned after the paying clients’ work is done. That said, big firms have specialized skills, particularly to grow startups into publicly-traded companies, that sole practitioners like me just don’t have. Do your homework.

Dealing with Growth Programs

Moral of the story is, as it was for investors, to know who you’re getting into bed with before signing on the dotted line. Any time you give up equity in your company, you’re taking on a business partner. Like any other partner, you want to make sure that they’ll pull their weight, and know what’s involved in getting yourself out of the deal if need be. The excitement of winning a business plan or pitch competition, or beating out hundreds of other applicants for one of a few positions shouldn’t stop you from doing your due diligence. Here’s some questions to know the answers to before you commit:

  • Who owns the incubator or accelerator?
  • How much of your company do they take, and what conditions are attached?
  • Who are their lawyers, accountants, marketers, and preferred investors? Are you free to choose your own, or do you run with theirs? What’s their interest and relationship?
  • What expectations are there of you?
  • What’s the exit plan? Are they building your company to sell, or take public?
  • Do they have your interests at heart, or do their loyalties lie with the person they have a pre-existing relationship with? What’s the advisor’s interest?
  • Who else have they launched? Did they deliver what was promised? Did their goals shift under the influence of the advisor network? Talk to their “graduates” and grill them on their experience.

Conclusion

Angel investors, venture capital, incubators and accelerators are all tools that are available to help you build your business. As with building anything, it’s important to use the right tool for the job. The right deal is a solid foundation from which to launch your company – you’ll get the mentorship, support, and training to bring your idea to market, build lasting business relationships, and make a bunch of money in the progress. The wrong deal can cram your square peg of a business into the round hole of their interests, and drag you down the long, unpleasant road to failure.

Be strategic. Think about what the end-state will be, when all is said and done. If you’re 100% owner now, and an incubator takes 20%, accelerator takes 10%, and venture capital takes 30%, what does that leave you with? Remember, you’ll be the last to get paid. What if the on-paper value can’t be pulled out for a certain number of years? Is 40% of a $10 million company more valuable to you than 80% of a smaller one? Is your product a flash-in-the-pan, or is it something that will still be relevant when you can cash out? Are you comfortable working with, and being beholden to the people you’re doing business with for that amount of time?

There’s no such thing as certainty in business. That’s what makes it simultaneously frustrating and fun. Do your research, and I strongly strongly strongly recommend getting experience, professional help to review, understand, and negotiate the deal before you sign over part of your company. At the very least, legal, accounting, and ideally an impartial business advisor/investment banker with experience in the types of deals you’re looking at.

After all, “All things will be clear and distinct to the man who does not hurry; haste is blind and improvident.”
– Livy, Ad Urbe Condita Libri, 9 BC

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

Outlook for Canadian Small Business

The Bank of Canada released the results its 2014 “Small Business Outlook” survey on Monday. I’ve plowed through that report and some other market research on the small business climate in Ontario, and found a couple common themes that may affect your business:

Export market strong, domestic market weak

A weaker Canadian dollar ups the profit margin for exports. This is a big help for manufacturing businesses in particular. Manufacturing, agricultural, and construction businesses are having trouble meeting production demands as it is. Savvy manufacturers are eyeing the increased profits as an opportunity to buy more machinery and equipment to increase production. It’s a particularly well-timed strategy, as most major banks and investors have eased their lending criteria. Overall, this means there’s more cheap money available to finance expansion.

The weaker dollar can hurt businesses that rely on domestic sales to drive them. This is amplified for companies that import a lot of goods – it costs more and more to buy the same ingredients or components. Hospitality and professional services businesses are often the canary in the coalmine for economic slowdowns – with less cash flow, businesses spend less on services. Small business owners are feeling the crunch, and worry that any more price increases will hurt their business. Many are considering absorbing the loss, rather than passing the added expense on to consumers. This is particularly so in Ontario, where a crowded marketplace is putting more pressure on businesses to keep prices down.

Business is good enough to hire

A majority of businesses are hoping to hire new employees in the coming year – many on a full-time basis. While most small businesses report no shortage of workers, many are finding it tough to find suitable new hires, particularly in niche businesses. This may be due in part to the continuing trend of baby boomers retiring, and not enough young workers to replace them. Therefore, employers are competing for talent. A more competitive hiring market can drive up wage and benefits demands – leaving many small businesses unable to compete. Good for talented young workers, not so good for business owners.

On the up-side, small businesses have a great deal more flexibility in tailoring employment to suit the employee – flexible working hours, work from home, opportunity for growth, employee stock options, etc. Well worth it, if you land the right employee!

Here’s the link to the full Bank of Canada report.

Hopefully this article gives you a little perspective on the environment you’re running your business in!

Mike Hook
Intrepid Lawyer
http://intrepidlaw.ca
@MikeHookLaw

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.