Crowdfunding is coming to Canada - What you must know...

Crowdfunding can be defined as the collection of funds from a large pool of disparate persons through an Internet portal. This method of raising funds has been used for such various endeavours as political campaigns (e.g. to support a candidate or political party), philanthropic campaigns (e.g. to assist persons in need), artistic campaigns (e.g. to finance a tour by an emerging artist), or commercial campaigns (e.g. to create and sell a new product). However, in some foreign jurisdictions, crowdfunding is emerging as a way for businesses, particularly start-ups and SMEs, to raise capital through the issuance of securities.

In Canada, securities regulators have been considering formally recognizing – and regulating - crowdfunding since at least 2012 but until now only the province of Saskatchewan has done so. On March 21, 2014 the Ontario Securities Commission (the “OSC”), leading the charge on behalf of some of the country’s other securities authorities, released for comment a proposed regulatory framework for crowdfunding.

Qualification criteria

The crowdfunding exemption will only be available to Canadian issuers, meaning those that, along with their parent company and principal operating subsidiary (if applicable), are incorporated or organized in Canada, have located their head office in Canada and whose board has a majority of Canadian resident directors. It is available to practically all types of issuers, both public and private, as long as the issuer has a written business plan.

The exemption applies to a wide variety of securities, including common shares, non-convertible preference shares, securities convertible into common shares or non-convertible preference shares, non-convertible debt securities linked to a fixed or floating interest rate, and units of a limited partnership.

Parameters of offering

Issuers cannot raise more than $1.5 million under the crowdfunding prospectus exemption in any 12-month period.  Furthermore, each investor is limited to investing no more than $2,500 in any given offering, to a maximum of $10,000 per issuer in any calendar year.

Any given round of financing under this exemption cannot remain open for more than 90 days.  A round cannot close unless the minimum offering is subscribed for and the issuer has enough financial resources to carry out the activities set out in its business plan.

Investor protection

Investors must sign a prescribed form acknowledging the risks of their investment. Issuers must provide investors with a comprehensive offering document, in accordance with a prescribed template. Investors are also entitled to receive financial statements, which in certain cases are required to be audited. Unlike a prospectus however, the document is not vetted by the securities regulators, although it still must be provided to them.

In addition to the usual investor rights in the event of a misrepresentation by an issuer, investors are provided with a “cooling-off” right that gives them the ability to withdraw from their purchase up to 48 hours before the end of the offering period.

Finally, issuers not subject to public reporting requirements must annually provide investors with financial statements, notice of how the proceeds of a crowdfunded offering have been spent and disclosure of certain major corporate events such as significant acquisitions or dispositions of assets.  The reporting requirements continue to apply until such time as the issuer becomes a reporting issuer, ceases to carry on business or has less than 51 security holders having acquired their securities under the crowdfunding exemption worldwide. Failure to abide by these requirements would remove the issuer’s ability to rely on the crowdfunding exemption in the future.

Portal registration

Crowdfunding requires an Internet portal on which the offering document, any document described in the offering document, and a term sheet or other summary of the information (including by way of a video) contained in that document is posted. The individual or company making the portal available to the public must be registered as a restricted dealer and comply with many of the requirements applicable to exempt market dealers regarding minimum net capital, insurance, record-keeping, etc. Portals are required to do certain due diligence checks in respect of the issuer, its directors, officers and other related persons and its offering document. Portals are not permitted to endorse or comment on the merits of any investment, nor are they permitted to actively solicit purchasers. Further, portals may not take more than a 10% equity position in an issuer.

What’s next?

The crowdfunding rules are now open for comment for a 90-day period. The OSC has invited written comments on many aspects of the crowdfunding rules. Therefore stay tuned.