By Don Collie. © DLA Piper (Canada) LLP. Reproduced with permission.
There is some confusion in the Canadian financial and legal marketplace about the exact state of the law regarding equity crowdfunding.
This confusion is understandable, given the fact that there have been a number of different recent developments, and that the current state of affairs is a mix of actual rules and proposed rules.
What has happened in Canada is partly a reflection of our somewhat balkanized securities law regime, where we have 13 provinces and territories, each with the ability to implement their own laws (even though we do have mechanisms for harmonization).
The purpose of this bulletin is to try to clear up some of that confusion.
Q: What is the general legal status of equity crowdfunding in Canada?
A: Currently in Canada, there is a law in place in certain provinces which permits “start-up” equity crowdfunding. Specifically, on May 14, 2015 the securities regulators in British Columbia, Saskatchewan, Manitoba, Quebec, New Brunswick and Nova Scotia (the “Current Crowdfunding Jurisdictions”) adopted registration and prospectus exemptions (the “Crowdfunding Rule”) that allow start-up and early stage companies to raise capital in those jurisdictions. The Crowdfunding Rule was detailed in CSA Notice 45-316.
With respect to more general, broad-based crowdfunding – i.e., a crowdfunding regime that would enable larger capital raises and apply to public companies – what we have at this point is a proposal (the “Crowdfunding Proposal”) by the securities regulators in Saskatchewan, Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia, in the form of Proposed Multilateral Instrument 45-108 Crowdfunding. The Crowdfunding Proposal was first published on March 20, 2014, and the Ontario Securities Commission recently published an update on the proposal in its Corporate Finance Branch Annual Report on July 14, 2015.
Q: What are the key elements of the existing crowdfunding rule?
A: The Crowdfunding Rule provides that, in order to carry out a crowd-funded offering of securities, the entity carrying out the offering:
- cannot be a “reporting issuer” (i.e., a public company) in any province or territory in Canada;
- cannot be an investment fund; and
- must have a head office located in one of the Current Crowdfunding Jurisdictions.
An offering carried out under the Crowdfunding Rule must proceed as follows:
- it must consist of common shares, preference shares, non-convertible debt securities or limited partnership units;
- the issuer must distribute its securities, and receive payment for its securities, through a qualified funding portal;
- the issuer must provide a disclosure/offering document in prescribed form, via the funding portal, that provides investors with basic information about the issuer, its management, the terms of the financing and intended use of proceeds;
- the issuer must provide investors with a contractual right of withdrawal via a 48-hour “cooling off period”; and
- an issuer cannot raise more than $1,500 from each individual investor or $250,000 in aggregate from any offering under the Crowdfunding Rule, and the issuer may only complete a maximum of two offerings per year under the Crowdfunding Rule.
Q: What are the main drawbacks of the existing crowdfunding rule?
A: The main drawbacks of the Crowdfunding Rule appear to be:
- the $1500 limit on each individual’s investment in an offering means that an issuer has to locate a fairly large number of investors in order to raise anything close to the maximum aggregate amount;
- the $250,000 limit on the aggregate amount raised per offering means that only fairly modest capital raises can occur under these exemptions (although it is possible to raise money via other exemptions);
- because of the $1500 individual investment limit, an issuer which manages to successfully complete such an offering will likely find itself with an unusually large number of small shareholders for a private company (it could conceivably be well over a hundred shareholders). This means that shareholder meetings and communication would be more expensive and administratively challenging than for a typical private company;
- only non-reporting issuers can use the Crowdfunding Rule, so it’s no solution for existing junior companies who have already gone public but need additional capital; and
- it is limited to the Current Crowdfunding Jurisdictions. The non-participation of Ontario and Alberta is particularly significant, given their prominent roles in Canada’s capital markets.
Q: What are the key elements of the crowdfunding proposal?
A: It is currently contemplated that the key elements of the Crowdfunding Proposal will include the following:
- a streamlined disclosure/offering document would have to be provided at the point of sale;
- an issuer would be permitted to raise up to $1,500,000 in any 12-month period;
- all investments must be made through a funding portal that is registered with securities regulators;
- while there would be fairly low investment limits for investors who do not qualify as “accredited investors” (i.e., the limits would be $2,500 in a single investment and $10,000 under the exemption in a calendar year), there would be higher investment limits for accredited investors (which includes individuals who meet certain wealth or income tests) and no investment limits for “permitted clients” (i.e., certain institutional investors);
- investors would have to sign a risk acknowledgement form; andissuers would have to make ongoing disclosure available to investors, including annual financial statements (which would have to be audited or reviewed, depending on whether the issuer has met certain capital-raising and expenditure thresholds), an annual notice regarding the use of the funds raised and notice of prescribed significant events.
Q: What are the main drawbacks of the crowdfunding proposal?
A: At this point, the main drawbacks of the proposal appear to be:
- the Canadian residency requirements (i.e., the issuer must be incorporated in Canada, its head office must be in Canada, and a majority of directors must be resident in Canada). These requirements mean that the Crowdfunding Proposal is not an option for some issuers with a significant foreign component, particularly in terms of senior management;
- while the overall investment limits are higher than under the Crowdfunding Rule ($1.5 million in a single offering versus $250,000), the Crowdfunding Proposal is still primarily aimed at start-ups and small to medium enterprises. In a lot of business circles, $1.5 million is a very modest capital raise;
- not all Canadian jurisdictions are proposing to participate, with Alberta and British Columbia being the two most prominent non-participants; and
- while the ongoing disclosure requirements would not impose any additional burden on existing reporting issuers, for non-reporting issuers this looks a bit like “reporting issuer lite.” Granted, this is less statutory reporting and disclosure than is required for a full-blown reporting issuer, but nevertheless it is significantly more than is required for an ordinary private company (particularly those private companies who meet the capital-raising and expenditure thresholds that will trigger the requirement for audited annual financial statements).
Q: What about jurisdictions that aren’t participating in the crowdfunding rule? What laws apply?
A: It is possible to do equity crowdfunding in those non-participating jurisdictions such as Ontario and Alberta, but there are two significant hurdles. The first is the registration requirement, and the second is the prospectus requirement.
The funding portal would either have to be registered in an appropriate registration category, or obtain a discretionary exemption from the registration requirement, neither of which is particularly easy or inexpensive to do.
The second hurdle is the prospectus requirement. Part of the point of equity crowdfunding is to be able to carry out securities offerings while avoiding the expense, complexity and regulatory burden of filing a prospectus and becoming a reporting issuer. So the obvious alternative is to carry out a crowd-funded offering under another, existing prospectus exemption, such as the accredited investor exemption. The problem with this alternative is that the essence of crowdfunding is to reach a broad, general audience of investors at relatively low cost, and the other available prospectus exemptions don’t really allow for that.
Q: What is the anticipated target date for the proposed crowdfunding rule?
A: According to the OSC, the final form of the Proposed Crowdfunding Rule should be out by the fall of 2015. We expect that a firm implementation date would be published at this time, and anticipate implementation in late 2015 to early 2016.
This article first appeared in the September 30 2015 edition of Lexology and is reprinted here with the kind permission of DLA Piper LLP