Crowdfunding in Canada: Is Your Startup Ready?

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By JOHN WIRES | PIVOT Magazine Contributor 

Riding the Crowdfunding Wave

The equity crowdfunding wave keeps getting bigger. Regulators all over the world have scrambled to put together their own equity crowdfunding frameworks after President Obama signed the JOBS Act on April 5, 2012.

A month after the Act was signed, I advocated for Canadian regulators to take a serious look at permitting equity crowdfunding here at home. At the time, the crowdfunding landscape in Canada was bleak. Few Canadian politicians had crowdfunding on their radar. There was no sign the various securities commissions across Canada were interested in re-writing how companies were permitted to raise capital from the public.

In an article Startup Canada had published in the Toronto Star, I made the age-old “brain drain” argument we Canadians love to make. That is, I feared Canadian companies unable to raise money from friends and family at home would surely head south of the border where they could turn to the online “crowd”. Or worse, Canadians would start investing in US startups, shunning economic development here at home. In my own legal practice I had a number of Canadian companies inquire about incorporating south of the border to take advantage of the new laws.

However, fast-forward two years and despite the JOBS Act being signed into law, regulators in the United States are yet to put equity crowdfunding into effect. As the debate around equity crowdfunding lingered, the power of rewards based crowdfunding sites like Kickstarter seemed to be amplified. As just one of the many rewards-based portals, Kickstarter has now raised over $1.1 billion (yes, billion) for 62,334 startups or creators from over 6 million backersall over the world.

There should be no doubt that crowdfunding has enormous economic potential. I get to see the results firsthand, having had the opportunity to work with Canadian companies who have raised large sums of money from Kickstarter.

Ontario’s Equity Crowdfunding Proposal to go Live

While US regulators pressed pause, the Ontario Securities Commission (“OSC”) played catch-up on equity crowdfunding. The OSC took the lead here at home and published a high-level equity crowdfunding proposal on March 20, 2014, which is expected to go live as early as the first quarter of 2015.

If the current proposal was implemented, Canadian companies in a participating jurisdiction, will be able to raise up to $1.5 million every 12 months from investors online. However, investors will be capped at contributing a maximum $2,500 per startup.

Preparing for Equity Crowdfunding

If you do the math, the proposal could lead to small companies taking on as many as 600 investors every 12 months. The large number of investors has led the OSC to place resale restrictions on shares purchased from crowdfunding companies, meaning there will be no secondary market for selling the shares of a crowdfunding company. That means having an exit strategy for your investors will be critical for successful offerings; whether going public, being acquired or having the company buy the investor’s shares back for cancellation.

The large number of investors also makes having a well thought-out company structure in your articles of incorporation essential. In anticipation, some companies have even begun setting aside a specific class of shares (let’s call them class “C shares”) in their articles of incorporation for the crowd.

However, the key component to list your company on an equity crowdfunding portal will be what the OSC is calling a “crowdfunding offering document”. The offering document provides your investors with a summary of your offering, a detailed business plan, financial information about your company, key employees and their compensation, the use of the investment proceeds and key risks the business will face. Nailing the offering document will be essential to not only persuade the crowd, but to reduce exposure to law suits for misrepresentations about your company.

A Unique Canadian Framework

One aspect of the OSC’s proposal, which deviates from other models, is the ability to merge rewards based crowdfunding campaigns with equity crowdfunding. That is, the OSC’s proposal permits startups to offer both rewards (for example, the actual product being developed by the crowdfunding company) and equity at the same time. So investors will be able to pre-purchase the product or service the company is trying to manufacture (just as they do on Kickstarter) and take an ownership stake.

While purchasing shares in a crowdfunding company will be very high risk for investors (with risks including both fraud and mismanagement), there is no doubt crowdfunding represents a real opportunity to properly finance a new era of startups and growth companies.

Equity crowdfunding helps solve a serious access to capital problem so many Canadian startups face. No longer will angle investors and venture capital firms with well polished shoes be the gatekeepers to accessing capital. In the future, early stage capital will be all about convincing the crowd of the utility of your product or service and your ability, as an entrepreneur, to execute a business plan.

John Wires is a lawyer and the founder of Wires Law, a firm geared towards entrepreneurs, small and medium sized businesses. John currently acts as a contributor to Pivot Magazine and is an advisor to the National Crowdfunding Association of Canada. He has been covered in the Globe and Mail, Toronto Star, CBC News, TechVibes and the Canadian Bar Association’s National Magazine on Crowdfunding in Canada. He has also been a guest lecturer at Ryerson University and Communitech on crowdfunding and corporate finance.