INVEST CROWDFUND CANADA

Transcription

1 INVEST CROWDFUND CANADA A Technical Legal Perspective by Andrea Johnson, Partner FMC

2 What is crowdfunding? Crowdfunding is the innovative use of technology and social media to raise small amounts of money from large numbers of investors, usually online. It has already been effectively deployed in the not-for-profit sector and through donation and reward portal sites such as Kickstarter. These portal sites list multiple offerings from various organizations and individuals. Is Crowdfunding Illegal in Canada? Crowdfunding to finance a business through the issuance of securities, as envisioned by the recent changes to U.S. securities laws, is not currently contemplated by Canada's securities laws. There are two main areas in which changes to the Canadian securities law regime would facilitate crowdfunding: Prospectus Exemptions for Issuers: In Canada, it is only possible for businesses to raise funds through the issuance of securities if the business either issues a prospectus or can rely on an exemption from prospectus requirements. In theory, in Canadian provinces and territories other than Ontario, it may be possible to crowdfund in reliance on the offering memorandum (OM) exemption. However, as discussed below the existing OM exemptions are a poor fit for crowdfunding. In Ontario, currently there is no OM exemption. Registration Exemptions for Crowdfunding Portals: The use of crowdfunding portals in Canada is not legal unless the portals are registered under the securities legislation in the province or territory in which they operate. Currently, no province or territory has established rules for portals, and none are currently registered. 2

3 What is the JOBS ACT? The U.S. Congress has recently passed crowdfunding legislation, which is contained in Title III of the Jumpstart Our Business Startups Act, Pub. L. No , 126 Stat. 306 (2012) (the JOBS Act ). Crowdfunding will not come into effect in the U.S. until the U.S. Securities and Exchange Commission (SEC) has completed a 270-day rule-making period during which the SEC will flesh out how crowdfunding should be implemented. The principal features of U.S. crowdfunding legislation include the following: disclosure requirements for the issuer, annual limits on the dollar amount that can be raised by the company through crowdfunding (to up to US$1,000,000 per year; provided that if the issuer wants to raise between US$100,000 and US$500,000 it must provide financial statements that are reviewed by an independent public accountant, and if the issuer wants to raise more than US$500,000 the financial statements must be audited), limits on the dollar amount an investor can invest in any company through crowdfunding in any 12-month period (up to the greater of US$2,000 and 5% of annual income or net worth in the case of investors with annual income or net worth of less than US$100,000; higher limits apply for investors with greater annual income or net worth), and securities purchased through crowdfunding cannot be resold for a period of 12 months after the date of issue. Crowdfunding intermediaries must be registered with the SEC as either a broker or a funding portal. A funding portal is exempt from registration as a broker or dealer but is subject to SEC authority; it is not permitted to offer investment advice, solicit purchases or sales of the crowdfunded securities offered on its website, compensate employees or others based on sales of crowdfunded securities, or hold or manage investor funds. 3

4 How does securities regulation work in Canada for private companies? Securities laws apply to all issuers, and not just to public companies listed on stock exchanges. Canadian securities laws apply to every corporation or partnership that has issued, or proposes to issue, securities (including common shares and stock options). This means that any new issuance of securities requires the filing of a prospectus, unless an exemption from the prospectus requirement is available under the securities laws. Common exemptions used by companies that are not public include the private issuer exemption. A private issuer means a corporation or partnership that, among other requirements, has less than 50 security holders (excluding employees and former employees) and has sold its securities only to the certain categories of persons (generally, accredited investors and persons having certain relationships with the company or its founders). Once a startup loses its status as a private issuer, it cannot regain that status, and it may, in connection with the issue of securities, be subject to filing requirements, some regulatory fees and the application, in some cases, of more stringent prospectus exemptions. If the private issuer exemption is no longer available to a startup, it can rely on other exemptions from the prospectus requirement, including the employee, executive officer, director and consultant exemption (which allows issuance of shares or stock options to employees, executive officers, directors and consultants), the accredited investor exemption (which allows issuance of securities to institutional investors or certain high-net worth or higher-income individuals) and the minimum amount investment exemption (which allows for an investment of least $150,000 per investor). Crowdfunding does not fit within the existing financing exemptions described above. 4

5 What about the Offering Memorandum exemption? Outside of Ontario, issuers currently have access to the offering memorandum (OM) exemption. An OM is a detailed disclosure document that includes audited financial statements. As mentioned above, the OM exemption is not available in Ontario, and outside of Ontario, the OM rules are not consistent across Canadian provinces. In some provinces including British Columbia and New Brunswick, any amount can be raised from any investor (regardless of net worth, income or sophistication), as long as an OM is provided. In other provinces including Alberta, use of the OM exemption is conditioned on the investors meeting eligibility criteria investor or a limit on the amount of the investment. In theory, OM exemptions could be used to permit crowdfunding in the Canadian provinces that have the exemption. Indeed, after SEC rule-making is complete, the U.S. crowdfunding regime may bear some resemblance to existing OM-based fundraising in Canada. However, in practice, there are problems with using existing Canadian OM exemptions to facilitate crowdfunding. 5

6 Issues with the Offering Memorandum exemption 1. The OM exemption currently requires the issuer to provide audited financial statements, even for tiny start-ups with no operational history. In such cases, the audit requirement does not provide investors with any useful information, but is prohibitively expensive for most start-ups. 2. The OM form is not well-organized and is overly complex for its intended audience of readers and preparers. Anecdotal evidence is that the OM exemption is little used in the provinces where it is available. 3. Canadian OM requirements may not align to the disclosure requirements that will be mandated by the SEC in the JOBS Act rulemaking process. This has several potential impacts: (a) If Canadian requirements are more onerous, Canadian issuers will be placed at a competitive disadvantage. (b If Canadian requirements are looser, this may undermine the confidence of U.S. securities regulatory authorities in Canadian crowdfunding platforms and discourage the development of a broader North American crowdfunding platform. c) Significant technology investments will be required to create crowdfunding platforms, which can also be expected to generally streamline the capital formation and record-keeping process for small businesses. A roughly parallel U.S.-Canadian legal regime will improve the chance that Canadians will be able to leverage investments in U.S. platforms. 4. The Canadian resale regime (indefinite hold until the issuer is a reporting issuer or a resale exemption is available) does not align to the resale regime for crowdfunded securities under the JOBS Act (12 month hold). Again, discontinuity between Canada and the U.S. is potentially problematic. 5. In the provinces where it is available, the OM exemption is working for at least some companies. Crowdfunding should not disrupt this status quo; particularly since a credible deployment of crowdfunding may well require additional restrictions and investor protections not currently found in existing OM exemptions. 6

7 Will the U.S Crowdfunding Exemption be available to Canadian Startups? The JOBS Act provides that the U.S. crowdfunding exemption is not available to companies not organized under and subject to the laws of a State or territory of the United States or the District of Columbia. So U.S. crowdfunding platforms will not be available to Canadian start-ups, unless the start-up incorporates in the U.S. This represents a significant departure from most U.S. private placement exemptions which permit fundraising from U.S. persons by non-u.s. companies. If Canada does not have robust crowdfunding platform that give Canadian start-ups fundraising opportunities available to their U.S. competitors, Canadian technology entrepreneurs will have additional reasons to incorporate in the U.S. and otherwise migrate south. What are the concerns with crowdfunding and how can they be addressed? The primary concern with crowdfunding is that it will open the door to fraud and abuse, particularly of unsophisticated investors who do not have the financial ability to sustain the loss of their investment. Indeed, this is the worst case scenario for advocates of crowdfunding as well, since crowdfunding will only work if the system is, and is seen to be, an improvement on existing means of raising funds for private companies, including on the level of investor protection. Many of the concerns have already been vigorously debated in the U.S. and are expected to be further addressed through the SEC rule-making process. 7

8 Will the U.S Crowdfunding Exemption be available to Canadian Startups? The JOBS Act creates a new concept of the funding portal. In the U.S., funding portals will be regulated, likely by FINRA. Crowdfunding must be conducted through these portals or registered broker-dealers. In contrast, start-up financing in Canada is often cobbled together informally, sometimes with the assistance of unregistered finders. The role of finders is difficult for regulators to monitor and it is easy for this activity to occur under the radar. From an antifraud perspective, regulated funding portals are potentially a significant improvement on the status quo. Won t large number of shareholders be difficult to manage? Some of the risks posed by crowdfunding - including managing large numbers of shareholders and ensuring investors are informed - can potentially be addressed through well-designed technology solutions. Indeed, the real promise of crowdfunding is leveraging technology and modern communications to make the process of capital formation for start-up companies transparent, easy to access, and easy to monitor, with standardized documentation and terms. Sectors including banking, securities trading, e-commerce, and government on-line have evolved along these lines while managing fraud risks of equal or greater complexity. Given the scale of the challenge, crowdfunding will only work if technology and business investments are made in funding portals. In Canada, these investments would be encouraged by a clear regulatory environment created specifically to facilitate crowdfunded investments, rather than attempting to shoe-horn this activity into the existing registration regime. 8

9 How Can I get Involved? To learn more about crowdfunding, visit icanada.nu/crowdfunding. This site will give you access to our whitepapers, information on our program development and access the latest news on crowdfunding. Sign our petition at icanada.nu/petition. Follow us on Twitter Contact your Member of Parliament and raise this issue. Include links to our whitepaper and technical legal perspective. For communications or press coverage, contact Andrew Weir, VP Communications at andrew@helixcommerce.com, or Maricel Dicion, VP Public Relations at MDicion@national.ca. To join us as a volunteer, and support our leadership efforts please contact Andrew Weir. 9

10 Whitepaper Primary Author Andrea Johnson is Invest Crowdfund Canada's Vice President Legal. She is a partner at FMC Law. Andrea s practice focuses on corporate and securities law, with an emphasis on technology and emerging growth companies. She has extensive experience in the private equity and venture capital area and has acted as lead counsel on many of the largest VC financings in Canada. Andrea also advises TSX-listed companies on IPOs, financings (including PIPEs), mergers and acquisitions, stock-based compensation and corporate governance. Andrea has received numerous recognitions for her work, including: Recommended by The Best Lawyers in Canada 2012 as one of Canada's leading lawyers in the area of Corporate Law. Named one of the "Top 25 People of Ottawa" by Ottawa Life Magazine. Named a "Canadian Corporate Lawyer to Watch" in the 2011 LEXPERT Cross-border Corporate Guide. Recipient of "LEXPERT's 2010 Rising Stars: Leading Lawyer Under 40" Award for her exemplary leadership and expertise advising on business law issues. She can be reached at andrea.johnson@fmc-law.com 10