On May 14, 2015, the securities regulatory authorities of BC, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia (the participating jurisdictions) each adopted, by way of local blanket order, a substantially harmonized start-up crowd funding exemption that will permit start-up and early stage companies to raise capital in these jurisdictions. BC’s start-up crowd funding exemption is found in BC Instrument 45-535 Start-up Crowdfunding Registration and Prospectus Exemptions (BCI 45-535) and includes an exemption from each of the prospectus and dealer registration requirements. BCI 45-535 is not available to a reporting issuer or an investment fund.
Certain key conditions of the prospectus exemption in BCI 45-535 are as follows:
- the issuer distributes its own eligible security through an online funding portal, which is relying on the registration exemption or operated by a registered dealer;
- an issuer is required to use an offering document in the required form to conduct the distribution and make it available to an investor through the funding portal’s website;
- the issuer’s head office is located in a participating jurisdiction;
- the issuer may raise a maximum of $250,000 per offering and is restricted to no more than two distributions in a calendar year;
- an investor may not invest more than $1,500 per distribution;
- the distribution may remain open up to a maximum of 90 days from the first date the offering document is made available on its funding portal’s website;
- the issuer is required to provide each investor with a contractual right to withdraw his/her offer to purchase securities within 48 hours of the purchaser’s subscription or notification to the purchaser of an amendment to the offering document; and
- none of the promoters, directors, officers and control persons (collectively, the principals) of the issuer is permitted to be a principal of the online funding portal.
The securities are subject to resale restrictions. They can only be resold under another prospectus exemption, under a prospectus, or four months after the issuer becomes a reporting issuer.
Certain key conditions of the registration exemption in BCI 45-535 are as follows:
- the funding portal must deliver the required forms for the funding portal and each of the principals to the BC Securities Commission at least 30 days before facilitating its first start-up crowdfunding distribution;
- the head office of the funding portal is located in Canada and the majority of its directors are Canadian residents;
- the funding portal does not provide advice to a purchaser or otherwise recommend or represent that a security is suitable;¹
- the funding portal does not receive a commission, fee or any other amount from an investor;
- the funding portal does not allow a subscription until the investor has confirmed that he/she has read and understood the offering document and the risk warnings;
- the funding portal receives payment electronically through the funding portal’s website and is required to hold the investors’ assets separate and apart from its own property, in trust for the investors and, in the case of cash, at a Canadian financial institution; and
- the funding portal is required to provide an investor with a contractual right to withdraw within 48 hours of the subscription, or return the funds to all investors if the minimum offering amount is not reached.
BCI 45-535 will expire on May 13, 2020.
The Canadian Securities Administrators and the participating jurisdictions are continuing to work with the Ontario Securities Commission in developing proposals for an “integrated crowdfunding proposal” under a multilateral instrument. When adopted, this integrated crowdfunding exemption will apply to both reporting and non-reporting issuers and have a higher offering limit of $1.5 million.
A Few Additional Thoughts
It will be interesting to watch how the crowdfunding craze will unfold. There is no doubt that many investors will believe they are making a worthwhile investment that will eventually generate a large return while not fully comprehending the risky nature of crowdfunding. Most start-up businesses are unfortunately doomed for failure right from the outset. Many of these entrepreneurs have grandiose ideas but lack the business acumen to develop or implement their ideas – lots of puffery but no execution.
Adding to the risk is the online nature of crowdfunding. Although the regulatory authorities in the participating jurisdictions are no doubt high-fiving each other for introducing an exemption that reflects the growth in social media and the US JOBS Act, they obviously did not think about the potential consequences of allowing online investing. Any unscrupulous con artist can make a convincing pitch for support on the Internet – the scripts should be entertaining! They will also have access to potential investors worldwide. This is so despite the condition in the registration exemption that con artists are required to take “reasonable measures” to ensure that an investor is resident in a participating jurisdiction where the offering document is made available.
You may be thinking that the regulators will screen principals by reviewing the individual forms that they are required to file. This is assuming someone is assigned to review them. The form is, however, relatively basic and asks the principal to check a yes or no box to whether he/she has committed any criminal or civil offence. That said, it is comforting to know that even a con artist has to sign the certification page, which states: “IT IS AN OFFENCE TO MAKE A MISREPRESENTATION IN THIS FORM” in bold.
Another risk is that investors will not really know how their money is being spent. The issuer is required to provide information on its intended use of proceeds raised in the offering document. There is no doubt that a lot of money will be used for “marketing”, that is, wild parties in Vegas and extravagant business trips to the Caribbean and “salaries”. Why not pay your spouse $200,000 per year for watering the plants if you can? We’ve already seen this happen during the tech boom. The point is the issuer is not required to provide investors with financial statements at the point of sale or on an ongoing basis.
You are probably thinking, but hold on, there are monetary limits. It is true that that BCI 45-535 and the other local blanket orders stipulate $250,000 is the maximum per offering and investors may only invest $1,500 per distribution. However, it is not entirely clear how the regulators intent to enforce these limits. There has certainly not been any discussion on this point from any of them. Therefore, it is doubtful that an investor would be prevented from investing more than $1,500. In any event, the investor could, for example, invest $1,500 for himself and each of his 25 children.
All of this to say that these potential risks are not good for investors but great for defence lawyers. We should look forward to receiving bulletins on this issue from the Enforcement Directors of the participating jurisdictions.
I am not opposed to the crowdfunding exemption although it probably sounds like I am. There are indeed legitimate start-up businesses that will benefit from this exemption. I am hopeful, too that it will help generate work in our otherwise flat securities industry. I simply wanted to point out that there are potential risks and the likelihood of success for most of these businesses is unfortunately minimal. It may be that investors would have better odds wagering on the worst nag at Hastings Park.
This article contains general information only and is not intended to provide a legal opinion or advice. Please consult a lawyer or compliance advisor for matters related to your situation before relying on any of the statements made in this article.
- The online funding portal is required to deliver the required forms to the securities regulatory authority of Saskatchewan, Manitoba, Québec, New Brunswick or Nova Scotia if it intends to operate in any of these jurisdictions.