In the United Kingdom, selling shares of your company to the crowd is an increasingly common way of raising money. Companies there raised £53.8 million ($90.98 million) via equity crowdfunding in the first quarter of 2018, according to an estimate by Beauhurst, a British startup and scale-up database.
In January 2016, new crowdfunding regulations allowing startups to raise money from retail investors lifted hopes that the model could work in Canada too. They were billed as a boon for early-stage firms looking for capital, and as a way to offer main street investors access to a market traditionally reserved for financial institutions and high-net worth individuals.
Statistics on startup crowdfunding in Canada are not readily available. However, an analysis by The Logic shows that those new startup crowdfunding rules have produced just $1.81 million in investment.
The startup crowdfunding rules include limits on deal size and how much backers can contribute—in most provinces, firms can raise no more than $1.5 million annually through this route, while retail investors can’t spend more than $2,500 per company. By comparison, venture capital investment in Canada totalled $3.2 billion in 2017, according to the Canadian Venture Capital Association. Industry insiders say the small amount of startup crowdfunding investment is the result of onerous regulations and a lack of public awareness.
The Logic analyzed publicly-available deal information on the websites of 17 startup crowdfunding portals listed by six provincial securities regulators. More than half of the listed portals had no publicly-visible deals, and four appeared to no longer have websites at all.
In equity crowdfunding, investors receive shares in a company in return for their money, rather than merchandise or early access to products—typical for the donation or rewards crowdfunding campaigns on platforms like Kickstarter, Indiegogo or Patreon. The Logic’s analysis focused on equity crowdfunding—specifically the startup crowdfunding and integrated crowdfunding exemptions introduced in 2016.
Since January 2016, Canadian startups have raised just $1.81 million through new startup crowdfunding rules, according to an analysis by The Logic of 17 funding portals across six provinces. That’s a fraction of what’s been raised in other countries. In the U.K., for example, equity crowdfunding brought in $90.98 million in the first quarter of 2018 alone. The lack of standard regulations across Canada and low public awareness are the main challenges in Canada, according to industry insiders.
The largest crowdfunding portal in Canada is the Vancouver-headquartered FrontFundr. The company has done 30 deals since it launched in May 2015, according to CEO Peter-Paul Van Hoeken. “I would definitely say that this industry is still in its infancy,” said Van Hoeken.
Companies have brought in $31.64 million in funding rounds listed on FrontFundr. Van Hoeken estimates 40 to 45 per cent of that total was raised via the portal itself—some of those deals involved companies that were raising money jointly on the site and through more conventional means, like VC or angel investing. Of the two sets of new regulations, about $750,000 was raised used the startup crowdfunding exemption. Van Hoeken said he hadn’t heard of a single offering using the integrated crowdfunding exemption, which has tougher regulatory requirements.
A third regulation, the offering memorandum exemption—based on an older rule that requires rigorous disclosure but has no cap on funding rounds—accounts for 40 per cent of the money raised on FrontFundr, and Van Hoeken believes it will ultimately be the main kind of equity crowdfunding in Canada.
To arrive at an estimate of equity crowdfunding activity in Canada The Logic collected the public deal information from 17 funding portals. The portals were those listed on the websites of the regulators of the six provinces that have the startup crowdfunding exemption (British Columbia, Saskatchewan, Manitoba, Quebec, Nova Scotia and New Brunswick). Portals that only listed deals for accredited investors or under the operating memorandum exemption—which requires a detailed corporate disclosure document, accompanied by financial statements—were excluded, as were real estate deals.
A major challenge for wider adoption, according to Van Hoeken, is that unlike the U.K. or the United States, Canada does not have country-wide equity crowdfunding rules. Each province has its own rules, and while there has been cooperation between financial authorities, regulatory regimes across the country “are not harmonized and are overly complex,” according to a report by the National Crowdfunding and Fintech Association of Canada presented to Finance Canada in March.
The document called on the federal and provincial governments to cooperate to “reduce the regulatory burden” and “champion innovation” in financial technology, as well as to support efforts to collect and analyze data about crowdfunding and fintech in Canada. The Department of Finance did not provide comment as to whether it plans to implement changes to equity crowdfunding rules or encourage provinces to do so, or to promote it, by deadline.
“I really question whether there’s actually a business case to run a funding portal using the startup crowdfunding rule only,” said Van Hoeken. The regulations limit how much investors can put into a single deal, and without an exempt market dealer license—which allows a firm to trade in certain kinds of private securities, and which FrontFundr has—he said a platform can’t make use of an additional, unlimited exemption for wealthier individuals to collect bigger cheques. “And it’s not even available in all provinces.”
Changes in January 2016 allowed startups in five provinces—Manitoba, Ontario, Quebec, Nova Scotia and New Brunswick (Saskatchewan and British Columbia already had rules in place)—to raise money from retail investors. But many firms that want to raise money this way must produce audited financial statements annually, as well as other documentation, which can cost tens of thousands of dollars.
Meet the exemptions
Companies seeking to raise money from investors can use one of several carve-outs created by securities regulators. Here’s a brief explanation of four commonly used exemptions, drawn in part from the NCFA’s documents:
Accredited investor: Available in all provinces and territories. An accredited investor is a person who has either had an individual net income before taxes of $200,000, or $300,000 with a spouse, over the previous two years, or assets excluding their primary residence of $1 million, or net assets of $5 million. There’s no limit on how much companies can raise via this exemption, or how much accredited investors can put in per round.
Offering memorandum: Available country-wide. Firms that want to use it must produce a detailed disclosure document about their current and prospective business plans and leadership, and provide audited financial statements. There are no restrictions on the size of the raise, and qualifying investors can put in up to $30,000 or $100,000, depending on the province and their circumstances.
Integrated crowdfunding: Available in Saskatchewan, Manitoba, Quebec, Nova Scotia, New Brunswick and Ontario. Companies are allowed to raise up to $1.5 million every year, and must produce annual audited financial statements. Non-accredited and accredited investors in most provinces are capped at $2,500 and $25,000 per deal, respectively. Ontario has annual limits of $10,000 and $50,000 for non-accredited and accredited investors respectively.
Startup crowdfunding: Available in British Columbia, Saskatchewan, Manitoba, Quebec, Nova Scotia and New Brunswick. Companies can raise up to $500,000 in two rounds in a single year, while investors’ contribution in most provinces is capped at $1,500 per deal. In B.C., investors who have vetted their decision to invest in a particular deal with a financial advisor can contribute up to $5,000.
In Ontario, startup crowdfunding is subject to strict non-solicitation rules, so the only advertising companies can do is to direct potential investors to their listing on a portal.
The NCFA’s submission called the rule “another example of unjustified regulation,” and asked governments to provide “funding and support” for education on crowdfunding, for both investors and companies.
Building public awareness and trust is a hurdle in all kinds of equity crowdfunding, according to Rubsun Ho, CEO of CrowdMatrix, a portal that tried to get accredited investors to “top up” deals put together by VCs and other financial firms. “We could generate eyeballs on deals, but to get [people] to actually invest was a little more difficult,” said Ho, whose platform did not make use of the startup crowdfunding regulations. Instead, CrowdMatrix has ended up primarily enabling private offerings in which the lead investors brought in individuals from their own networks—nine deals in total so far.
Over the past two years, the initial coin offering (ICO) has replaced equity crowdfunding as the buzziest way for a company to raise money. Token sales generated US$5.3 billion globally in 2017, according to industry publication CoinDesk, and US$6.3 billion in the first quarter of 2018 alone.
In the U.S., the Securities and Exchange Commission (SEC) has argued that most companies conducting ICOs should be registered with financial regulators, and a judge ruled in September that securities laws apply to them. But very few token sellers have registered, and the SEC has been shutting down ICOs and subpoenaing companies that have conducted them. The Canadian Securities Administrators—the umbrella group for provincial regulators—has said its members will decide on tokens on a case-by-case basis. Regulators in Ontario and Quebec each authorized a single ICO in 2017.
Ho thinks most investments in ICOs were likely “purely speculative in nature,” so that money wouldn’t automatically be available for more regulated kinds of deals like equity crowdfunding. But “there is certainly some issuer demand that’s been satiated by the ICO market,” he said.
Ho’s CrowdMatrix plans to use blockchain technology to create digital securities for various kinds of alternative investments, including private company shares. “The reason most issuers don’t want to raise from a whole bunch of small investors is because it’s a pain to manage,” said Ho. Digital, “tokenized” securities would make tasks like distributing dividends or screening buyers easier by embedding the rules right into the financial product itself. And while crowdfunding-bought equity is illiquid—unlike publicly-traded stocks, there typically isn’t a readymade market to sell them on—tokenized assets could be transferred more easily between investors.
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Van Hoeken also predicts blockchain technology will become widely used to administer and issue securities. But he said the more immediate future for equity crowdfunding in Canada is companies that have grown beyond the startup phase using it to raise money—something that has already begun in the U.K. When RE Royalties raised part of a $12-million funding round on FrontFundr earlier this year, it already had a deal in place to list on the TSX Venture Exchange via a reverse takeover. “The investors through our platform now also have liquidity,” said Van Hoeken.
In the NCFA’s 2016 end-of-year report, Van Hoeken said equity crowdfunding “empowers everyone to invest in young companies they believe in” and is “democratizing investing.” But he also said harmonizing the rules across the country was essential.
So while deal closings on FrontFundr have increased in recent months, Van Hoeken said he is not surprised that the industry as a whole remains in its early stages. “The fact that you introduce some rules doesn’t mean that the public is now saying, ‘Fantastic, we’re going to go online and invest.'”