Crowdfunding Exemptions Adopted by Canadian Securities Regulators
By Norman Snyder on 2015/07/08
Crowdfunding has become an increasingly attractive and innovative way for start-up businesses and smaller private companies to raise capital in North America through the pooling of smaller, individual contributions by investors. Those wishing to invest equity are connected with businesses seeking capital through the use of the internet and social media networks. There are essentially two models for crowdfunding. The first is a donation or reward model, whereby investors (often a large number) provide money (often each in quite small amounts) to fund a specific project or financing goal, with no commitment in return other than the promise to complete the project or, in some instances, the promise of some form of non-financial reward or recognition (such as being publicly identified as a supporter or by receiving a gift). More recently this has evolved into a second model which more closely resembles an equity investment, where businesses seek online investors to provide money in exchange for an equity or ownership interest in the profits of an existing or start-up business. It is only this second model which attracts securities regulation.
Until recently, most Provinces in Canada only permitted equity crowdfunding in reliance on existing private placement prospectus exemptions (such as the accredited investor exemption, minimum investment amount exemption, prescribed offering memorandum exemption or the close friends, family and business associates exemption). In response to increasing interest in equity crowdfunding, in March of 2014 the Canadian Securities Administrators (the “CSA“) published a notice for publication and request for public comment on proposed prospectus exemptions relating to equity crowdfunding. On May 14, 2015, the CSA announced a set of crowdfunding registration and prospectus exemptions pursuant Multilateral Notice 45-316 – Start-Up Crowdfunding Registration and Prospectus Exemptions (the “Crowdfunding Exemptions“) which permit a company to raise start-up capital by the sale of its securities to the public through a non-registered online crowdfunding portal.
Securities laws in Canada are provincially legislated and apply to companies and investors based on the province in which each resides. The Crowdfunding Exemptions have been adopted by the securities regulatory authorities in each of Manitoba, British Columbia, Saskatchewan, Québec, New Brunswick and Nova Scotia (the “Participating Jurisdictions“) by way of blanket orders which will remain in force for a period of five years, expiring on May 13, 2020 (Start-up Crowdfunding Prospectus and Registration Exemption Blanket Order 45-502 ). Notably absent from the list of Participating Jurisdictions is Ontario, which did not adopt the Crowdfunding Exemptions. Earlier this year, the Ontario Securities Commission did indicate that it intends to publish its own proposal for a crowdfunding prospectus exemption along with regulatory requirements applicable to an online crowdfunding portal.
The Crowdfunding Exemptions generally are comprised of two elements: a prospectus exemption, permitting a company or business (typically referred to as an “issuer”) to distribute securities without a prospectus, and a registration exemption, exempting a funding portal from having to register as a dealer. The funding portal is an online platform which can be used by an issuer to raise funds. A funding portal will list investment opportunities and facilitate the payment of the purchase price by the investor to the issuer.
The main conditions that apply to the use of the Crowdfunding Exemptions include the following:
- the exemptions are only available to non-reporting issuers (and not investment funds) and the issuer must have its head office in a Participating Jurisdiction;
- no more than an aggregate of $250,000 may be raised in a single offering distribution and issuers are limited to a maximum of two such distributions per calendar year (i.e. a maximum aggregate of $500,000 may be raised per year);
- the maximum investment amount per individual investor is limited to $1,500 per distribution (there is no limit, however, on the number of distributions in which an investor may participate);
- offerings may only remain open for a maximum of 90 days;
- issuers must produce an offering document, in a prescribed form which contains basic information about the issuer, its management and the distribution;
- investors must each be provided with a contractual right to withdraw their subscription by within 48 hours of their subscription;
- principals of an issuer (a promoter, director, officer or control person) are precluded from being a principal of the funding portal;
- the funding portal is not permitted to provide advice to any investor or potential investor and may not recommend any security or receive any commission or fee from an investor in respect of any subscription; and
- the resale of any securities acquired under this exemption will be subject to an indefinite hold period and can only be resold under another prospectus exemption, pursuant to a prospectus or four months after the date on which the issuer becomes a reporting issuer.
The funding portal, unless it is a registered dealer, will be subject to a further set of conditions in order to qualify for the registration exemption, including:
- the funding portal must deliver a funding portal information form and individual information forms for each of its principals to the applicable securities regulators at least 30 days prior to facilitating its first start-up crowdfunding distribution;
- the head office of the funding portal must be located in Canada;
- a majority of the funding portal’s directors must be residents of Canada;
- the funding portal may not provide advice to a purchaser or otherwise recommend or represent that a security is suitable for purchase, nor may it speak to the merits of the investment;
- the funding portal may not receive a commission, fee or any other amount from any investor (although it is entitled to receive a commission and/or fee in respect of a distribution from the issuer);
- the funding portal must make the issuer’s offering document and the associated risk warnings available online to purchasers and may not permit the completion of a subscription until the investor has confirmed having read and understood these documents;
- the funding portal keep all invested funds separate and apart from its own property, in trust for the investors; and
- the funding portal must either release funds to the issuer after the minimum offering amount has been reached (provided that the 48-hour right of withdrawal has elapsed) or return the funds if the minimum offering amount is not reached, a withdraw right is exercised or if the distribution is withdrawn by the issuer.
The Canada Revenue Agency recently published a statement indicating that, in its view, whether funds received by a taxpayer in the context of crowdfunding activities will be construed for Canadian tax purposes as either a loan, capital contribution, gift, income or a combination thereof, will depend on the terms and conditions of each particular crowdfunding arrangement. Accordingly, before undertaking any crowdfunding activities, tax advice should be sought and obtained. Taylor McCaffrey’s Tax Department would be happy to assist in this regard.
The Crowdfunding Exemptions are intended to be responsive to the public demands to have equity crowdfunding available as a viable source of capital to non-reporting issuers at an early stage of development, however, in order to qualify for the exemptions, businesses interested in offering securities through a funding portal should carefully consider the applicable conditions which must be met and be aware that depending on the jurisdiction in which the company or investors are based, different regulatory regimes may apply (note, for instance, the current lack of a crowdfunding exemption in Ontario).
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