In Canada, two separate crowdfunding initiatives have been implemented:
- The securities regulatory authorities in British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia (collectively, the “start‑up participating jurisdictions”) recently adopted substantially harmonized registration and prospectus exemptions (together, the “start‑up crowdfunding exemptions”) that allows start‑up and early stage companies to raise capital in these jurisdictions, subject to certain conditions; and
- The securities regulatory authorities in Manitoba, Ontario, Québec, New Brunswick and Nova Scotia (collectively, the “45‑108 crowdfunding participating jurisdictions”) are publishing in final form a crowdfunding prospectus exemption (the “45‑108 crowdfunding exemption”) and a registration framework for funding portals (the “funding portals”) (the 45‑108 crowdfunding exemption and the funding portals collectively, the “45‑108 crowdfunding regime”).
The 45-108 crowdfunding regime and the start-up crowdfunding exemptions are viewed by those jurisdictions (except for British Columbia, which is not a jurisdiction participating in the 45-108 crowdfunding regime) as complementary regimes, as the 45-108 crowdfunding regime is available to both reporting and non-reporting issuers and provides both higher investment limits for investors and higher limits on the amount issuers can raise.
Substance of the start‑up crowdfunding exemptions
The start‑up crowdfunding exemptions are comprised of an exemption from the prospectus requirement (the “start‑up prospectus exemption”) and an exemption from the dealer registration requirement (the “start‑up registration exemption”).
The start‑up prospectus exemption permits non‑reporting issuers to issue eligible securities, subject to a number of conditions. The key conditions are:
- the head office of the issuer is located in a start-up participating jurisdiction;
- the issuer distributes eligible securities of its own issue through an online funding portal;
- the issuer distributes eligible securities using an offering document in the form required that is made available through the online funding portal. The offering document includes basic information about the issuer, its management and the distribution, including how the issuer intends to use the funds raised and the minimum offering amount;
- the issuer group cannot raise aggregate funds of more than $250,000 per distribution and is restricted to not more than two start-up crowdfunding distributions in a calendar year;
- no person invests more than $1,500 per distribution;
- the distribution may remain open for up to a maximum of 90 days;
- the distribution must be made through a funding portal that is either relying on the start‑up registration exemption or is operated by a registered dealer. Registered dealers that operate funding portals must meet their existing registration obligations under securities legislation and confirm to issuers that they meet or will meet certain conditions provided in the start‑up registration exemption;
- the issuer provides each purchaser with a contractual right to withdraw their offer to purchase securities within 48 hours of the purchaser’s subscription or notification to the purchaser that the offering document has been amended; and
- none of the promoters, directors, officers and control persons (collectively, the “principals”) of the issuer group is a principal of the funding portal.
The eligible securities are subject to an indefinite hold period and can only be resold under another prospectus exemption, under a prospectus or four months after the issuer becomes a reporting issuer.
The start‑up registration exemption permits funding portals to facilitate distributions under the start‑up crowdfunding exemptions, subject to a number of conditions. The key conditions are:
- the funding portal must deliver a funding portal information form and individual information forms for each of its principals to the participating regulators at least 30 days prior to facilitating its first start‑up crowdfunding distribution;
- the head office of the funding portal is located in Canada;
- the majority of the funding portal’s directors are Canadian residents;
- the funding portal does not provide advice to a purchaser or otherwise recommend or represent that an eligible security is suitable, or about the merits of the investment;
- the funding portal does not receive a commission, fee or any other amount from a purchaser of eligible securities;
- the funding portal makes the offering document of the issuer and the risk warnings available online to purchasers and does not allow a subscription until the purchasers have confirmed that they have read and understood these documents;
- the funding portal receives payment for an eligible security electronically through the funding portal’s website;
- the funding portal holds the purchasers’ assets separate and apart from its own property, in trust for the purchasers and, in the case of cash, at a Canadian financial institution;
- the funding portal maintains books and records at its head office to accurately record its financial affairs and client transactions, and to demonstrate the extent of the funding portal’s compliance with the orders implementing the start‑up crowdfunding exemptions for a period of eight years from the date a record is created;
- the funding portal either:
- releases funds to the issuer after the minimum offering amount has been reached and provided that the 48 hour right of withdrawal has elapsed, or
- returns the funds to purchasers if the minimum offering amount is not reached or if the start‑up crowdfunding distribution is withdrawn by the issuer; and
- a participating regulator has not notified the funding portal that it cannot rely on the start‑up registration exemption because its principals or their past conduct demonstrate a lack of integrity, financial responsibility or relevant knowledge or expertise.
Substance of the 45-108 crowdfunding regime
The 45‑108 crowdfunding regime encompasses measures which are intended to provide effective protection for investors. The key provisions are:
- issuers can only offer non-complex securities;
- the total proceeds raised by the issuer group in reliance on the 45-108 crowdfunding regime does not exceed $1,500,000 within the rolling 12-month period;
- investors are subject to the following investment limits:
- an investor that does not qualify as an accredited investor:
~ $2,500 per investment, and
~ in Ontario, $10,000 in total in a calendar year,
- an accredited investor other than a permitted client:
~ $25,000 per investment, and
~ in Ontario, $50,000 in total in a calendar year,
- in Ontario, no investment limits for a permitted client;
- issuers are required to prepare an offering document that contains all of the information about the issuer and its business that an investor should know before purchasing the issuer’s securities;
- investors must complete a risk acknowledgement form requiring them to positively confirm having read and understood the risk warnings and information in the crowdfunding offering document before they can enter into an agreement to purchase securities;
- issuers are accountable for and are subject to a standard of liability on the crowdfunding offering document and other permitted materials, and investors are provided with a related right of action;
- a prohibition on advertising and general solicitation;
- non-reporting issuers must make available to investors (i) annual financial statements, (ii) a notice of use of proceeds, and (iii) in New Brunswick, Nova Scotia and Ontario, a notice of a discontinuation of the issuer’s business, a change in the issuer’s industry or a change of control of the issuer; and
- reporting issuers must continue to comply with all of their disclosure requirements.
Under the 45-108 crowdfunding regime, funding portals are regulated such that:
- issuers can only distribute securities through a single funding portal that is registered as an investment dealer, exempt market dealer or restricted dealer as outlined in the Rule, and must post the offering document and other permitted materials solely on that funding portal’s online platform;
- funding portals are prohibited from offering securities of a related issuer;
- a funding portal must fulfill certain gatekeeper responsibilities prior to allowing an issuer access to its online platform, including reviewing the issuer’s disclosure in the crowdfunding offering document and other permitted materials for completeness, accuracy and any misleading statements; and
- a funding portal must review information and obtain background checks on the issuer and its directors, executive officers and promoters, and deny an issuer access to the funding portal in certain circumstances.
Recently, the Securities and Exchange Commission (the “SEC”) advised that it will consider whether to adopt final rules that would allow the offer and sale of securities through crowdfunding. The recommended rules would give small businesses an additional avenue to raise capital and provide investors with important protections. If adopted, this would complete the Commission’s major rulemaking mandated under the JOBS Act.
Highlights of the Recommended Final Rules
The recommended rules would, among other things, enable individuals to purchase securities in crowdfunding offerings subject to certain limits, require companies to disclose certain information about their business and securities offering, and create a regulatory framework for the intermediaries facilitating crowdfunding transactions. More specifically, the recommended rules would:
- permit a company to raise a maximum aggregate amount of $1 million through crowdfunding offerings in a 12 month period;
- permit individual investors, over a 12 month period, to invest in the aggregate across all crowdfunding offerings up to:
- if either their annual income or net worth is less than $100,000, than the greater of:
~ $2,000; or
~ 5 percent of the lesser of their annual income or net worth.
- if both their annual income and net worth are equal to or more than $100,000, 10 percent of the lesser of their annual income or net worth; and
- during the 12 month period, the aggregate amount of securities sold to an investor through all crowdfunding offerings may not exceed $100,000.
Under the recommended rules, certain companies would not be eligible to use the exemption. Ineligible companies would include non‑U.S. companies, Exchange Act reporting companies, certain investment companies, companies that are subject to disqualification under the proposed regulations for crowdfunding, companies that have failed to comply with the annual reporting requirements under the proposed regulations for crowdfunding during the two years immediately preceding the filing of the offering statement, and companies that have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.
Securities purchased in a crowdfunding transaction generally could not be resold for one year. Holders of these securities would not count toward the threshold that requires a company to register its securities under the Securities Exchange Act of 1934, Section 12(g), if the company is current in its annual reporting obligations, retains the services of a registered transfer agent and has less than $25 million in total assets as of the end of its most recently completed fiscal year.
In addition, all transactions relying on the new rules would be required to take place through an SEC‑registered intermediary, either a broker‑dealer or a funding portal.
Disclosure by Companies
Companies that rely on the recommended rules to conduct a crowdfunding offering must file certain information with the SEC and provide this information to investors and the intermediary facilitating the offering, including among other things, to disclose:
- the price to the public of the securities or the method for determining the price, the target offering amount, the deadline to reach the target offering amount, and whether the company will accept investments in excess of the target offering amount;
- a discussion of the company’s financial condition;
- financial statements of the company that, depending on the amount offered and sold during a 12 month period, are accompanied by information from the company’s tax returns, reviewed by an independent public accountant, or audited by an independent auditor. A company offering more than $500,000 but not more than $1 million of securities relying on these rules for the first time would be permitted to provide reviewed rather than audited financial statements, unless financial statements of the company are available that have been audited by an independent auditor;
- a description of the business and the use of proceeds from the offering;
- information about officers and directors as well as owners of 20 percent or more of the company; and
- certain related‑party transactions.
In addition, companies relying on the crowdfunding exemption would be required to file an annual report with the SEC and provide it to investors.
A funding portal would be required to register with the SEC and become a member of a national securities association (currently, FINRA). A company relying on the rules would be required to conduct its offering exclusively through one intermediary platform at a time.
The recommended rules would require intermediaries to, among other things:
- provide investors with educational materials that explain, among other things, the process for investing on the platform, the types of securities being offered and information a company must provide to investors, resale restrictions, and investment limits;
- take certain measures to reduce the risk of fraud, including having a reasonable basis for believing that a company complies with the propose regulations for crowdfunding and that the company has established means to keep accurate records of securities holders;
- make information that a company is required to disclose available to the public on its platform throughout the offering period and for a minimum of 21 days before any security may be sold in the offering;
- provide communication channels to permit discussions about offerings on the platform;
- provide disclosure to investors about the compensation the intermediary receives;
- accept an investment commitment from an investor only after that investor has opened an account;
- have a reasonable basis for believing an investor complies with the investment limitations;
- provide investors notices once they have made investment commitments and confirmations at or before completion of a transaction;
- comply with maintenance and transmission of funds requirements; and
- comply with completion, cancellation and reconfirmation of offerings requirements.
The rules also would prohibit intermediaries from engaging in certain activities, such as:
- providing access to their platforms to companies that they have a reasonable basis for believing have the potential for fraud or other investor protection concerns;
- having a financial interest in a company that is offering or selling securities on its platform unless the intermediary receives the financial interest as compensation for the services, subject to certain conditions; and
- compensating any person for providing the intermediary with personally identifiable information of any investor or potential investor.
The proposed regulations for crowdfunding would contain certain rules that are specific to registered funding portals consistent with their more limited activities than that of a registered broker‑dealer. The rules would prohibit funding portals from, among other things: offering investment advice or making recommendations; soliciting purchases, sales or offers to buy securities; compensating promoters and other persons for solicitations or based on the sale of securities; and holding, possessing, or handling investor funds or securities.
The rules would provide a safe harbor under which funding portals could engage in certain activities consistent with these restrictions. The rules also would require funding portals to maintain certain books and records related to their transactions and business.
The foregoing is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, please contact the author who would be pleased to discuss the issues above with you, in the context of your particular circumstances.