The Ontario Securities Commission (OSC), Canada’s largest provincial capital markets regulator, has proposed new rules that would allow startups and small- and medium-sized enterprises to issue securities through crowdfunding.
Crowdfunding has become an important new method of raising capital through the internet for a broad range of purposes, describes the OSC in the proposal, but such activities in Canada are limited to models that do not involve an offering of securities.
These are the “donation model”, “reward model”, and “pre-purchase model” which involve donating to a project or venture for either nothing of tangible value, a reward or perk, or a future consumer product.
The two crowdfunding models which regulators interpret as selling securities are the “peer-to-peer lending model” – money lending between individuals and a project or business (usually in the form of unsecured personal loans) through an online intermediary, and the “securities-based model” – crowd investing in a business in exchange for equity and debt securities.
Under securities law, a prospectus, or document detailing information about the issuance of securities, must be prepared, unless exemptions apply. An example would be the accredited investor exemption which refers to those who own more than C$1 million in financial assets and assumes they, as savvy investors, do not need a prospectus and can sustain a loss if something goes wrong.
The crowdfunding prospectus exemption, one of four new exemptions proposed by the OSC, will allow businesses to issue securities to small, non-accredited investors without having to spend time and money to prepare and file a prospectus.
Under the new rules, a company can raise up to C$1.5 million per year from crowdfunding, while an investor can put up to C$2,500 in a single investment and up to a total of C$10,000 per year.
Startups, small- and medium-sized enterprises, social enterprises, crowdfunding platforms, and crowdfunding platforms with a focus on social enterprises have been waiting on the changes as it helps raise capital, provides offerings to small investors, and democratizes finance, but there are inherent risks to investors.
There is a chance that investors may not be able to sell their investment, or at least quickly, because these securities are not publicly traded, which also means they are not subject to public reporting standards and could lead to lack of information for investors. Crowdfunding is typically employed by newer, riskier companies and investors could face the risk that the businesses shut down and take their money with it.
The OSC says that low investment limits reduce an investor’s exposure. It found in a survey that investors are only willing to commit small amounts through crowdfunding – 40 percent of respondents said they would invest C$1,000 or less and 40 percent said they would invest between $1,000 and $4,999. Only 20 percent said they would invest $5,000 or more.
As for other requirements, companies must offer its securities through a registered funding portal, which some see as safeguards to prevent fraud, and can only offer its securities on one portal during the distribution period established, which can be no longer than 90 days.
“Today we have proposed new tools, which will transform Ontario’s exempt market by providing greater access to capital for businesses and expanding investment opportunities for investors. We have done so in a balanced and responsible manner that is intended to facilitate capital raising while maintaining an appropriate level of investor protection,” said Howard Wetston, CEO of the OSC, in a statement last week.
A public comment period for the OSC’s four proposed prospectus exemptions is open until June 18.
“We look forward to receiving input on these proposals, which are tailored to address the needs of Ontario’s capital markets,” said Wetston.
In the US, a public comment period had just ended in February on a draft for new crowdfunding rules proposed by the Securities and Exchange Commission (SEC). Under current regulations, transactions involving the offering of securities must be registered with the SEC. But the costs of doing so and the ongoing reporting typically outweigh the benefits of raising small amounts of capital, as in the case of crowdfunding.
The proposed rules, now awaiting final wording, permit a registration exemption on crowdfunding transactions that do not raise more than US$1 million in a 12-month period. Investors can invest no more than the greater of $2,000 or 5 percent of annual income or net worth in a 12-month period if annual income or net worth is less than US$100,000 (10 percent if annual income or net worth is more than US$100,000). Transactions must be conducted through a registered broker or funding portal.
Saskatchewan, a province much smaller in population size than Ontario, is currently the lone province in Canada with a crowdfunding exemption introduced in December. A single investment is limited to C$1,500 and companies can make no more than two, six-month offerings of C$150,000 per year.
