Unless you’ve been living on a remote desert island for the last few years, you’ve heard about crowdfunding or stories of entrepreneurs raising thousands or millions of dollars online. This blog provides a brief history of modern day crowdfunding and explains the rules surrounding securities crowdfunding.
Crowdfunding is the process of fund raising through the collection of small contributions from the general public (known as the crowd) to fund projects initiated by other people or organizations. Crowdfunded projects may include creative works, products, non-profit organizations, businesses or donations for a specific purpose (e.g. to pay for a medical procedure). While the term “crowdfunding” itself dates back to 2006 in relation to fundraising efforts for a video blogging site launched by Michael Sullivan, the concept dates back to at least the 1700’s and the Irish Loan Fund (founded by, among others, the author Jonathan Swift). Crowdfunding as we know it today usually takes place via an online web portal that handles the financial transactions involved, and may also provide services such as media hosting, social networking, and facilitating contact with contributors.
There are two main models of crowdfunding. The first is donation (or rewards) crowdfunding. The birth of crowdfunding came through this model, where funders donate via a collaborative goal-based process in return for products, perks or rewards. The second and more recent model is investment crowdfunding, where a business raises funds through the Internet by issuing securities (such as bonds or shares) to many people. The persons buying the securities have a potential for financial return, unlike in the donation model.
Crowdfunding History and Growth
If we accept the “web” and the “crowd” as two essential elements in defining crowdfunding as an activity, the very first examples of crowdfunding could perhaps be found in the late 90’s, when some Internet campaign-funded projects and charity fundraising platforms started to appear.
On the social web front, in the mid-1990’s, Six Degrees.com and AOL Instant Messenger were launched and people started signing up for online profiles and to connect with friends, to share information or to just keep in touch. Web connectivity between people started to grow and go beyond simple email exchanges.
On the creative artist’s front, in 1997, the British rock band Marillion funded a North American tour through online donations from its US fan base. Other recording artists (endowed with a loyal and now connected fan base) started asking their “crowds” to fund new music, albums or a tour. Inspired by this innovative method of financing, ArtistShare became the first dedicated crowdfunding platform in 2000. ArtistShare also operates as a record label and business model for creative artists which enables them to fund their projects by allowing the general public to directly finance, watch the creative process, and in most cases gain access to extra material from an artist.
Similarly, charity fundraising began to see the potential of the web and crowds when in 2000, JustGiving was founded as a charity fundraising site for challenge fundraising. The company's website allowed people to donate to charities registered with the site with a credit or debit card online, and offered people with sponsored events the chance to build their own webpage to collect sponsorship from supporters. In June 2011, JustGiving claimed that it had provided its service for more than 9,000 UK registered charities and 1.9 million fundraising pages for users, collecting over £770 million since launch.
While these examples tapped into the web, passion and the innate generosity of human beings, what was missing was the right technical “social” infrastructure tools and – most importantly – the mindset that underpins their use.
In 2005, Kiva Microfunds was launched. Kiva is a lending site that facilitates loans via the Internet between lenders in wealthy countries and entrepreneurs in developing countries.
What makes Kiva “social” are some of the by now typical features we expect in a social network, like photos, profiles, updates; but more than that, it’s the sense of personalization that originates from knowing that what you’re doing with the money you are giving.
In 2008, IndieGogo was founded to “democratise fundraising” and “empower creative entrepreneurs with Do-It-With-Others (DIWO) tools.” In 2009, Kickstarter initiated as a “new way to fund creativity.”
Many filmmakers have raised funding for films on popular rewards sites like Kickstarter and IndyGoGo.
These sites have found success raising free money for ultra-low budget films and other projects through crowdfunding models where people can pledge as little as $1 and as much as they like to a variety of different projects. What donors get in return are things like “thank you” credits in films, DVDs, tee-shirts, flowers, cookies, and concert tickets.
A good example of a Canadian based rewards crowdfunding site is Fundrazr https://fundrazr.com/pages/.
Rewards crowdfunding is about free gift-money with no financial interest in the funded project. Investment crowdfunding, on the other hand, is about investing in a project and enjoying a financial interest in the project.
In 2010, GrowVC launched, starting what is known as equity crowdfunding, GrowVC, which defines itself as “a new community funding model,” wanted to be the new Kiva for technology start-ups and help start-up companies secure initial funding of up to $1 million. It has grown to over 9,000 entrepreneurs, investors and experts from 200 different countries.
GrowVC was followed in 2011 by Crowdcube, the world’s first business finance crowdfunding platform for business to raise equity finance. Crowdcube gives entrepreneurs a platform to spread their news about their ideas while investors can choose the ideas they support. Shares in the business are issued to members of the crowd.
Both GrowVC and Crowdcube inaugurated a model that was impossible to emulate in Canada and the US because of securities law restrictions. Securities laws in the US and Canada prohibit offering and selling securities without a prospectus and through a registered broker dealer, unless an exemption is available. Investment crowdfunding exemptions have only become available in the US and Canada recently.
US Equity Crowdfunding Landscape
The first big push towards an equity crowdfunding exemption in the US came in April 2010, when Paul Spinrad of Make magazine, Jenny Kassan of the Sustainable Economies Law Center (SELC), and Danae Ringelmann of Indiegogo launched the Crowdfunding Campaign to Change Crowdfunding Law to fund the legal work to draft a petition to the U.S. Securities and Exchange Commission (SEC) for a crowdfunding exemption. After much back and forth among the various stakeholders (e.g. key lawmakers, regulators, entrepreneurs and investors), The Entrepreneur Access to Capital Act became part of the The Jumpstart Our Business Startups Act or JOBS Act, which was ultimately passed into law by President Obama on April 5, 2012. The term "The JOBS Act" is also sometimes used informally to refer to just Titles II and III of the legislation which are the two most important pieces to much of the US equity crowdfunding and startup communities. Title II went into effect on September 23, 2013. On October 30, 2015, the SEC adopted final rules allowing Title III equity crowdfunding. The final rules and forms are effective May 16, 2016.
The SEC exemption, titled “Regulation Crowdfunding”, limits an issuer’s capital raise to an aggregate of US$1 million through crowdfunded offerings in a 12-month period and, in that same period, limits investors across all crowdfunding offerings to: (i) the greater of US$2,000 or 5% of the lesser of their annual income or net worth if either is less than US$100,000; or (ii) if both their annual income and net worth are equal to or more than US$100,000, 10% of the lesser of their annual income or net worth (not to exceed US$100,000 for any individual). Regulation Crowdfunding may not be used by companies that already report to the SEC or by non-US incorporated companies.
Canadian Equity Crowdfunding Landscape
There is no federal securities regulator in Canada, so it was not an option for the federal government to legislate changes in provincial securities laws to enable equity crowdfunding. Instead, provincial securities regulators have taken the lead.
On November 5, 2015 securities regulators in Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia (Participating Jurisdictions) published in final form the crowdfunding regime: Multilateral Instrument 45-108 Crowdfunding (Crowdfunding Regime) which includes a crowdfunding prospectus exemption (Crowdfunding Exemption) and a registration framework for funding portals. The Crowdfunding Regime came into force in the Participating Jurisdictions on January 25, 2016.
The Crowdfunding Exemption permits both non-reporting and reporting issuers to issue securities to investors over the internet subject to certain conditions designed to protect investors. Some key conditions are as follows:
Issuer Limits: Issuers may use the Crowdfunding Exemption to raise no more than $1.5 million a year.
Investor Limits: Investors who are not “accredited investors” are limited to $2,500 per investment and $10,000 per year; accredited investors who are not “permitted clients” are limited to $25,000 per investment and $50,000 per year. There are no investment limits for permitted clients (being certain institutional investors and individuals whose net financial assets exceed $5 million).
Canadian Issuer: The issuer must be incorporated and have its head office in Canada and a majority of its directors must be resident in Canada.
Simple Securities: Issuers can offer only non-complex securities, including common shares and preference shares (and securities convertible into such shares), limited partnership units and flow-through shares.
Disclosure Document: Issuers must prepare an offering document that contains all of the information about the issuer and its business that an investor should have access to before buying the issuer’s securities. The disclosure takes the form of 45-108F1 Crowdfunding Offering Document (Crowdfunding Offering Document). Unlike the typical 38-point prospectus detailing every aspect of an issuer’s business, the Crowdfunding Offering Document is what the Ontario Securities Commission calls a streamlined 11-point disclosure document meant to be easier for issuers to prepare and for investors to read.
Financial Statements: Non-reporting issuers that distribute securities under the Crowdfunding Exemption must have their financial statements: (i) audited or reviewed by a public accounting firm if the cumulative raise is between $250,000 and $750,000; and (ii) audited if the cumulative raise is over $750,000.
Funding Portal: A crowdfunding offering may only be conducted through a single online portal which hosts the offering document and other offering related documents (e.g. the subscription agreement and risk acknowledgment form). Closing of the crowdfunding offering, including payment for the securities purchased, takes place through the portal acting as agent for the issuer. The portal must fulfill certain gatekeeping responsibilities including reviewing the issuer’s offering document and its other marketing materials before allowing an issuer access to the portal.
Portals may not advertise or solicit purchasers for a crowdfunding offering.
The funding portal must be registered as an investment dealer, exempt market dealer or restricted dealer.
Advertising and Solicitation: All relevant information about the issuer’s crowdfunding offering must be made available on the funding portal’s online platform and not on any other website. An issuer may, however, inform potential investors of its proposal to offer its securities under the Crowdfunding Exemption and refer potential investors to its online platform.
Hold Period: Securities issued under the Crowdfunding Exemption are subject to a four-month hold period if the issuer is a reporting issuer and to an indefinite hold period if the issuer is a non-reporting issuer.
British Columbia Crowdfunding Developments
The securities regulators of British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick or Nova Scotia have implemented changes to their securities legislation to provide for registration and prospectus exemptions for start-ups and early-stage companies that wish to raise capital through crowdfunding (the Start-up Crowdfunding Exemption). The notable difference between this exemption and the Crowdfunding Exemption is that the Start-up Crowdfunding Exemption is available only to non-reporting issuers. The Start-up Crowdfunding Exemption is available if both the investor and the issuer’s head office are located in any one of British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick or Nova Scotia.
Issuer Limits: The offering limit under the Start-up Crowdfunding Exemption is $500,000 per year ($250,000 per each of two distributions) versus $1.5 million under the Crowdfunding Exemption.
Investor Limits: Investors are limited to investing up to $1,500 per investment.
Funding Portal: There are two types of funding portals that may facilitate start-up crowdfunding:
• funding portals that are operated by registered investment dealers or exempt market dealers that must provide advice on suitability of the investment to investors, and
• funding portals that are operated by persons relying on the start-up registration exemption and that cannot provide suitability advice.
The issuer may choose either of the two options for its start-up crowdfunding campaign.
Rescission Rights: Investors may withdraw their investment within 48 hours following the investor’s subscription. Investors may also withdraw their investment within 48 hours of the funding portal notifying the investor of an amendment to the offering document.
Disclosure Document: The issuer must provide an offering document with basic information about the business and the offering, how it will use the money and any risk to the project. The issuer must also state the minimum amount it needs to raise to accomplish its goal. The information contained in the offering document must be kept up to date throughout the duration of the start-up crowdfunding campaign. If information contained in the offering document is no longer true, the issuer must amend the offering document as soon as practicable and send the new version to the funding portal. This could be the case if, for example, an issuer wants to change the price of the offered securities or the minimum or maximum offering amount. The funding portal must post the new version of the offering document on its website and notify investors about the amendment.
Financial Statements: Under the Start-up Exemption, issuers are not required to provide financial statements to investors with the offering document. If an issuer wants to make its financial statements available to investors, it can place a hyperlink on the funding portal leading to the financial statements. However, the hyperlink must not appear in the offering document because the financial statements do not form part of it.
Canadian Crowdfunding Directory
The National Crowdfunding Association of Canada http://ncfacanada.org/canadian-crowdfunding-directory/ maintains a directory of active (or beta) Canadian Crowdfunding platforms, alternative finance funding portals and service providers.
Examples of BC-based start-up crowdfunding portals are ConsiderFunding.com https://www.considerfunding.com/ and Front Fundr https://www.frontfundr.com/.
The information in this blog is for educational purposes only and does not constitute legal advice.