Canada is the second largest country in the world by land mass and the 10th largest economy by nominal GDP. At around 35 million in total population, Canada is a country that has consistently punched above its weight class economically. The extensive border with the US has helped as the two countries have a robust trading environment. The combination of solid infrastructure, rule of law and a highly educated population, makes Canada a great place to live and work (if you don’t mind a bit of snow in the winter). What is missing from this North American country is a robust innovation-driven economy. Access to capital, always high on the list of fostering creative entrepreneurs, is an area Canada can do better. According to one alternative finance expert, a lot better, as Canada’s crowdfunding exemptions are dead in the water.
Crowdfund Insider recently spoke with this individual who, because of their interactions within the securities industry and crowdfunding sector, requested not to be named.
If you are not in the habit of working in the Canadian securities realm it can be a convoluted and confusing labyrinth of rules and regulations. There is no national securities regulator, everything is managed at the provincial level. Yes, the US is encumbered by a litany of state rules on top of federal exemptions but the Feds have the power to override the states in certain situations which means a more manageable playing field (at times … not always).
Crowdfund Insider’s update on the Canadian crowdfunding environment is below, along with several suggestions that regulators can embrace, to make things more workable for early stage companies.
Crowdfund Insider: Please describe the Canadian / Provincial approach to regulating investment crowdfunding?
Canada has three specific crowdfunding exemptions: (1) The “integrated crowdfunding exemption [NI 45-108]; (2) the startup crowdfunding exemption [CSA notice 45-316] and the newly adopted (3) startup business exemption [ASC Rule 45-517] that was adopted in Alberta today. Canadian issuers can also rely on the accredited investor exemption and the offering memorandum (OM) exemption, which is similar to Regulation A+ in the US to raise capital through crowdfunding their securities.
These crowdfunding exemptions are not available across Canada but only in certain provinces. The integrated crowdfunding exemption is available in Ontario, Saskatchewan, Manitoba, Quebec, New Brunswick and Novia Scotia. The Startup crowdfunding exemption is available in British Columbia, Saskatchewan, Manitoba, Quebec, New Brunswick and Novia Scotia. The startup business exemption is available in Alberta (Nunavut had been looking to adopt this exemption as well when introduced in 2015, but has not done so as of today’s date).
|Availability of the Crowdfunding Regimes in Canada|
and Nova Scotia
|Start-up crowdfunding exemptions||Yes||Yes||No||No|
|Integrated crowdfunding exemption||Yes||No||No||No|
|Startup business exemption||No||No||No||Yes|
These crowdfunding exemptions are not harmonized and vary considerably in terms of which issuers can use the exemption, offering limits, investor investment limits, disclosure requirements, and post raise filing requirements.
As a result, issuers in Canada do not have one clear crowdfunding road map.
It is too early to know how the startup business exemption will be received by issuers in Alberta as it was only adopted this week. The start-up crowdfunding exemption which came into force in May of 2015 has had modest use in the participating provinces. There have been no offerings under the integrated crowdfunding exemption which came into force in January of 2016.
Crowdfund Insider: Ontario is the economic center of Canada, yet no one is using the Integrated CF exemption since it was adopted. Why?
There are no funding portals registered as “restricted dealer funding portals” under the integrated crowdfunding exemption. Registered dealers can amend their registration to include sales under the integrated crowdfunding exemption and there may be one registered dealer who has done so, but so far there are no active funding portals with issuers using this exemption.
There is also little to no interest by issuers in using the integrated crowdfunding exemption to raise capital. No one is using it. In fact, you would need to be a crazy person to use it if you were a tech startup or non-reporting issuer. The rule requires issuers to provide financial statements which are:
- audited or reviewed by a public accounting firm if the cumulative amount an issuer has raised under any securities exemption since its formation is $250,000 or more but is less than $750,000, or
- audited if the cumulative amount an issuer has raised under any securities exemptions since its formation is $750,000 or more.
Using a cumulative threshold pretty much guarantees most issuers considering using the exemption would require audited financial statements. This wouldn’t be so bad on its own, but if you raise capital under the integrated crowdfunding exemption once (regardless of the amount raised or type of security offered), the issuer is required to provide financial statements to its shareholders and regulators annually.
Whether these annual statements are required to be audited is based on determining each year how much an issuer has raised to date. Issuers are also required to file other continuous disclosure documents such as annual disclosure of use of proceeds, and if resident in or raising capital in Ontario, New Brunswick, and Nova Scotia, notice of key events.
There is no reasonable sunset clause to these continuous disclosure requirements. An issuer must either become a reporting issuer, wind-up or dissolve its business, or have fewer than 51 security holders worldwide before it can apply to stop these requirements.
Could you imagine raising $500,000 under the integrated crowdfunding exemption using a debt security and then be caught for the next 20 years of your business filing audited financial statements with securities regulators?
It would be a losing proposition as the cost of ongoing compliance alone could outstrip the amount actually raised.
Crowdfund Insider: Are there any types of businesses that may be inclined to use the exemption?
The integrated crowdfunding exemption is best suited for: public companies, companies considering going public in the near future, funds (other than investment funds), real estate limited partnerships, and other businesses either continually raising capital or which have a limited life span. All of these companies can take into consideration and absorb the cost of raising capital under the exemption and the cost of the ongoing continuous disclosure requirements. It’s a very narrow band of issuers, which frankly, are already being served by other existing securities law exemptions which is why you have not seen any uptake to date by these issuers in using the integrated crowdfunding exemption.
Crowdfund Insider: What about other Provinces? Any movement elsewhere?
No, none at all. The above comments apply to all of the provinces which have adopted the integrated crowdfunding exemption.
As mentioned previously, the startup crowdfunding exemption has had some use but its use has been relatively isolated compared to the use of Title III and the intrastate crowdfunding exemptions in the US. The offerings under the exemption have mainly been concentrated in British Columbia and Quebec.
The real winner over the last ten years in Canada has been the offering memorandum exemption. This exemption has been used to raise significant capital by funds, real estate issuers and private mortgage investment corporations. Well over a billion dollars per year. Two issuers alone are looking to raise almost that much in 2016, (Antrim Balanced Mortgage Fund Ltd. ($600M OM) and Capital Direct I Income Trust ($375M OM)), never mind the amounts recorded in all 62 offering memorandums filed since January 2016 (see Sedar.com & search database – companies – offering memorandum). This exemption is rarely used by other issuers than the ones mentioned above. One of the main reasons it is not used by early stage companies is that it requires audited financial statements prepared using IFRS for public companies or US GAAP if a foreign issuer. This means private companies need to convert their financial statements from private enterprise Canadian GAAP to IFRS standards.
Ontario also threw in an additional spanner in January 2016 making this exemption unattractive by requiring identical ongoing disclosure requirements as they require for issuers using the integrated crowdfunding exemption. Five other provinces joined Ontario in adopting these new requirements in May 2016. Preparing IFRS public company like financial statements is an expensive process for companies to do. If you are raising $30 million or more, no big deal. If you are raising $5 million and under it makes raising capital expensive.
Crowdfund Insider: What needs to be fixed for the crowdfunding exemption to work? What about the exemption cap?
If the purpose in adopting the integrated crowdfunding exemption was to provide another exemption for public issuers, funds, real estate issuers and mortgage investment corporations, regulators should raise the maximum offering and investment caps. Otherwise, the offering memorandum exemption makes more sense for these issuers to use when they want to raise capital from retail investors who are not otherwise accredited investors. The investments caps should be raised to $3000 or higher if someone gets suitability advice from a registered dealer.
If the purpose in adopting the integrated crowdfunding exemption was to make capital available to early stage tech, biotech, small and medium enterprises in general (SMEs), the regulators need to rethink the exemption in its entirety.
IF regulators actually want real companies to use the exemption they MUST eliminate or provide a reasonable sunset clause on requiring issuers to provide audited financial statements annually and other continuous disclosure requirements. This is a show stopper. Just think if an SME never raises capital again and they are required to file audited statements forever. It is just not worth it for SMEs to use this exemption to raise capital and to move their business forward. This exemption is DOA for use by SMEs. Only desperate SME entrepreneurs or those with broken crayons for professional advisors will ever attempt to raise capital under the integrated crowdfunding exemption, or the new Ontario offering memorandum exemption for that matter.
The same issues that plague Title III crowdfunding in the US, also plagues the integrated crowdfunding exemption in Canada. The exemption does not allow testing the water, solicitation or advertising during the campaign, low offering ($1.5 M CAN) and investment caps ($2,500 CAN), no funding portal curation allowed, portals are required to do KYC, KYP and suitability assessments, and no special purpose vehicles (SPVs). Funding portals must also remove all trace of the offering documents of an issuer at the close or withdrawal of the offering eliminating any chance of investors actually being able to independently discover and verify what capital was raised previously by an issuer. You need to know what has been said previously and the involvement of individuals in prior raises. This is a real blow, in my opinion, to investor protection.
Crowdfund Insider: Isn’t the TSX Venture exchange a diamond in the rough in Canada?
This is the missing piece to a vibrant small cap market in the US. In Canada, we have had a venture exchange for over 100 years. The existing TSX Venture Exchange is the result of several mergers of pre-existing exchanges. It is not a new exchange. The difference between the TSX Venture Exchange and an exchange like NASDAQ or NYSE Market is that the TSX Venture Exchange provides a right sized regulatory environment and structure for smaller companies to provide an active trading market for their securities for investors and at that same time build and do their business. It recognizes that for a small company to be successful you do not want independent directors. You want people whose fortunes are tied to the business. Someone on the board also needs to know how to raise capital or has deep pockets themselves. If you look at Silicon Valley, each successful startup has an investor who is willing to keep digging into their pockets or an entrepreneur that knows how to tap into angel and venture capital investors.
Biotech or tech, companies that are under $50 million in market cap that list on the TSX Venture Exchange end up getting market coverage and investment interest from institutional investors they would not get in the US. Similar companies in the US with a market cap of less than $750 million get almost no coverage by analysts and spotty investment by institutional investors.
The reason these companies experience the love in Canada is because there is not a lot of them and institutional and other investors in Canada need them for diversity in their portfolio. The US has killed off its small cap market because of the costs and risks. Unfortunately, there is a one size fits all approach by the SEC and FINRA. There are small companies that are good companies that have been orphaned in the US. Regulation A+ may bring that market back in the US. The complaint by issuers is there are not enough brokerage firms to properly market and support Regulation A+ offerings and there is a limited after-market. The OTC market has improved over the years but it is still not the first choice or the signal quality companies want to send to investors. In Canada, it is almost impossible to deposit stock that is traded on the OTC markets. This is true of all tiers of the OTC.
Crowdfund Insider: Are regulators / politicians aware of the challenge for small businesses seeking access to capital?
Canadian securities regulators invested a lot of human resources into looking at crowdfunding and crafting all three of the crowdfunding exemptions. The integrated crowdfunding exemption was based off Title III crowdfunding in the US, with a couple of fatal twists. Our regulators could not even agree on adopting at least one of the three crowdfunding exemptions in every province and territory in Canada. The lack of use of the integrated crowdfunding exemption and light use of the start-up crowdfunding exemption should be a clear signal to regulators they did not get the right balance between investor protection and access to capital. If regulators hired people with actual capital raising experience from SMEs versus big law firms and corporations they may have realized how hard it is out there for SMEs to raise capital. Getting a government or big corp paycheck is very different than working for a high growth SME that can’t pull in enough dollars through the door to fund their growth. If you are located outside Toronto or Vancouver, God Bless You for trying to build a business with limited access to investor dollars. Regulators focus on “the what if catastrophes”, businesses and investments that have gone sideways, but what they don’t see are the real businesses that are the backbone of North America. The engine that keeps 80% of people employed. If regulators continue to take the view of killing all avenues for SMEs to raise capital it won’t be just the private markets they will hurt it will be our entire economy.