The proposed instrument by the Canadian Securities Administrators (CSA), an umbrella network of provincial and territorial regulators, is intended to improve the harmonization of the regulatory framework for securities crowdfunding by start-ups and early stage issuers, proposes to increase the thresholds for capital-raising and investing, and eases regulatory burdens.
If adopted, National Instrument 45-110 Start-up Crowdfunding Registration and Prospectus Exemptions will replace the patchwork of local instruments and blanket orders that provide for prospectus and registration exemptions for start-up crowdfunding activities. The CSA is also considering whether to repeal Multilateral Instrument MI 45-108 Crowdfunding, which is currently available in Ontario and a number of other provinces.
Regulators are hoping that the proposed changes, which are subject to public consultation, will stimulate the equity crowdfunding market in a way that the last effort did not. In 2015, the CSA adopted a variety of crowdfunding exemptions and orders but it proved to be a dud. Approximately $3.5 million in total was raised in 70 distributions by 62 different issuers under the existing regime over a four year-stretch, according to CSA figures. Another $130,000 was raised under Alberta rules. The average investment per investor for distributions was $734, added the CSA.
“It’s clear that they needed to act,” remarked Geoffrey Cher, a Toronto lawyer who leads the digital economy initiatives at Wildeboer Dellelce LLP. “It’s a positive step forward in terms of enhancing investment limits. It’s great that they’re talking about harmonization in a way that I think will have a meaningful impact.”
But the CSA could have been more ambitious, assert securities lawyers. Its proposal would increase the maximum total amount that could be raised by a business under the crowdfunding prospectus exemption from $500,000 to $1 million. Its proposition would also raise to $2,500 from $1,500 the maximum investment a purchaser can make in an offering.
Toronto securities lawyer Barbara Hendrickson, while commending the harmonization efforts, believes that the CSA could have increased the limits.
“It’s definitely a step in the right direction,” said Hendrickson, the managing partner and founder of BAX Securities Law. “The question is whether they have raised the limits for issuers to raise per year enough and whether they’ve raised the limit for investors high enough.”
Equity crowdfunding is an expensive and highly regulated option, pointed out Hendrickson. Because under the CSA proposal the amount that individuals can invest is capped at $2,500, it can create a burden on issuers to manage large numbers of investors, added Hendrickson.
“It doesn’t make sense to have to raise $1 million and have hundreds of investors,” said Hendrickson. “It’s not practical from a corporate administration point of view. If they really want to give crowdfunding a head start, look at raising it above $1 million.”
Michael Partridge, a corporate and securities lawyer with Goodmans LLP, concurs.
“There’s probably not a lot of companies out there that think that it’s worth the effort that it takes to go through the process that’s required before you raise that money,” noted Partridge. “A million dollars is a more significant amount and that’s starting to get to what you’d typically expect companies to be raising in a customary seed-round type of financing. But it only makes a difference to companies that think that crowdfunding is a viable alternative for them in the first place.”
Equity crowdfunding, added Partridge, is normally a haven for retail investors who want to back an idea they find interesting and like the idea of having a stake in the success of a “neat” business. Sophisticated investors such as institutions have not yet been lured by the Canadian securities crowdfunding market. In order for equity crowdfunding to “really work,” Partridge believes that there needs to be less regulation than is now the case on the amounts that investors can put it in and issuers can raise.
“Until more fundamental changes are made to those types of things, it’s not going to become a significant source of funding for companies,” said Partridge.
The underlying assumptions underlying the CSA the proposal needs to be considered, added Cher. One assumption is that private companies are looking to develop a path where they go from start-up to growth to eventually an initial public offering (IPO), a strategy that large technology companies successfully adopted until the market had other ideas as was underlined by the WeWork IPO fiasco as well as the failed IPOs by Lyft and Uber. It’s also a strategy that rests on the notion that a company can grow through debt. The vast majority of activity “in terms of new platforms” coming online and the capital that has been raised come from the debt side of the balance sheet, said Cher. He would like the CSA to pay more attention “to the fact that a ton of companies that are raising capital today are doing it with debt and a big part of it is because you don’t have the restrictions there that you do here on the equity side of the ledger.”
The CSA proposal also grants an exemption from the prospectus requirement that allows a non-reporting issuer to distribute eligible securities through an online funding portal. It also provides for an exemption from the dealer registration requirement for funding portals that facilitate online distributions by issuers relying on the start-up crowdfunding prospectus exemption. That is a positive step, assert securities lawyers.
This story was originally published in The Lawyer’s Daily.