Friday February 14, 2014

What You Need to Know About Crowdfunding

Authored by: Ted R. Sawa Posted in: Legal Updates

Crowdfunding is a coined word to describe an increasingly popular method for raising money using the Internet.  In a report published in January 2014 by TD Economics, the global crowdfunding market is estimated to be worth $3.25 billion. The website Indiegogo is perhaps one of the better known examples of a portal to assist people and groups looking for alternative sources of financing. There are many examples of donation crowdfunding – or online organized efforts to raise money for not-for-profit purposes. Using crowdfunding for commercial capital raising purposes has lead securities regulators, principally the SEC in the U.S., to set rules on how crowdfunding can operate within existing models of securities regulation.

Some clever entrepreneurs have come up with donation-based crowdfunding in order to raise capital for new businesses without getting entangled in traditional securities regulation, which might require them to engage in onerous disclosure and compliance regimes.   Under the donation crowdfunding model, instead of purchasing shares or other forms of traditional security, an investor may be rewarded with public recognition, or a product (such as a lifetime membership or discount).

While donation crowdfunding raises some unique issues (such as how to report the funds received for tax purposes and whether GST/HST must be charged on products provided to donors), because no securities are issued, securities regulators do not regulate this activity.

Crowdfunding that involves issuing securities to investors is regulated in Canada by provincial securities commissions. The role of the commissions is to protect members of the general public from unscrupulous fundraising.  In general, a company must file a prospectus, or a significant disclosure document, before issuing securities to the public unless the company can rely on one of several specific exemptions from this requirement.  At present, no province except Saskatchewan has a crowdfunding exemption that would permit a company to issue securities via crowdfunding without the requirement to file a prospectus.

On December 6, 2013, Saskatchewan became the first province to establish specific rules for a crowdfunding exemption.  The Ontario Securities Commission has announced that in the first quarter of 2014 it will publish a draft crowdfunding exemption for comment. These developments confirm that crowdfunding is gaining momentum in Canada.

Being first out of the gate, the Saskatchewan exemption illustrates the challenges in developing workable crowdfunding regulation in Canada, where each province regulates the distribution of securities within its borders. The main elements of the Saskatchewan exemption are:

Only companies and individuals resident in Saskatchewan can invest by this method. 
There are limits on the amount of capital a company can raise and how much an individual can invest.  
Companies must provide specific information about the investment opportunity so that investors are sufficiently informed.
The website/funding portal must be independent from the companies raising capital and must ensure that investors and companies are complying with the regulations (such as investment limits).

The fact that a province can regulate only activity taking place within its borders is somewhat ironic in that the power of crowdfunding via the Internet is premised on the global reach of the Internet.  The regulation of crowdfunding for traditional capital raising is still in its early stages in Canada, and in Nova Scotia in particular the provincial regulator is watching these developments but has no present plan to introduce regulation.  Therefore, entrepreneurs investigating the possibility of raising money through crowdfunding should definitely seek legal advice before embarking on such activity.

For further information about sources of business financing and the regulation of securities in Nova Scotia, please contact a member of our Business Law team.

Claire E. Milton, Q.C.
Phone: 902.460.3412

Ted R. Sawa
Phone: 902.460.3437

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