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Attracting a crowd

Understanding alternative financing.


453691415Crowdfunding has enormous potential as a financing alternative for Canadian startups, micro-enterprises and small and medium-sized businesses. It connects entrepreneurs with the cash they need to fund ideas or products through the “crowd” while enhancing the country’s underdeveloped venture capital market, according to a report by TD Economics.

For manufacturers, growth in the Canadian crowdfunding market could enhance their ability to attract the investments they need for new equipment, R&D and even production of a new product at a time when too many regulatory barriers and a starved venture capital market have obstructed their routes to traditional financing.

Venture capital funds and investments in Canada have been declining, and seed-stage and startups are particularly hungry, having obtained just 16% of overall venture capital raised in 2007, says TD Economics economist Sonya Gulati.

Between 2000 and 2010, 25% of small businesses looked to external financing for operational expenses each year, most of which were young, innovative, growth-oriented and R&D intensive, according to an Industry Canada report. It concluded public policy action would improve access to financing and help these kinds of businesses reach their full potential.

According to professional services firm Deloitte, global investors put US$3 billion towards crowdfunding projects in 2013. Massolution, an advisory and implementation firm that specializes in projects funded by the crowd, pegs that figure closer to US$5.1 billion, which would amount to an 81% increase over 2012. It says the number of worldwide platforms increased by 54% in 2011 and by 60% in 2012.

Based on estimates by the International Economic Development Council, crowdfunding could create 60 million new angel investors in the US alone, an increase of 1,000% from current numbers.

Success stories include the Pebble e-paper watch in the US, which connects to smartphones via Bluetooth to alerts with a silent vibration. The project attracted 68,929 backers that pledged more than $10.2 million to get the watches manufactured – way ahead of its initial $100,000 funding goal.

In Canada, Colt Hockey and technology licensor Integran Technologies Inc. took to Kickstarter Canada to raise the money needed to manufacture its “unbreakable” hockey sticks in 2013. The stick, which had an initial funding goal of $75,000, generated $100,672.

“Crowdfunding powers business growth and is a strong economic generator for start-ups and SMEs who need capital and investors to fuel to compete globally,” says Debra Chanda, president of funding portal Launch 120, and an advisor at the National Crowdfunding Association of Canada (NCFA).

There are now 92 portals and services providers in Canada, 65% of which reside in BC and Ontario, according to the NCFA.
It’s equity crowdfunding has piqued the interest of securities regulators, and will require rules to protect investors against rampant fraud. Advocates, however, argue over-regulation will hamper the growth of what they call the future of raising startup capital in Canada.

In Australia, where equity crowdfunding has been allowed for five years, its leading portal ASSOB (Australian Small Scale Offerings Board) has raised more than $130 million in seed and growth capital for over 130 companies, of which 83% are still operating without a single incident of fraud.

Meanwhile, the Jumpstart Our Business Startups (JOBS) Act was signed into US law in April 2012 to boost job creation by improving access to capital for public and non-public companies, and now exempts crowdfunding participants from the registration requirements of the Securities Act of 1933. The legislation allows companies to offer up to US$1 million in securities to the general public. Last October, the Securities Exchange Commission (SEC) lifted an 80-year ban on general solicitation, which gives American businesses permission to publicly advertise capital needs.

Raising capital
Canada has jumped onboard. On March 20, the Ontario Securities Commission (OSC) along with six other provincial regulators in BC, Manitoba, Quebec, Saskatchewan, New Brunswick and Nova Scotia, outlined proposed rules to regulate the raising of limited amounts of capital and selling of shares.

Rules differ between each province, but the OSC’s proposition would allow companies to raise a maximum of $1.5 million in equity in any 12-month period. Individuals would be allowed to invest no more than $2,500 into a single project, to a maximum of $10,000 per year. In BC, companies would be allowed to raise only $150,000 per offering, twice a year. Investors would be limited to a maximum of $1,500 in a single offering.

Canadian crowdfunding sites or portals would have to be registered with securities commissions as “restricted dealers” and comply with minimum capital and insurance requirements as well as various reporting rules. They will also be required to do background checks on companies and their directors and officers.

The OSC says it will be the responsibility of the portal to shut out issuers it believes to be fraudulent.

The rules are now subject to a 90-day comment period.

Canada’s crowdfunding industry has welcomed the proposals, but says the regulations need some fine tuning, such as the provision that would not allow portals registered under existing securities rules to take advantage of the new registration. They say the provision could make raising capital more expensive as companies would need to pay fees for both.

For regulation to be a net positive, regulatory and compliance costs must be lower than those of traditional financing channels, Gulati writes.

But regulators can’t drag their feet, she says. Over-regulation will hamper growth and force entrepreneurs to shift their focus to jurisdictions that embrace the model.

Although crowdfunding offers support for out-of-the-box ideas and innovation, how well it drives entrepreneurship and economic growth will depend on regulating it properly.

For more information on equity crowdfunding, including rules and regulations, visit the National Crowdfunding Association of Canada.

Read Gulati’s report, Crowdfunding: a kickstarter for start-ups.

Find this article in the April 2014 issue of PLANT.

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