There has been a lot of news of late regarding crowdfunding and the ability of companies and individuals to raise money for their projects online. However, the term “crowdfuding” is confusing as it can refer to many different types of online fundraising activities; some of which are viable capital raising options for Canadian companies, and some of which are not.
Crowdfunding most commonly refers to the act of raising money for creative projects and/or charity causes on sites like www.Kickstarter.com, www.Peerbackers.com, www.Kapipal.com, www.indiegogo.com, www.chip-in.com (I will refer to this as “Reward Based Crowdfunding”). Reward Based Crowdfunding does not involve the sale of securities or the sharing of profits, but rather the granting of some type of reward or non-monetary benefit in return for a small contribution. Reward Based Crowdfunding is generally small; the most common contribution is normally less than $25.00 and projects generally raise an average of not more than $5,000.00, with some notable exceptions like the Pebble Smartwatch project which raised more than $10 million through Kickstarter. Therefore, unless you are a start-up consumer electronic company with an inexpensive prototype which you are trying to bring to market and/or pre-sell, Reward Based Crowdfunding may not be the ideal place to raise a decent amount of early stage capital ($250,000 to $1,000,000).
Crowdfunding can sometimes also refer to the act of raising short term debt on internet sites like www.40billion.com and www.ibank.com (I will refer to this as “Short-Term Debt Crowdfunding’). Short-Term Debt Crowdfunding does not normally involve the sale of a security because in most jurisdictions short term debt is not defined as a security. However, in my opinion these sites are not the ideal place to raise a decent amount of early stage capital either, as most debt offerings of this type (if successful) don’t raise a lot of money, come with relatively short repayment terms and relatively high interest rates.
More recently, Crowdfunding has begun to refer to as the act of raising equity capital on the internet. Although this activity is prohibited in many jurisdictions, including Canada, it recently became legal in the United States (and in certain European jurisdictions like the U.K.). In 2012 President Barrack Obama signed the U.S. Jumpstart Our Business Startups Act, or the JOBS Act, which among other things, created the opportunity for companies to raise equity capital from investors in the United States using the internet. Under the JOBS Act, this type of equity Crowdfunding will be permitted to take place in two different ways: (i) through SEC Registered crowdfunding platforms (I will refer to this as “Section 4(6) Crowdfunding”), or (ii) directly by companies exclusively to U.S. Accredited Investors (I will refer to this as “Rule 506 Crowdfunding”).
The JOBS Act created a brand new exemption under Section 4(6) of the US Securities Act, which provides an exemption from the registration requirements of the U.S. Securities Act of 1933 for offerings made through U.S. registered broker dealers and/or SEC registered Crowdfunding platforms. Under the Section 4(6) Crowdfunding exemption, U.S. companies can raise up to $1 million dollars on the internet within any 12 month period, provided that they (i) raise no more than $2,000 from each investor or 5% of the annual net worth or income of such investor (if either the annual income or the net worth of the investor is less than $100,000), or no more than 10% of the annual net worth or income of such investor (if the annual income and the net worth of the investor is more than or equal to $100,000), (ii) file with the SEC and provide certain disclosures to investors and the relevant U.S. registered broker-dealer or SEC registered Crowdfunding funding portal concerning, among other items, the company business, business plan, pricing, ownership, capital structure, valuation, risk factors, financial condition, intended use of proceeds and target offering amount, and (iii) conduct the Section 4(6) Crowdfunding offering through a U.S. registered broker dealer or SEC registered Crowdfunding portal. Canadian companies should note that the Section 4(6) Crowdfunding exemption will not be available to non-U.S. issuers, U.S. public companies, or investment companies, and that the SEC has not yet published all of the applicable regulations for Section 4(6) Crowdfunding, and therefore that Section 4(6) Crowdfunding is not yet permitted. The SEC is not expected to publish regulations on Section 4(6) Crowdfunding until the end of 2012 or the beginning of 2013.
The other new exemption created by the JOBS Act, which is available to Canadian companies, is the Rule 506 Crowdfunding exemption. Under the Rule 506 Crowdfunding exemption Canadian companies will be able to access an unlimited amount of capital from online investors; provided that (i) all online investors are located in the United States (i.e., are U.S. Persons), (ii) all online investors are U.S. Accredited Investors (and for Canadian companies, also Canadian Accredited Investors – the definition is very similar but not the same), and (iii) no more than 2,000 investors are allowed to invest in the company (breaching the 2,000 shareholder limit will require the company to register as a public company in the U.S. (like Facebook had to do)).
Under both of these new Crowdfunding exemptions, companies will be allowed for the first time to conduct advertising in connection with such offerings, which will allow them to buy online advertising, and use all of their links on Twitter, Facebook, Pintrest and other social media sites, including their website, to promote their Crowdfunding offerings.
This is a brave new world, which will dramatically increase access to U.S. capital for early stage and start-up Canadian companies. Let’s just hope that Canadian provincial securities regulators will jump on the bandwagon and allow equity Crowdfunding offerings to be made to Canadian investors in the not too distant future as well.