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Executive Summaries Aug 25, 2020

Equity Crowdfunding: An Alternative to Traditional Financing Not Enough Used by SMEs

In recent years, due to the aggressive growth of financial technologies, commonly referred to as FinTech, and of social media, a phenomenon has emerged that allows easier access to capital for individuals as well as companies or organisations: crowdfunding.*

Crowdfunding can be defined as a means of raising capital, in small amounts, from several members of the public, usually through a web portal. In most cases, this is a fairly flexible way of raising money to finance an economic, cultural, artistic or other project.

There are different types of crowdfunding such as:

  • donation;
  • reward; or
  • equity crowdfunding.

Equity crowdfunding is especially interesting for startups or small and medium-sized enterprises (SMEs). The main feature that sets equity crowdfunding apart from more “traditional” crowdfunding is that members of the public, who actually are investors, will, for their financial contribution, obtain shares, debt or other eligible securities in the business in which they invest.

This underwriting transaction is made through an equity crowdfunding portal, which acts as an intermediary between the company - or issuer - and the investors. By offering the project’s holder the opportunity to establish direct connections with the contributors, the equity crowdfunding portal helps to avoid traditional intermediaries like financial institutions and investment brokers, at least on the surface. In the province of Quebec, eight equity crowdfunding portals are currently offering their services, of which only one is registered as a broker.

An Alternative to Traditional Financing That Is Accessible but Rarely Used

Equity crowdfunding offers an alternative to more traditional means of financing businesses, such as those offered by banks, venture capital companies or angel investors, among others. The growing attractiveness of equity crowdfunding from a legislator’s and regulator’s point of view over the last few years can thus be explained by the economic fallout from the 2007-2008 financial crisis and by the reluctance of banks and other traditional financing providers to inject money into the economy in the form of loans to private companies.

Unlike other forms of crowdfunding, which are mostluy unregulated, equity crowdfunding is subject to a number of regulations. However, so far, this “new” method of financing businesses has had little success. This can probably be explained by the general lack of information on the subject or by a sometimes inadequate and restrictive regulatory framework.

The Canadian Securities Administrators (the “CSA”) have recently confirmed the limited expansion of equity crowdfunding in Canada: the number financed projects is small and their amount is limited. In the CSA notice of consultation published on February 27, 2020, for a proposed National Instrument 45-110 respecting Start-up Crowdfunding Registration and Prospectus Exemptions, the CSA quantified equity crowdfunding as of December 31, 2019, as follows:

  • 11 funding portals have relied on the registration exemption under the startup crowdfunding blanket orders in order to establish platforms;
  • A total of 70 distributions have been completed in reliance on the prospectus exemption under the startup crowdfunding blanket orders by 62 different issuers;
  • the aggregate proceeds of all distributions made under the startup crowdfunding blanket orders is $3,470,754 ($4,709,919 including the amounts raised with other prospectus exemptions as part of the same crowdfunding offering);
  • the average investment amount per investor for distributions made in reliance of the startup crowdfunding blanket orders is $734; and
  • no one has taken advantage of the regime introduced by Regulation 45-108 respecting Crowdfunding.

Nevertheless, in the current economic conjuncture characterized by a global economic downturn caused by the COVID-19 pandemic, it may be even more relevant for financially distressed companies to use one of the various regimes surrounding equity crowdfunding than ever before. Such financing is a valuable tool to help them get out of their financial difficulties. Now would be the perfect time for the CSA to complete the process surrounding the enactment of the new regulation on equity crowdfunding, i.e., draft Regulation 45-110 respecting Start-up Crowdfunding Registration and Prospectus Exemptions, so that Quebec and Canadian startups can use this capitalization instrument to secure their current and future activities.

Should you have any questions regarding this article or corporate financing in general, please do not hesitate to contact our corporate finance and securities team.

 

* This article is written jointly with Ivan Tchotourian, associate professor at the Faculty of Law of Université Laval and co-director of the Centre d'études en droit économique (CÉDÉ).

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