Crowdfunding first became popular on micro-financing sites such as Kiva.org, where the "crowd" has now lent more than $416-million to small borrowers all over the world. The loans have helped launch small businesses in developing countries with projects ranging from general stores to a herd of goats.
Crowdfunding quickly morphed into funding artistic, gaming and technology projects. Online platform Kickstarter.com, for one, has grown significantly in the past few years, with the crowd having contributed more than $450 million to posted projects.
What's amazing is that contributors have not received equity stakes in any of the businesses or any expectation of repayment. Instead, funders are provided rewards, often in the form of an end product or simply an acknowledegment.
While there have been issues with Canadians being able to list their projects on sites such as Kickstarter, Indiegogo.com has started marketing its funding platform north of the border.
Equity-based crowdfunding
With innovative startups desperate for early stage investment, and politicians looking to decrease unemployment, the United States passed the Jumpstart Our Business Startups Act (JOBS Act) more than a year ago to permit equity-based crowdfunding.
Once the act's regulations are passed, "emerging growth companies" will be allowed to raise up to $1 million (U.S.) online from up to 2,000 investors without the traditional regulatory hurdles.
The U.S. holding pattern
Although the legislation doesn't take effect until the U.S. Securities and Exchange Commission (SEC) finalizes its regulations, an entire industry has grown, almost overnight, from equity crowdfunding portals and trade associations to due diligence services such as CrowdCheck.
Most of that industry is patiently waiting for the green light, which couldn't come soon enough. While the regulations were supposed to be released by January, 2013, David Drake, founder and chairman of LDJ Capital in New York, has said he believes it won't happen until January, 2014.
In the meantime, SEC chair Elisse Walter has been calling for international co-operation to harmonize equity crowdfunding rules across international borders – a call Canadian regulators should be responding to.
Once in operation, it will significantly change the way companies are funded and increase access to capital for startups. Others have argued that by permitting equity-based crowdfunding, investment opportunities will be democratized in the sense that access to early stage investments will no longer be limited to "accredited investors."
While there are certainly risks associated with equity-based crowdfunding, particularly from an individual investor's standpoint, the crux of an earlier article, Crowdfunding – Time for Canada to Jump Onboard, was to call on provincial regulators to adopt similar crowdfunding legislation or regulations.
The risk of inaction is that it gives rise to the age-old "brain drain" argument. That is, we risk having Canadian talent and young companies lured south to raise money and create innovative new companies and jobs there.
Wheels are turning in Canada
When I wrote the above article almost a year ago, the landscape was quite bleak in Canada. In the same month, TechVibes reported that Canadian securities regulators seemed uninterested in permitting equity crowdfunding. The site interviewed Bill Rice, head of the Alberta Securities Commission, who stated that crowdfunding would be "a pretty big leap, I think, for us to take ..."
The landscape has changed. In June, 2012, the Ontario Securities Commission (OSC) released a staff notice stating that it would "consider developments in the U.S. with respect to capital raising contained in the JOBS Act."
Seven months later, in December, 2012, the OSC made the "big leap" with its own proposed crowdfunding framework or "concept" for public comment.
The OSC's concept is similar to the framework set out in the JOBS Act with some minor variances. For example, the OSC proposed that only Canadian companies, with a head office in Canada, would be able to list their securities for sale and the cap would be pushed up to $1.5 million as opposed to $1-million in the United States.
While there are a number of details that need to be hashed out, the potential for crowdfunding to grow well-built and properly financed Canadian companies cannot be understated. The potential for significant impact on economic development has been underrated. While crowdfunding has not attracted the kind of political attention it deserves, some politicians, including former Liberal party candidate Marc Garneau, are voicing public support.
The OSC's public consultation
A number of industry groups have made submissions to the OSC on its proposed framework and encouraging permission of equity crowdfunding before the SEC releases its regulations.
One of the industry groups that made submissions is the National Crowdfunding Association, or NCFA (disclosure: I sit on the advisory committee). To date, the NCFA had very positive meetings and public consultations with the OSC. While the OSC made it clear that its proposed framework does not mean it has committed to permitting crowdfunding in Canada, it has certainly taken significant and positive strides.
What your startup can do to prepare for crowdfunding
With equity crowdfunding on the horizon in both the United States and Canada, cash-starved startups at home are eagerly awaiting the opportunity to list their shares for sale on a portal of their choice. Here are five things Canadian companies can do to prepare for the significant changes that are likely coming to the way companies are funded:
1. Have a well-educated and experienced board of directors in place.
2. Consider how the crowd will realize a return on its investment. That is, does your company have the ambition to go public, to be purchased by private investors or perhaps to buy back its shares on terms favourable to investors?
3. Have a well-prepared business plan.
4. Have a prototype of your product ready for the crowd.
5. Consider how much equity you are willing to give up and whether you can "bootstrap" any longer.
John Wires is the founder of Wires Law, a firm based in Toronto focused on start-up law. He acts as a legal adviser to the National Crowdfunding Association and he writes about crowdfunding and start-up legal issues at LaunchLaw.ca. He can be reached at jwires@wireslaw.ca and on Twitter @LaunchLaw.