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Sean Burke and Peter-Paul Van Hoeken of FrontFundr

FrontFundr

New equity crowdfunding rules are being hailed by proponents as good news for small businesses looking to expand. However, some experts are warning crowdfunded businesses will face a big challenge in managing a broad base of retail investors.

Unlike regular crowdfunding, where people donate cash to help get a project off the ground, equity crowdfunding allows investors to buy a stake in the venture and cross their fingers for a financial return. Until recently, only accredited investors could get in on these private deals in Canada.

The changes, which are slated to come into effect on Jan. 25, are being adopted in Ontario, Manitoba, Quebec, New Brunswick and Nova Scotia. The new rules will allow companies in these provinces to raise up to $1.5-million annually, with a $2,500 ceiling for individual investors per deal. Investors in Ontario will face an annual cap of $10,000 a year for total crowdfunding investments.

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Accredited investors – those who are wealthier and have more investment holdings will be able to invest up to $25,000 per investment, although Ontario will also impose a total annual crowdfunding limit of $50,000 for individuals.

There will be no investment limit for so-called "permitted" clients in Ontario who have net financial assets above $5-million.

But despite the new rules that create a larger pool of investors, equity crowdfunding will come will its own set of headaches for a company.

"Having that many individual investors would be very difficult for a startup to manage, especially if many of the investors are inexperienced with this type of investing," says Michael Mahon, director, strategic investments and partnerships at BDC Capital.

To achieve the maximum $1.5-million investment, Mr. Mahon notes that a startup would have to crowdfund from a minimum of 60 individual accredited investors, or up to 600 retail investors.

For investors looking for future growth, that many investors documented in the company's investment ownership record or "cap table" could also be off-putting to angel investors or venture capitalists looking for a more simple capital base. It could also be challenging for companies to round up investors' approvals on the future direction of the company.

"It's a viable funding alternative, but I would encourage founders to consider where they see their growth path taking them," said Mr. Mahon, noting that equity crowdfunding should be considered one part of a startup's broader fundraising strategy.

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The new rules are a "nice to have," according to Chad Bayne, a partner and co-chairman of the emerging companies practice group at Osler Hoskin & Harcourt LLP. However, he expects few companies will use it, especially in the technology space he deals in.

"Do you really want to have hundreds of shareholders you don't even know?" Mr. Bayne says, noting that it can be a distraction, not to mention a huge administrative burden for small companies with limited resources.

"I would look at all other options before you go down this path because this is going to be an expensive way to raise capital."

Marcus Daniels, co-founder and chief executive officer of the venture-capitalist-backed accelerator Highline, said equity crowdfunding will likely be more attractive to smaller businesses not looking for massive scale, or those seeking to fill smaller financing needs.

"It allows them to collect some financing that maybe typical VCs or angel investors wouldn't touch," says Mr. Daniels.

The new crowdfunding exemption follows a similar but separate "startup exemption" that was adopted in May in B.C., Saskatchewan, Manitoba, Quebec, New Brunswick and Nova Scotia. Under the startup exemption, companies in those provinces can raise up to $500,000 per year – but no more than $250,000 in one offering. Individual investments are capped at $1,500 per deal.

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Vancouver-based investment platform FrontFundr has already started supporting companies in places like B.C., but founder and CEO Peter-Paul Van Hoeken says adding Ontario to the mix will allow him ramp up the business, given the economic might of the country's most populous province.

"Not being able to raise capital [in Ontario] has been challenging for us," said Mr. Van Hoeken. "There are a lot of startups and investors in Ontario who have been locked out of this type of investing, until now … it fits very well with our expansion plans."

Craig Asano, executive director of the National Crowdfunding Association of Canada, said the changes will "energize the emerging crowd economy," in Canada, and make it more competitive.

For example, the U.S. Securities and Exchange Commission recently approved new crowdfunding rules for startups south of the border as part of its Jumpstart Our Business Startups (JOBS) Act, enacted in 2012 to help spur small-business growth.

"It about time that Ontario, which is a juggernaut in Canada in terms of a financial centre, had a position [on equity crowdfunding] and supported it," says Mr. Asano. "We don't want to fall behind other leading countries in this space."

Yuri Navarro, executive director of the non-profit National Angel Capital Organization, likes the new rules because they allow for crowdfunding to occur "without muddying the lines with angel (accredited) investors.

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"One of our biggest concerns leading up to this was that the regulators would somehow make changes that affect accredited investors and we haven't seen anything that concerns us yet," Mr. Navarro said.

"The ultimate test will be when founders have to decide if they want dozens of small investors on their cap table, or if follow-on investors (angels and VCs) will be willing to deal with cleaning up cap tables that look that messy."

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