Imagine you’ve just come up with a great idea for a new product and you can’t wait to start designing, building, and selling it on the market. There’s only one problem: you need money to start your project. You’re still paying off student loans, your parents are saving up for their retirement, and your friends are off enjoying “funemployment.” You’ve tried pitching the project to high net-worth investors, including venture capitalists and angel investors, but they say that there’s too much risk to invest.
This is where crowdfunding comes in. Crowdfunding involves small businesses and entrepreneurs pitching their new project on a website, and raising funds from the broader public. Crowdfunding allows smaller startups to gather investors outside of the realm of family, friends, high-worth investors, and initial public offerings (IPOs). Within crowdfunding, there are a range of different models that startups can use.
The first model is the donation-based system featured on websites such as Indiegogo and Kickstarter. Entrepreneurs pitch their project with a funding goal and a few non-monetary incentives for investors. For example, a Kickstarter project for the computer game Obduction has a funding goal of $1.1 million, and pledging $45 or more gets you a strategy guide, a digital artbook, and a soundtrack from the game. The basic premise of the donation-based system is that investors do not gain ownership of the company; rather, they simply make donations and then receive non-monetary incentives.
The second model is the equity-based system of crowdfunding. Though less well known, there are successful examples such as U.K.-based Crowdcube. The facilitation of crowdfunding occurs through the same medium: entrepreneurs pitch their idea on a website to the public. However, in this model, the investor receives equity from the startup. When we think of equity, we often think of IPOs, which can be very expensive due to legal and accounting fees needed for a full prospectus disclosure. The equity-based crowdfunding model essentially allows startups to have their own makeshift IPO. They still have to go through a vetting process similarly to IPOs, but it is less strict and significantly less costly.
While the donation-based model is legal in Canada and in the U.S., the equity-based system is only legal in Australia, the U.K., Netherlands, France, Belgium, and Germany. In the U.S., there is rapid movement towards equity crowdfunding through the Jumpstart Our Business Startups (JOBS) Act which passed through the Senate in 2012. Since then, the U.S. Securities and Exchange Commission (SEC) has opened equity crowdfunding only to “accredited investors”–those with over $1 million of net worth–and closed equity crowdfunding to the general public. The SEC is looking to extend equity crowdfunding to non-accredited investors, but needs to establish rules and regulations to ensure that investors do not face risks of fraud or low returns.
Meanwhile, the Canadian Securities Administrators (CSA), which co-ordinates provincial securities commissions, is taking a wait-and-see attitude according to CSA Chairmain Bill Rice. Provincially, the Ontario Securities Commission (OSC) has launched a review process of equity crowdfunding in a Canadian framework. The OSC understands the benefits of crowdfunding for startups, but like the SEC, is concerned about the financial risks associated with it.
The Ontario government has already shown support for the move towards crowdfunding. At a Technicity conference last year, the former Minister of Economics Development and Innovation, Brad Duguid, highlighted the need to keep up with competitors: “With the U.S. heading in this direction, it’s really important that Ontario keep pace if not even try to get out in front if we can do that in a way that ensures protection for consumers and investors” he said. At this point, the implementation of the equity crowdfunding model lies largely on the coordination of the 13 regulators around the country. While it is understandable that there are risks and securities commissions needed to protect the pockets of the general public, there is also a sense of urgency in not being left behind.
Equity crowdfunding would allow Canadian startups to keep in pace with American ones, or even close the gap between the two countries in innovation and startup funding. Canadian Advanced Technology Alliance (CATA) President John Reid noted that if the U.S. moves toward the equity crowdfunding model before Canada, our entrepreneurs may start heading south for cash. Additionally, the National Crowdfunding Association of Canada (NCA) stressed the need for crowdfunding to fill the gap in Canadian venture capital, which has fallen by 80% since the $6 billion peak in 2000.
This innovative model could open startups to a whole new market of investors ready to fork over cash for exciting projects. Unaccredited investors–everyday people like you and me–could have an impact on new ideas and initiatives by Canadians. There is an obvious challenge for securities commissions to find the right balance between protecting investors and the ease of investing, but this is the opportunity to turn the general public into one big Dragon’s Den.
Wesley Anam is a 2015 Master of Public Policy Candidate at the University of Toronto’s School of Public Policy and Governance. He holds a BA (Honours) in Economics from the University of Waterloo, and has worked as a Research Analyst at the Ontario Ministry of Finance. He is interested in microeconomic policy aimed at enhancing market efficiency.