Equity Crowdfunding Comes to Ontario – finally!

Canadian-100-dollar-billsThis could be big, really BIG! For entrepreneurs and startup founders this could be a monumental change, potentially opening the floodgates onto the dry and barren land of seed funding. At the very least it should offer new options for cash-starved startups and early-stage businesses. The recently proposed (as of March 20, 2014) Ontario Securities Commission (OSC) new set of regulations provides for

“a crowdfunding exemption that would allow businesses, particularly start-ups and early stage businesses, to raise capital from a potentially large number of investors through an online platform registered with the securities regulators.”

More specifically, this ‘Crowdfunding Exemption’ would allow startups and SMEs to raise up to $1.5M per 12 month calendar year with investors being able to invest up to $2,500 per deal and up to $10,000 per year.

Why is this so important, then? The issue is that under the current Canadian securities laws, startups can only raise money by selling equity in their business to so-called “accredited investors,” who are strictly defined and typically include family members, angel investment firms or venture capitalists. Should you wish to raise funds from a broader circle of individual investors, your company needs to go through a process of stock listing on a publicly traded exchange that is normally prohibitive to a startup.

The advancements in internet technology, however, make it possible these days to approach and raise the required capital in small amounts from a much broader group of individuals. Why is this approach relevant? It all has to do with risk management and sharing. To illustrate the issue let me quote from my article recently published in The Ottawa Citizen.

“Let’s say I need to raise $0.5M for my startup. I go to you and ask you for the whole sum or just a $100K chunk. Even assuming you have the means, you are going to agonize at length over your decision. However, if I ask you to invest $10-15K, you will spend far less time worrying and be much more predisposed to take the chance. By employing this tactic, an entrepreneur will likely raise her $0.5M because the risk is shared among many investors and each of them does not risk that much.

This is exactly how I raised, some time ago, angels financing for ATMOS Corp. I brought in about 20 private investors, with each contributing between $10K and $25K. The beauty of this approach is that nobody is going to loose sleep and the entrepreneur gets his objective accomplished. In fact, this is the same principle in action that powers the IPOs and syndicated VC rounds albeit in a smaller scale. It works, therefore, use it.”

The key to increase seed financing in this country is to implement some practical systemic initiatives. People respond to incentives. If we want to encourage seed funding to enable entrepreneurship and startups we need to create incentives which reward financial risk taking. The OSC proposal is a good step forward to create a viable framework enhancing options for seed investing. The Canadian Advanced Technology Alliance (CATA) led by John Reid should be congratulated for spearheading the industry lobbying effort. Not to rest on laurels, the Angel Investment Incentives initiative should be advocated, advanced and implemented next. With these two in place we would have a really strong system platform to support the entrepreneurial startup culture in Ontario.
Nevertheless, some folks are concerned about a potential for fraud and taking advantage of un-sophisticated investors. Would you agree that the advantages outweigh the risks? What do you think?

PS
The Notice and Request for Comment is available for public consultation on the OSC website www.osc.gov.on.ca and the comment period runs until June 18, 2014.

Advertisements

Angel Investment Incentives – Blueprint for Ontario

There is no point in re-inventing the wheel. The existing time-proven British Columbia Equity Capital Program (BCECP) provides excellent blueprints to be adopted by the  Government of Ontario following its election promises (see this post).

The program provides individual investors (angels) incentives by way of a refundable tax credit when they invest in eligible small business. The highlights of this program include:

  • 30% refundable cash credit (good as cash) with a maximum of $200,000 investment for a maximum annual tax credit of $60,000 per individual investor
  • Ability to invest directly, or in a holding company known as a Venture Capital Corporation (VCC), which in turn can invest in one or more eligible businesses
  • RRSP eligibility for VCC shares which can drive max tax savings up to 74% !
  • Hassle factor – low; apparently administration of the program is fairly smooth with a minimum of red tape

More details on the BCECP program can be found in this succinct overview.

As a support document for the policy-makers there is an excellent recent study published by the Ministry on the effectiveness of the BCECP program.

A program like this implemented in Ontario would do wonders to re-invigorate our stagnating high-tech ventures, resulting in great economic benefits for everybody. There was an initiative earlier this year involving Terry Matthews of Wesley Clover and Bruce Lazenby of Invest Ottawa to have this included in the last provincial budget but it fell through. Now is the time to try again.

So, what are we waiting for? Let’s push our elected politicians to fulfill on their promises and provide support for startups, small business, and new ventures.

How Can Canadian Startups Access AngelList?

The recent phenomenon of AngelList in the US holds a promise of revolutionizing seed funding for startups. The reason for it is three-fold: it addresses the toughest stage of startups – I call it “Two guys and a piece of paper” – financing, it applies the effective principle of risk-sharing, and thanks to the recently passed US JOBS act, it uses a legal framework which makes it palatable to the investors and founders. With the recent addition of the syndication mechanism it all works even better. The question is how could Canadian (or other non-US) startups access it and benefit from this nirvana?

There are at least two practical issues to address:

  • The legality of fundraising through the sale of equity under Canadian laws. The issue is that under the current Canadian securities laws, startups can only raise money by selling equity in their business to so-called “accredited investors,” who are strictly defined and typically include family members, angel investment firms, or venture capitalists. Should you wish to raise funds from a broader circle of individual investors, your company needs to go through a process of stock listing on a publicly traded exchange that is normally prohibitive to the startup. Alternatively, you need to operate under an exemption. More details on that are available in an excellent and succinct six-page document, “General Overview of Canadian Securities Laws Relating to Raising Capital By Early Stage Companies” prepared by FMC Law, members of the CrowdSourcing Advocacy Committee of CATA, and available through their office. Are there any other complications when soliciting funds in the US?
  • The practicality and the effectiveness of a Canadian startup (“Two guys and a piece of paper”) raising funds in the US market. Clearly, investing abroad in an unknown entity is yet another hurdle to overcome for US investors. The reality is that only a few sophisticated US investors would feel comfortable in this scenario.

One of the solutions to these concerns might be a structure involving a US holding parent company, say a Delaware corporation. That way the US parent corporation receives the investment through AngelList and flows through the funds to its Canadian subsidiary which is the operating entity. A structure like this might even qualify as a CCPC for tax purposes. In addition, we get the benefit of the generous Canadian SRED refund for R&D expenses (up to 65%) while simplifying a potential liquidity event (exit) for the benefit of the US investors. I have used an investment structure like this in one of my previous ventures and can vouch that the complexity and the cost overhead is quite reasonable.

So, since the issues around AngelList are new and fresh, now is your chance to weigh in. Please share your experience, thoughts, and views in the Comments section below.

Rise of the $10 Million VC Seed Fund

This trend could be helpful in cash-poor Ottawa where we already start seeing micro-funds such as Lionica, Mistral, and others ‘under construction’.

David Cummings on Startups

With the massive drop in cost to start a tech company, combined with successful VCs raising larger funds requiring bigger investments, there opened up an opportunity in the market for super angel / VC seed funds. In Atlanta alone we’ve seen several new funds within the past 12 months in the $10 million – $20 million range including Mosley Ventures, BIP Early Stage Fund, and Forté Ventures.

Here are a few characteristics of the $10 million VC seed fund:

  • Sole general partner that makes the decisions and runs the fund
  • Ability to move faster than both angels and traditional VCs since they have committed capital and don’t have a consensus decision making process
  • Invests $200k – $500k and can go up to $2 million
  • Example investment strategy might be 10 $400k investments ($4 million) and six $1 million follow-on investments (it’ll likely be more nuanced with varying levels of…

View original post 108 more words

The battle of crowdfunding in Canada

There is a fierce battle going on right now in Canada’s high-tech sector, lobbying for the legislative changes in the country’s security laws to enact, so-called crowdfunding” or “crowdsourcing” legislation, which would permit Canadian entrepreneurs to raise up to $1M for their startups in small chunks solicited (often over the Internet) from a fairly large number of individuals.

What is the problem, then?
 The issue is that under the current Canadian securities laws, startups can only raise money by selling equity in their business to so-called “accredited investors,” who are strictly defined and typically include family members, angel investment firms or venture capitalists. Should you wish to raise funds from a broader circle of individual investors, your company needs to go through a process of stock listing on a publicly traded exchange that is normally prohibitive to the startup. More details on that is available in an excellent and succinct six-page document, “General Overview of Canadian Securities Laws Relating to Raising Capital By Early Stage Companies” prepared by FMC Law, members of the CrowdSourcing Advocacy Committee of CATA and available through their office.

The advancements in internet technology, however, make it possible these days to approach and raise the required capital in small amounts from a much broader group of individuals. Why is this approach important? 
It all has to do with risk management and sharing. To illustrate the issue let me quote from my article recently published in The Ottawa Citizen.

“Let’s say I need to raise $0.5M for my startup. I go to you and ask you for the whole sum or just a $100K chunk. Even assuming you have the means, you are going to agonize at length over your decision. However, if I ask you to invest $10-15K, you will spend far less time worrying and be much more predisposed to take the chance. By employing this tactic, an entrepreneur will likely raise her $0.5M because the risk is shared among many investors and each of them does not risk that much.

This is exactly how I raised, some time ago, angels financing for ATMOS Corp. I brought in about 20 private investors, with each contributing between $10K and $25K. The beauty of this approach is that nobody is going to loose sleep and the entrepreneur gets his objective accomplished. In fact, this is the same principle in action that powers the IPOs and syndicated VC rounds albeit in a smaller scale. It works, therefore, use it.”

As is often the case, our American friends are much faster on their feet and have already kick-started the required changes by the U.S. President Obama enacting the Jumpstart Our Business Startups (JOBS) Act
 on April 5, 2012. The act includes provisions to relax rules around online equity crowdfunding and will allow businesses to raise up to $1-million  via online “funding portals”. There is a real risk of Canada falling behind on the legislative side but also, more importantly, of having Canadian startups falling behind their competitors in the US.  Recently, Andrea Johnson, Partner with Fraser Milner Casgrain, summarized nicely the risks of falling behind the U.S. in this video interview with BNN.

Given that, unlike the US, Canada has no federal securities regulator and
 instead, securities are regulated at the provincial  level, we are likely looking at a rather fragmented approach to this problem –  with some provinces taking the lead and others a wait-and-see approach. In a typical fashion, it will likely take about 2 years for Canada to get its act together and catch up. The only bright side and some hope is the energetic lobbying campaign currently underway conducted by  the Canadian Advanced Technology Alliance (CATA) led by John Reid, president and chief executive officer. They deserve our strong support so take action today by writing and talking to your MPP or MP!

In a broader context of supporting and fostering entrepreneurial culture, why do we often
 have to be so reactive and lackadaisical in Canada? We need to create conditions in this country which encourage and make it easy to pursue new, especially knowledge-based, business creation. How about Canada as a startup nation? We already have a reasonably solid R&D infrastructure, we have system incentives, through the SRED mechanism, to encourage innovation. What we do not have are strong financial incentives that support risk- taking and capital raising for early-stage companies. This is not rocket science, a number of attractive measures have been put forward, including the proposed angel financing tax credit or these crowdfunding ideas. We need to lobby our politicians to take action now!

Seed funding and Ontario politics

No matter what your personal political convictions or choices are, if you are a technology entrepreneur you need to be paying attention to what is being proposed, if anything, by the major parties in the current provincial elections in Ontario. What is at stake here is the dismal state of capital funding for high-tech startups which has dropped down by a factor of 10 over the last decade.

What is the essence of difficulty with seed funding? It all has to do with risk and risk management. It goes without saying that at the seed stage risks are enormous and, what is worse, they are hard to mitigate. For all practical purposes, it means therefore that the risk will stay high and is unavoidable. Now, on the other hand, many, though certainly not all, innovative early-stage companies hold an allure of “changing the world” and bringing high financial pay-offs to their investors.

Certainly from the societal standpoint it is a good thing to create and invest in innovative companies. In fact, there seems to be some hard economic data for Canada, which indicates that “40% of new jobs is created by young companies which make up about 4% of businesses.” Clearly, finding a workable mechanism which would ease the pain of raising seed funding and provide practical incentives to investors, should result in increased new business formation and therefore significant economic benefits which would contribute to the prosperity of all of us.

So, what is happening on the political stage in Ontario in this context? Well, it appears that just about the only proposal to address these issues is coming from the Liberals. Glen Murray, the Ontario Minister of Research and Innovation, recently proposed
the “angel investment” incentives program which would offer tax credits for individuals contributing seed capital to fledgling startups. The details are somewhat vague and will need to be worked out but, as an example, someone investing $100,000 in a startup could get a 25-per-cent tax credit.

Apparently, this plan is modelled on a similar one which has been in operation for 10 years in British Columbia and has proven to be successful while costing the province something like $30 million a year.
If implemented sensibly and within a reasonable time this plan could really make a difference and help immensely. It would provide incentives to people willing to take a risk – and seed funding new companies is all about risk management and sharing.

To illustrate principles, let’s say I need to raise $0.5M for my startup. If I go to you and ask you for the whole $0.5M or just a $100K chunk, even assuming you have the means, you are going to ponder this and agonize over the decision endlessly. However, if I go and ask you to invest $10-15K, you are going to spend far less time worrying about it and will be much more predisposed to take flight. Thus by employing this tactic, an entrepreneur will likely raise their $0.5M because the risk is shared among many investors and each of them does not risk that much individually.

This is exactly how I had raised angels financing for ATMOS Corp by bringing in about 20 private investors, each of whom on average contributed anywhere between $10K and $25K. The beauty of this approach is that nobody is going to lose sleep and the entrepreneur gets his/her objective accomplished. In fact, this is the same principle in action that powers the IPOs and syndicated VC rounds, albeit in a smaller scale. It works, therefore, use it. Of course, there are some pitfalls to watch, such as government regulations, accredited investors requirements etc., but these can be navigated around.

The key in seed funding is to incentivize and reward risk taking. It is disappointing that other political parties are not paying attention to this important issue. The current Ontario Liberals proposal is addressing this need well. Let’s hope we shall see it implemented without much delay.
%d bloggers like this: