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.

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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.

On the Virtues of Controlling Your Ego

Oh, the pleasures of having your ego tickled! Who is immune to that? I bet even the pope upon election cannot suppress an inner smile from having all those impressive titles bestowed upon himself. However, the trouble with startup founders is that it is so easy to ingratiate yourself with a grandiose feel-good title which often leads to unforeseen difficulties in the future.

I have been recently working with a tech startup founded by a brilliant engineer with a strong research background and interests, who adopted himself a couple of co-founders:  another engineer and a sales guy. For several years they were pursuing a bootstrapped advanced engineering design services business with its usual ups and downs, but were recently ready to turn it into a product-focused venture. As I started to work with the company a number of issues popped up related to the deceptively innocent sins from the early days of company setup.

The use of self-awarded job titles in an early-stage company could be a problem if the real qualifications do not correspond to the scale of the job title. It all starts quite innocently. The newly formed company needs formal management, so the main founder becomes the President & CEO,  a technical expert becomes VP of Engineering and the sales guy naturally becomes the VP of Sales & Marketing. This might be fine if the startup is moving at the speed of Hyperloop and the calibre of folks involved is adequate to the task – but this is rare with early-stage companies.

In this particular case, the individuals involved were all very talented but simply did not have the management or business experience to occupy these positions as the company started to grow. The problems manifested themselves at several levels:

·        Fundraising – the quality of the management team is key in any investment decision, and in this case was not passing scrutiny, but just becoming a major hurdle in raising the sought $2M round

·        Customer relationships – as the company typically had large organizations as its customers, the imbalance  of titles in the intense customer interactions was creating awkward situations when our “VPs” were often dealing either with junior corporate managers or with true senior executives; not good in either case!

·        Internal operations – with the business growth came the increase in staff hiring, HR issues, etc. and it became clear that being a brilliant engineer does not necessarily translate into a “titled” manager

·        Shareholders – having individuals as subordinates, while at the same time being major shareholders, creates tricky problems which could easily de-stabilize the company; reasonable measures and safeguards need to be put in place to protect against catastrophe

It took me, as an appointed company Chairman, quite a while and a lot of tip-toeing and gentle maneuvering to rectify this situation. We ended up re-classifying job titles as CTO, Director of Sales, and, a face-saving, Chief Designer. This created room to bring in more experienced talent to help steer the company. It goes without saying that nobody likes to feel “degraded” and it was not easy on all the fragile egos involved. It all worked out for the better but could have been avoided if only we learned to control our egos!

Take-aways from this post:

·        Members of the Founders team should go easy on the job titles and avoid loftiness incommensurate with experience

·        As a controlling Founder, be careful with the use of fancy titles, in lieu of adequate compensation, as a bait to attract talent  – it could be difficult to undo it

·        Expect and plan to bring along experienced new hires while having org chart room and job titles available

·        Don’t confuse shareholders role with the employment function; build safe guarding measures to protect from interference

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