Since, early 2016 regulatory authorities have allowed a new “equity” based vehicle for the online matching of Canadian investors with Canadian entrepreneurs. While not restricted to larger issuers, the new crowdfunding regulations are aimed at small and medium-sized businesses looking to raise equity capital online.
History and Background of Crowdfunding
Crowdfunding is described as the practice of funding a project through the raising of funds, with small donations, from a large number of people. Traditional crowdfunding is an alternative type of financing accomplished outside of the traditional financial system. Three things are needed for a crowdfunding initiative:
- A project initiator
- Likeminded individuals or groups who support the idea
- An organization or platform that can bring the parties together for a successful undertaking.
Some of the more notable crowdfunding projects before the Internet were:
- Johann Heinrich Zedler who in 1728 offered the works of Martin Luther by selling subscriptions before the publication. The donors received a copy of the manuscript at a discounted price after it was published.
- In 1885 the Statue of Liberty was funded by publisher Joseph Pulitzer who used the New York World newspaper to petition the public to fund the project. He offered a series of rewards that was determined by the size of the donation e.g. a one dollar donation received a six-inch statue and a five dollar donation received a twelve inch statue.
- During the U.S. civil war the Southern states used crowdfunding to purchase iron clad warships. Southern women made and sold quilts to fund the purchase of the ships.
- In the 1920’s Aimee Semple McPherson, an evangelistic minister, launched a campaign to raise funds for a radio transmitter through a magazine called Bridal Call. Asking the donors to “Help Convert the World by Radio” she raised $25,000 to build a broadcasting facility.
In 1997 a British rock band funded their reunion tour through online donations from fans. In this case the band was the initiator, the fans were the group and the Internet was the platform. From this start ArtistShare http://www.artistshare.com/v4/ became the first dedicated crowdfunding platform in the year 2000. From that start the crowdfunding industry has grown exponentially year by year. According to Marketwired – March 31, 2015, Massolution®, a research firm specializing in the crowdsourcing and crowdfunding industries, revealed that $16.2 billion was raised worldwide in 2014. North American crowdfunding volumes grew 145% to $9.46 billion.
Crowdfunding Models
The main crowdfunding models are:
- Donation-based
- Rewards-based or pre-purchase based
- Peer-to-peer lending based
- Securities or equity based
Donation-based Crowdfunding
Based on number of platforms, Donation-based crowdfunding is the largest crowdfunding category worldwide. This model is based on giving to a cause in exchange for nothing. Charitable organizations were collecting online before Web-based crowdfunding portals emerged. New platforms such as GoFundMe https://www.gofundme.com/ in the United States or https://ca.gofundme.com/ in Canada. FundRazr https://fundrazr.com/canada/ is a similar platform in Canada that allows very small organizations and individuals to solicit donations from the crowd. Money has been raised for, among other things, startups, charities, healthcare and medical bills, animals and pets, accidents and disasters. The Rebel Media uses crowdfunding for some of the financing for their operations.
Rewards-based or pre-purchase Crowdfunding
Rewards-based crowdfunding is based on donating to a project in return for some type of tangible reward. ArtistShare is a platform, established in 2003, where artists and musicians can seek donations from their fans to produce digital recordings, films, videos and/or photography projects. The funds raised can be quite significant if the project is properly presented and the reward tangible. An initial success was a recording artist who for a $9.95 contribution to her project gave the contributor the opportunity to download the album upon its release. Fans who contributed more got more significant rewards. The artist raised over $130,000, enabling her to compose the music, pay her musicians, and produce the album.
With this success more rewards-based crowdfunding platforms were launched, including Indiegogo https://www.indiegogo.com/ in 2009 and Kickstarter https://www.kickstarter.com/ in 2009. A successful Canadian Kickstarter project was STACT Wine Racks that raised over $100,000 from over 340 backers to build wine wall racks from aircraft-grade anodized aluminum and premium wood veneers. Donors were able to purchase wine racks at up to 40 per cent off the retail price.
The platforms such as Kickstarter charge a percentage fee, often 5 percent of the funds collected in a fully funded campaign. Since it is impossible to fund all projects there are different types of funding models. There is an all-or-nothing funding model that does not provide any funds to the project if the funding goal is not met. If the campaign does not reach the stated goal within the stated time period the funder’s credit cards are not charge. Similarly the platform does not earn any money on the project. Some platforms offer keep-it-all campaigns. In keep-it-all campaigns the project receives any monies raised in the campaign and the platform receives a percentage of the total funds raised.
It should be noted that in all rewards-based crowdfunding the campaigners retain their intellectual property rights e.g. patents, trademarks and copyrights. The campaigner does not have to pledge assets to any funder or platform. The platforms are intermediaries that bring the campaigner and backers together so they can communicate among themselves to assess the merits of the project.
Projects that are fully funded are not necessarily risk free to the funders as there is no guarantee that the entrepreneur will fulfill their promises to funders, or that they will do it on time. Platforms do not intervene if projects are not fulfilled on time or as promised. They have done their part by bringing the funder and the entrepreneur together.
Funded projects appear to have a limited amount of fraud. This is likely because of the close interaction of the funder and the entrepreneur through social media and other types of contact. Questions can be asked, discussion forums can be established and the probability of success debated between other funders and the entrepreneur. The openness and transparency of the process is likely a deterrent to fraud.
Rewards based or pre-purchased crowdfunding is a useful tool to determine the likely success of your product. If you are offering a product below the retail price as a reward for funding and significant numbers of people provide funds for pre-orders your product should have success after the initial crowdfunding process. The entrepreneur will have a track record to attract conventional financing after getting his or her initial start through crowdfunding.
Peer-to-peer lending based Crowdfunding
Peer-to-peer lending, (P2P) or Debt-based crowdfunding, or marketplace lending is where an online intermediary or platform facilitates bringing willing lenders and the borrower together to facilitate the funding of a project or need.
P2P lending started in the UK in 2005 and then spread to the United States a year later. This type of crowdfunding allows individual borrowers to apply for, in most cases, unsecured loans i.e. loans without pledged assets. The platform will have established criteria, evaluated by an automated process, that the borrower must meet and if the borrower is approved then the money will be borrowed from the crowd. The borrower must pay the loan back with interest. The platforms generate revenue by charging a onetime percentage of the loan amount to the borrower and a loan servicing fee (either a fixed annual fee or a onetime percentage of the loan amount) from the investors. For the borrower the application process is free. This vehicle is attractive for investors as they earn interest on each loan or package of similar loans. There is always the risk that the borrower will not make timely payments or in the worst case not pay at all.
From the borrower’s point of view getting a P2P loan is usually simpler, quicker and cheaper than borrowing from a bank or on a credit card. Assets do not always have to be pledged by the borrower. The loan process can be cheaper and quicker because the platform has automated processes to do the application review and verification, the credit check, loan disbursement, payment processing, collection, compliance and reporting.
P2P crowdfunding has been very popular in the United States. Lending Club, https://www.lendingclub.com/ started in 2006 in San Francisco, is the largest P2P platform in the world in terms of issued loan volume and revenue. According to Orchard, a platform designed to explore the P2P lending industry Lending club has an approval rate of between 5 and 10 percent https://orchardplatform.com/. Application volume has surged as consumers have shifted away from banks. As of September 2015, Lending Club has lent a cumulative total of more than $13.4 billion. The average loan size is $14,677. The most common loan purpose is to refinance other debt e.g. credit card debt.
The Lending Club grades borrowers from A to G with A the best quality borrower and G the borrower with the lowest credit score. Lending Club projects returns to investors of about 5.6 percent for loans in the least risky tranche and 9.2 percent in the riskier tranches. The P2P model has become so popular that both Lending Club and Prosper https://www.prosper.com/ (the second-largest P2P platform) have attracted institutional investors to the platforms. In 2013 Google invested $125 million in Lending Club and in December 2014 Lending Club went public raising over $1 billion dollars with a valuation of approximately $9 billion.
Even with all the interest and success in the United States P2P crowdfunding regulations in Canada have prevented similar platforms from forming. Prior to October 2015 platforms that had been setup In Canada to provide loans to business have been restricted to investments from institutional and accredited investors. It should be noted that accredited investors make up about 5% of the Canadian population. An accredited investor is defined as:
- An individual who, alone or together with a spouse, owns financial assets worth more than $1 million before taxes but net of related liabilities or An individual, who alone or together with a spouse, has net assets of at least $5,000,000.
- An individual whose net income before taxes exceeded $200,000 in both of the last two years and who expects to maintain at least the same level of income this year; or An individual whose net income before taxes, combined with that of a spouse, exceeded $300,000 in both of the last two years and who expects to maintain at least the same level of income this year In Canada matching lenders to borrowers online constitutes dealing in securities and anyone who offers securities must prepare a comprehensive prospectus and provide it to regulators and investors for review. A prospectus does not have to be prepared if the online platform is restricted to “accredited” investors. Vancouver based Grouplend was initially established to provide personal loans. In November 2015 it rebranded and changed the name to Grow and renamed the website to “poweredbygrow.com” https://www.poweredbygrow.com/ but it still does not provide loans to businesses. Similarly Borrowell https://www.borrowell.com/ is only lending to individuals using accredited investors.In October of 2015 the first P2P platform for individual investors, Lending Loop, https://www.lendingloop.ca/, was launched. The core focus of the platform is to provide businesses with up to $500,000 of accessible capital at a fair interest. The platform gives all Canadians with $50 the ability to pool the money into larger loans and gain access to simple and attractive returns by supporting the growth of Canadian businesses. The platform appears to be structured in a way that makes it compliant with existing securities regulations in Canada.Websites for additional information
- Companies interested in using crowdfunding to finance their business should be aware that depending on the province in which the company is located, different regulatory rules will apply. Depending on the type of crowdfunding used and the terms and conditions in the funding, the amounts received may be included in computing the recipient taxpayer’s income and sales taxes may also have to be collected. As with any type of business transaction it is important to seek qualified legal and accounting advice prior to and during the fund raising activities.
National Crowdfunding Association of Canada (NCFA): http://ncfacanada.org/ is a cross-Canada non-profit actively engaged with both social and investment crowdfunding stakeholders. NCFA Canada provides education, research, leadership, support and networking opportunities to over 1000+ members and works closely with industry, government, academia, community and eco-system partners and affiliates to create a strong and vibrant crowdfunding industry in Canada.
Membership is comprised of a network of entrepreneurs, investors and the emerging ‘crowd economy’ participants such as crowdfunding platforms, consultants, marketing and media specialists, angel and VC investors, lawyers, accountants, and social enterprise groups interested in crowdfunding markets in Canada and beyond. The NCFA is a networking and solutions-based organization that provides education, research, advocacy, support and leadership to Canadian crowdfunding communities
2015 Canadian Crowdfunding Directory: http://ncfacanada.org/canadian-crowdfunding-directory/ The National Crowdfunding Association of Canada does their best to keep this directory up-to-date.
CMF FMC Crowdfunding in a Canadian Context: http://crowdfunding.cmf-fmc.ca/directory or for the home page: http://crowdfunding.cmf-fmc.ca/. This site is intended to help understand crowdfunding in a Canadian context, particularly in the creative industries. It will be updated on a regular basis and provide up-to-date and relevant data about the industry. Developed by the Canada Media Fund in collaboration with Nordicity, this online resource includes a working definition of crowdfunding as well as a description of the various crowdfunding models in use. The website is updated on a regular basis to provide the latest statistics and data available, suggest best practices, present case studies based on successful campaigns and explain the regulatory framework and legislative base that govern crowdfunding in Canada.
MaRS – Crowdfunding: https://www.marsdd.com/mars-library/crowdfunding/. This is an online resource about crowdfunding with useful resources for anyone thinking of using crowdfunding.
Canada Business Network: http://canadabusiness.ca/grants-and-financing/crowdfunding/. This is an online resource maintained by the federal government to provide information and resources for entrepreneurs looking for financing. There is also useful information on using online marketing.
Futurpreneur Canada: http://www.futurpreneur.ca/en/resources/mentoring-tools/crash-courses/crowdfunding-101/. This website provides online courses and mentoring for entrepreneurs. One of their courses explains crowdfunding, how to use it and whether or not it would be a good fit for an entrepreneurs business.
Some Canadian Crowdfunding Sites:
Kickstarter: https://www.kickstarter.com/discover/countries/CA Kickstarter, although US based, has been available for creative projects in Canada for over a year and a half. The platform is designed for unique ideas that can excite potential investors. Kickstarter takes 5% of the funds raised and a payment provider fee of 3% plus $.20 Cdn per pledge. It is an “all or nothing”, funding model i.e. if all the required funds are not raised you do not get anything. Investors will get their money back or their credit cards will not be charged. It has funded considerable projects in Canada. This is a rewards based or donor based model.
FundRazr: https://fundrazr.com/canada/ FundRazr allows the entrepreneur to raise money for a wide range of projects. The costs are 5% of the raised funds plus payment of a provider fee of 2.9% plus $.30 Cdn for transaction fees. They use social media technology to reach potential donors. This is a rewards based or donor based model and can be either an “all or nothing” or a “keep it all” model.
Lending Loop: https://www.lendingloop.ca/.This is Canada’s first peer-to-peer lending marketplace. It focuses on providing businesses with accessible capital at fair interest rates through a simple online process. Borrowers pay a fee once they receive their funds. There are no upfront costs and no costs to apply for a loan. The one-time borrowing fee is taken from the loan amount when the funds are transferred to the borrower. The fee is based on the amount of the loan and the length of the payback period e.g. up to $100k and less than one year the fee would be 3.5%, over $100k and over 37 or more months the fee is 5.5%.
Now that the regulations have been drafted there will be more equity/loan based lenders enter the crowdfunding arena. It should usher in a new era in entrepreneurship as entrepreneurs and investors will have several portals to list and evaluate opportunities.
