Angel investors can’t sit on crowdfunding sidelines

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Screen Shot 2013-11-14 at 11.43.11 AMBy Francis Moran

The biggest mistake Canadian angel investors could make if and when equity crowdfunding is made more widely available in Canada “is to sit on the sidelines and do nothing and let crowdfunding pass them by,” says one of this country’s leading legal experts on the subject.

Lawyer Brian Koscak, who will be part of a crowdfunding panel discussion at next week’s National Angel Capital Organization national summit in Banff, said in an interview that the potential broadening of equity crowdfunding in parts of Canada “is a wonderful opportunity for angels to step up and show what they’ve got.” Angels, he said, have a wealth of expertise both in the specific sectors in which they invest and in the investment process itself, making them invaluable participants in any crowdfunding portals that are established.

Angel investors are often the first external source of funding that startups and young companies receive. (A survey of 20 out of NACO’s 24 angel group members reported that angels made 139 investments worth $40.5-million in 2012.) In Canada, as in most other countries, angels must have a minimum income or net worth before being allowed to invest, criteria that shuts out most investors. Securities regulators in Ontario and Saskatchewan have proposed expanding the opportunity for early-stage private investment by allowing companies to solicit small investments from larger pools of individual investors. Even if these proposals never become law, ordinary investors can already, under certain circumstances, participate in early-stage investing everywhere in Canada except Ontario.

Both Koscak and fellow NACO Summit panelist Sandi Gilbert say the key to expanding crowdfunding in Canada is to strike the right balance between the needs of young companies that want to raise small amounts of financing with minimal red tape and regulation and those of ordinary investors who are keen to back companies they like but need to be educated so they understand and accept the risks associated with doing so.

“The regulators are struggling with this,” Gilbert told me in an email. Current models that allow ordinary investors to back small companies have “some rather onerous disclosure requirements that they (the regulators) feel protects the investor against fraud, and if they were to reduce such disclosure, the potential for fraud may rise.” Both she and Koscak, however, pointed to the Australian Small Scale Offerings Board that, according to Gilbert, “has raised over $130M from accredited and non-accredited investors over five years and not a single case of fraud has been reported.”

Koscak said the potential for fraud could be easily minimized through the use of “educational tools to really inform investors that they could lose all their money.” Oblige investors to watch a video setting out all the risks and then complete a questionnaire that proves they understood the material. Under such circumstances, Koscak said, “it would be hard for them to say they didn’t know what they were doing.”

Gilbert, who recently launched SeedsUp Canada, a portal that hopes to soon be able to match young companies with both accredited and ordinary investors using existing regulatory frameworks, said crowdfunding is attractive to company founders because it “can validate the market for the company’s service or product. If the crowd is willing to invest in the company, they must believe in the company’s product or service.” Additionally, she said, raising funds quickly means founders will have more time to work on their businesses.

Koscak agreed that making crowdfunding easier would be a boon to startups “because it represents access to new sources of capital.”

Two new crowdfunding frameworks being considered

The Ontario Securities Commission published an equity crowdfunding framework late last year that proposed allowing companies to raise up to $1.5-million a year while limiting investors to no more than $2,500 in a single investment and no more than $10,000 in total such investments in a calendar year. Ontario is the only province where companies and ordinary investors cannot come together under the so-called “offering memorandum exemption” allowed elsewhere. In a chapter on Canada he wrote for the European Crowdfunding Network’s recently published Review of Crowdfunding Regulation 2013, Koscak said, “Ontario believes there should be a less burdensome framework” than the OM exemption, but that the province “is waiting for the United States to come out with its (crowdfunding) draft rules and regulations before finalizing any framework in Ontario, if at all.”

Saskatchewan’s Financial and Consumer Affairs Authority, whose framework published last year focuses specifically on startups, would limit companies to a maximum of $150,000 per offering and individual investors to $1,500 per offering, with the added stipulation that both company and investors must have a Saskatchewan address. In the ECN report Koscak said “Saskatchewan will likely adopt its framework by the end of 2013.”

NACO Summit combines networking, knowledge sharing

NACO’s annual angel summit, which takes place November 20 to 22 in Banff, Alberta, is the largest gathering of angel investors in Canada. Besides the panel on crowdfunding, other highlights include global trends in angel investing, syndication and cross-border investing and, it being Alberta after all, angel investment opportunities in the energy sector.

This is the third year running that we have been media sponsors of the summit, and I will be there, live-blogging and reporting back on this critical source of financing for startups.

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