Crowdfunding needs investor safeguards, VCs and angels warn

Don’t let hype overshadow investor safety if equity crowdfunding becomes legal in Canada, two of the country’s angel and venture capital groups warn.

Some leaders in Canada’s angel and VC sector say equity crowdfunding isa great opportunity to boost access to early stage capital, but warnsafeguards must be woven in to protect both investors and startups ifit’s legalized in Canada.

“I’m excited about it. We certainly need more capital out there,” saidBryan Watson, executive director of the National Angel CapitalOrganization (NACO), a Toronto-based association for angel investors.

Crowdfunding (using social media channels to raise equity capital forstartups) could particularly help fill the gap between early stagefriends and family stage financing and larger funding from angels orVCs, Watson said. What’s not clearis whether protective rules will beincluded so investors and startups don’t take undue risks, he said.

Under accredited investor rules in each province, Watson said, anindividual can only invest a certain maximum percentage of their networth in equity investments. The rule is meant to prevent people fromputting too much of their money at once into higher risk ventures.

“There’s different types of (accreditation) thresholds … (so) that if(a startup ) fails, the impact it would have on the investor would notnecessarily adversely affect the investor. So a situation like ‘Martha(loses) her entire life savings,’ that wouldn’t happen.”

A similar protective threshold has been written into the U.S. JOBS Actlegalizing equity crowdfunding south of the border. But since the moveto legalize it in Canada is still in its infancy, it’s unclear if suchsafeguards will be written into any regulatory changes that might bemade in each province here, Watson said.

Investor accreditation
Some commentators have expressed concerns that crowdfunding willattract investors who are less experienced, have a smaller financialcushion to fall back on, and don’t appreciate how high the startupfailure rate is when putting in their money.  Due tothoseconcerns, investor safeguards like accreditation thresholds like theones described above should be included in any crowdfunding laws, saidGenevieve Morin, co-president of Reseau Capital, Quebec’s VC industryassociation.

“We might be getting money perhaps from people that are earning quite abit less than even angel investors,” Morin said. “The amount they’reallowed to put into a single company or (invest in various startups)all together should be kept to a maximum.”

NACO’s Watson also worries about potentially negative effects of crowdfunding on startups themselves.

“One concern is how it could affect the capitalization structure of acompany. We want to make sure companies understand the implications ofthat type of investment and the implications on later rounds offunding,” Watson said.

For example, he asked, how does having thousands of people own anequity stake in a startup affect how it is run and managed, given thatstartups don’t have the same resources or structure as companies thathave done an IPO? It’s also possible, he said, that startups won’t beable to raise as much money through second or third rounds ofcrowdfunding as they did the first time – or the same amount they wouldhave with follow-on VC rounds.

“Trying to get in the next round of investments may be difficult forcompanies,” Watson said. “You have bootstrapping, friends and family,then angels. Adding a new player into that (mix), we’re still trying tofigure out how the later rounds of funding will react to that sort ofnew player, because it will make a difference in the structure of thecompany and how it’s funded that way.”

Morin echoed the concern that crowdfunding might not raise as muchcapital for startups during subsequent rounds: “I can’t imagine(crowdfunding) could offer much better valuations (than VCs) for toolong.”

The OSC’s response
Since securities regulations fall within provincial rather than federaljurisdiction, asked the Ontario Securities Commission ifit has heard from any stakeholders in the startup and investmentcommunities on the issue. The OSC’s director of corporate financeLeslie Byberg replied in a prepared statement that the OSC hasofficially opened the matter for discussion and is seeking input on it.

“On June 7, 2012, we announced that we were broadening the scope of ourexempt market review to consider whether the OSC should introduce newprospectus exemptions that may assist capital raising for businessenterprises while protecting the interests of investors,” Byberg saidin the statement. “We are planning to publish a second consultationnote this fiscal year to seek further feedback on the exempt marketregulatory regime and to explore whether the OSC should adopt any newprospectus exemptions and, if so, under what circumstances or terms.”

“As part of our review, we recently launched an ad-hoc Exempt MarketAdvisory Committee, which will inform staff on possible regulatoryapproaches to the capital raising segment of the exempt market,”Byberg’s statement added.

As for whether crowdfunding presents a competitive threat to VCs, Morinsaid no, because VCs serve later stage startups than crowdfunding andprovide value beyond just  capital, such as business adviceand connections.

“If (crowdfunding) wants to compete, it can. But I don’t think it willfor very long,” Morin said. “To me it’s not really an investment, it’smore like a vote of confidence or a show of interest – and possibly alottery ticket. Are we worried about it? No. I don’t think it couldreplace VC investors.”

During a webinar earlier this week, the Quebec vice-presidentof Invest Crowdfund Canada (a national group dedicated tolegalizing crowdfunding) said some Quebec VCs see crowdfunding as acompetitve threat.

Christine WongChristineWong is a Staff Writer at and CDN. E-mail her at [email protected],connect on Google+,follow her on Twitter,and join in the conversation on the IT BusinessFacebook Page.

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Christine Wong
Christine Wong
Christine Wong has been an on-air reporter for a national daily show on Rogers TV and at High Tech TV, a weekly news magazine on CTV's Ottawa affiliate. She was also an associate producer at Report On Business Television (now called BNN) and CBC's The Hour With George Stroumboulopoulos. As an associate producer at Slice TV, she helped launch two national daily talk shows, The Mom Show and Three Takes. Recently, she was a Staff Writer at and is now a freelance contributor.

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