The debate over allowing equity-based crowdfunding is heating up in Canada’s largest province as the Ontario Securities Commission (OSC) is collecting letters from different groups either advocating for change or warning against it.
This week, a group protecting investor rights weighed in on the issue with a letter to the OSC that opposes crowdfunding. It says allowing it would put investors at higher risk of fraud, undermine investor confidence in markets, and will not result in businesses gaining more access to capital. The letter from the Foundation for Advancement of Investor Rights (FAIR) argues that the effort to regulate an equity-based crowdfunding market would require too many resources or else lead to investor harm. It challenges statement in support of crowdfunding made by proponents like Invest Crowdfunding Canada (ICC, a division of the Canadian Advanced Technology Alliance) or the Exempt Market Dealers Association (EMDA).
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Equity-based crowdfunding is an idea similar to the rewards-based crowdfunding seen on sites like Kickstarter and Indiegogo. But instead of offering perks such as the promise of a product to be produced later, investors would actually own a small piece of the company. Similarly to perks-based portals, Web sites would serve as platforms to present companies seeking funds to investors and manage the transactions. Existing laws in Ontario and the rest of Canada do not allow for this style of fundraising, but some people want to change that.
That’s a bad idea, according to Marian Passmore, associate director of FAIR Canada.
“We don’t see there’s sufficient evidence that it will lead to real capital formation,” Passmore says in an interview. “It risks an increase in fraud and harming investors.”
Crowdfunding could open up opportunities for scammers to scoop up investors’ money and that could harm legitimate businesses seeking capital, FAIR says. Investor confidence could be harmed and that would have the effect of raising the cost of capital.
But the risk of fraud is true of any business, says Brian Koscak, the chairman of EMDA Canada. His group submitted a letter to the OSC March 8 that endorses a type of crowdfunding that would limit the maximum size of individual investments in a firm, and mandates that a registered dealer manage the crowdfunding investments for the small to medium-sized businesses that seek them. This would allow SMBs to raise a larger amount of capital and provide assistance to investors. Overall, it recommends a cautious approach to a crowdfunding exemption.
“The small amount of capital should small enough that it won’t harm the investor,” Koscak says. “People lose money in investments everyday… that’s the nature of business whether its online or offline.”
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Whether that investment limit is $5,000 or $20,000 is a judgment call the OSC must make, he adds.
Proponents of crowdfunding have suggested that it would open up equity ownership to the man on the street. No longer would investment opportunities be limited to the small amount of the population registered as investors – less than four per cent of the population, according to OSC statistics. But FAIR argues the general public lacks the sophistication to determine what investors are good or bad, and need protection against losing their money on a risky startup business or worse, a fraud.
“Just because there’s more information out there doesn’t mean people are more financially literate,” Passmore says. “I don’t see any data that shows people today are more financially literate than they were 20 years ago.”
A crowdfunding model allows a startup firm to take their traditional first stage of “friends and family” fundraising to the next level and extend out to their social network, Koscak says. Using social media, the assumption of crowdfunding would be that people would gain confidence in their investments by seeing how much support they’ve collected from others. It would also allow crowd intelligence to act as a detriment to bad business.
“It’s a different type of due diligence,” he says. “Why shouldn’t you be able to make an investment and do your own due diligence Government can only protect you so much, but there comes a point when you have to protect yourself.”
The U.S. adopted a crowdfunding framework through its National Securities Administration when it passed the JOBS Act last year. But the implementation of that hasn’t been put into effect as the details of the regulations are being worked out by regulators. Crowdfunding supporters say Canada could risk losing entrepreneurs to south of the border if it doesn’t provide the same crowdfunding opportunities.
“If we don’t do this, we’re going to have an exodus, a brain drain,” Koscak says.
But that sense of urgency isn’t shared by FAIR.
“It’s actually stalled down there. Who knows how long it will take to come into effect?” Passmore says. “There’s other ways to attain funding in Canada.”
The OSC originally set a deadline for comments on its consultation process for Feb. 12. but that was extended to March 8.