Jul 18

Crowdfunding in Canada

Crowdfunding is a high profile means of raising seed capital for start-ups.   Services such as kickstarter and indiegogo are frequently looked to by Canadian companies as potential funding vehicles.   Unfortunately, raising money by crowdfunding services such as these is not a viable option for most Canadian start-up businesses.   The reason being that the investment model of crowdfunding, sometimes referred to as “equity crowdfunding” – where funders provide money in exchange for equity or debt in the start-up company – violates Canadian securities laws.  On the other hand, the rewards model of crowdfunding, where funders provide seed money in exchange for a non-financial benefit, such as a pre-order of a new product or service like a watch or a phone app., do not generally violate Canadian securities laws.   In a nut shell, crowdfunding is only an option if your start-up business model lends itself to the rewards model of crowdfunding.

Canadian companies raising capital by issuing equity or debt to investors – regardless of whether the funding round is seed financing, angel investment or second round financing – must continue to comply with the capital raising prospectus exemptions available in their jurisdiction and the jurisdictions of their investors.   The most frequently relied upon exemptions being: accredited investor exemption, family, friends and business associates exemption, private issuer exemption and offering memorandum exemption.  These exemptions are available only if the company seeking the investment and the investor fit squarely within the capital raising exemption criteria.

There is reason to be optimistic that some form of equity crowdfunding will eventually be permitted in Ontario.    The Ontario Securities Commission (OSC) is reviewing the rules regulating equity and debt financing in Ontario and this review includes the consideration of the adoption of a prospectus exemption to permit crowdfunding.   Essentially, Ontario is following the Jumpstart Our Business Startups Act (the JOBS Act)  recently enacted by the U.S. Congress in April 2012, which will allow non-accredited or non-sophisticated investors to buy small equity stakes in companies without going through the costly process of preparing and filing a prospectus.   (The JOBS Act is currently waiting on more detailed rulemaking by the SEC).   However, such optimism should be tempered because even if the OSC does eventually adopt an equity crowdfunding prospectus exemption, unless other provinces in Canada adopt a similar exemption, it will only help companies in Ontario raise seed financing from investors in Ontario.

For more information, give us a call or send us an email.

Phone: 613 869 5440
Email: koby@lawyercorporation.ca

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May 13

Why is an Offering Memorandum rarely used to raise money in Ontario?

An “offering memorandum” (“OM”) is a disclosure document intended to provide investors with the ability to make an informed investment decision.

A client recently approached us wanting to use an offering memorandum to raise money in Ontario.  Our advice was to suggest the company use a term sheet, which is a bare bones description of the financing and use of proceeds, and a subscription agreement and not to use an offering memorandum.  Here’s why:

First, all Canadian provinces except Ontario have an “offering memorandum” prospectus exemption.   In Ontario, a company can provide its potential investors with an offering memorandum, but there is no offering memorandum exemption.  Even if the company prepares and provides investors with an offering memorandum, the client would need to rely on  prospectus exemption to offer and sell its securities – typically, the “accredited investor” exemption.

Generally, for individual investors to qualify as an accredited investor, the individual must be:

  • an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1 000 000,
  • an individual whose net income before taxes exceeded $200 000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300 000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year, Unofficial consolidation for financial years beginning on or after January 1, 2011,
  • an individual who, either alone or with a spouse, has net assets of at least $5 000 000.

Second, although the level of disclosure in an OM is less than that required in a prospectus offering, preparing an OM is onerous.  The format and contents of the offering are set out in Form 45-106F3.  As the April 26, 2012, Canadian Securities Administrators’ guidance demonstrates, the expectations are high for an issuer’s disclosure included in an offering memorandum.  See Form 45-106F3 and also see Multilateral CSA Staff Notice 45-309 Guidance for Preparing and Filing an Offering Memorandum under National Instrument 45-106 Prospectus and Registration Exemptions; and CSA Staff Notice 45-308 Guidance for Preparing and Filing Reports of Exempt Distribution under National Instrument 45-106 Prospectus and Registration Exemptions.

Third, under the offering memorandum exemption, subscribers in Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island and Saskatchewan have statutory rights of action that must be described in the offering memorandum distributed to them. Subscribers in Alberta, British Columbia, and Québec will be entitled to contractual rights of action for damages or rescission similar to the statutory rights provided to purchasers in Ontario.  These rights are in addition to, and do not derogate from, any other right or remedy that purchasers may have at law.

Section 5.2 of Ontario Securities Commission Rule 45-501 – Ontario Prospectus and Registration Exemptions provides such investors who purchase securities offered by an OM with a statutory right of action against the issuer of securities for rescission or damages in the event that the offering memorandum and any amendment to it contains a “misrepresentation”. The term misrepresentation” is defined to mean an untrue statement of a material fact or an omission to state a material fact that is required to be stated or that is necessary to make any statement not misleading in the light of the circumstances in which it was made. These remedies, or notice with respect to these remedies, must be exercised or delivered, as the case may be, by the purchaser within the time limits prescribed by applicable securities laws.  If the purchaser elects to exercise the right of rescission, he must do so not more than 180 days after the date of the transaction; or, in the case of any action other than an action for rescission, the earlier of: (i) 180 days after the plaintiff first had knowledge of the facts giving rise to the cause of action, or (ii) three years after the date of the transaction that gave rise to the cause of action.

 

The bottom line for clients is that preparing an offering memorandum is costly and increases their liability exposure and they will still need to rely on another prospectus exemption if they wish to accept investment from Ontario residents.  

 

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Feb 1

Starting a Franchise System

If you have a successful business and would like to grow it, one option available to you is to franchise your concept and sell franchises to other would-be entrepreneurs.   Franchising potentially allows you to add revenue through moneys paid to you by purchasers of franchises and through royalties received by you from franchisees from their operations.

The franchise model makes sense if you have developed a business formula that you believe is “portable”.   It also makes sense for businesses that are best run by “owner-managers” as opposed to professional managers (i.e. hired help).   For example, a professional services business or a restaurant business are often more successful if run by an owner-manager.    Other examples of such businesses that have been successfully grown through franchising include drivers education, fast-food outlets, coffee shops, computer repair outlets, car repair shops, gyms and training institutes.    The logic goes something like this: A franchise owner will “care” more because they have a vested interest in the success of the business.    Put simply, unlike someone who is hired to work for a business, a franchise owner has real skin in the game – they’ve put some hard-earned money down to purchase the franchise and they’ll want to make sure the business succeeds.

From a franchisee’s perspective, purchasing a franchise is often very appealing than starting a business from scratch.  Statistacally, franchise businesses are more likely to succeed than new businesses.  In addition, many would-be entrepreneurs like the idea of purchasing a “turn-key” business.

Establishing a Franchise System

There are generally four steps to setting up your franchise system:

  1. Organizing Your Business For Franchising
  2. Developing Your Franchise System
  3. Marketing and Selling Franchises
  4. Operating Your Franchise Business

In addition, not only are these four steps applicable when you start your franchise system, but as you operate your franchise system you will likely continually engage and revisit each of these four steps.

Organizing Your Business For Franchising

Your first step is to determine, and then establish, the appropriate structure of your franchise system.  Note, the structure you will want in place for franchising is likely different than the structure you may have in place for your existing business operation.   To determine the best structure for your franchise system, we recommend you consult with your legal and tax/accounting advisors.   The reason being, the best structure for your franchise system will be the one that protects your intellectual property, limits your liability (including shielding your existing successful business from the liability associated with operating a franchise system), complies with all applicable legal and regulatory requirements and, wherever and however possible, minimizes your tax exposure.

Developing Your Franchise System

Once your “house is in order”, your attention will turn to developing your franchise system.   Put simply, this is the package you will be offering to franchisees.  What will they contribute?  What will they receive in return?   What are the rules franchisees must follow?

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Post in: blog, Franchise Law

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