FINANCIAL REPORTING AND IR

Crowdfunding, a method of raising money over the Internet, has become one of the hottest options for startups looking to raise investment to fund artistic endeavours, consumer technology innovations, or the development and sale of products. Crowdfunding campaigns typically seek relatively small contributions, but from many people – the crowd – to reach their fundraising goals. According to a recent estimate by Massolution, worldwide crowdfunding raised $16.2 billion in 2014, almost double the amount of the year before.

There are three main crowdfunding models:

1. Donations/reward

• The majority of crowdfunding activity has historically been reward based, where an individual contributes to a project such as a film or music production and receives something of value in return (e.g. a ticket to a performance, credit on the album or film, or a copy when it is released). These rewards are often more symbolic and the value is often much lower than the amount contributed.
• Some projects collect donations from the crowd, but the contributors do not receive any specific benefit in return.

2. Lending

• Significant crowdfunding growth has occurred in lending, also known as peer-to-peer lending. Here, the organization or company borrows money from the crowd. The details of the loan, such as the payback period, return, instrument (e.g. bond), etc., are defined by the fundraiser and the platform.
• If the lending is for a social purpose, the lender will not usually receive any financial return on the loan.
• This model is mainly used as an alternative to bank financing by organizations that are somewhat more mature but still have a limited size and lack steady cash flow.

3. Equity

• This crowdfunding approach provides equity financing to companies. In this model, the company will attempt to raise capital from a large group of small investors instead of a small number of large investors. In exchange for the investment, the investors receive company shares.
• The equity model is generally used by startup companies that are not yet generating cash.

Requirements for becoming a crowdfunding issuer

In Canada, securities may be issued by either filing a prospectus that is approved by a regulator, or under a specific exemption to the prospectus requirements. Crowdfunding can be significantly lower cost, allows potential individual investors to invest less money and spreads the risks more widely.

The securities regulators of six jurisdictions in Canada (British Columbia, Saskatchewan, Manitoba, Quebec, New Brunswick and Nova Scotia) have issued startup equity crowdfunding exemptions for non-reporting issuers. This means that startup and early stage companies can raise capital without having to file a prospectus or register as a dealer in Canada. For example, the Ontario Securities Commission generally limits the amount raised by an issuer through crowdfunding to $1.5 million in a 12-month period. Additionally, an individual’s investment during a 12-month period is limited to $2,500 per deal, to a maximum of $10,000 per year.

Who uses crowdfunding?

Many of the companies applying for crowdfunding have come from the consumer tech sector, making use of well-known platforms such as Kickstarter and IndieGoGo. In the past 12 months, however, the scope of companies looking to raise funds via crowdfunding has widened and, increasingly, they are looking for larger sums of money. As they are finding, crowdfunding cannot usually provide this, nor are crowdfunding investors as interested in these businesses.

The two sectors that dominate and tend to succeed on Crowdcube, another crowdfunding platform, are tech-online companies and food and drink businesses. This may well be a result of the ‘pleasure’ factor that comes from investing in something you like or something that’s easy to understand.

Many startups initially assume that they will secure angel funding easily and that money is readily available. In time, many of these businesses find this isn’t the case, and turn to crowdfunding – realizing the benefits of this sector. One of the greatest benefits comes from the public nature of the investment process. The application alone builds awareness and gets people talking about the business. In this way, crowdfunding can act as a public relations exercise as well as an investment platform.

Early days

Crowdfunding is still in its early days, which means that in many respects we are still in unchartered waters. It’s too early to point to instances of disputes between investors and the businesses they invest in, but many observers feel that anything happening in the ‘normal’ financial world will also likely happen in the crowdfunding sector.

One of the great advantages of crowdfunding is that it makes a startup ‘raise its game.’ Businesses working through the crowdfunding process often come out stronger because of the questions asked of them and the scrutiny involved. A business seeking crowdfunding will likely be put under the spotlight by finance, technology and marketing experts in the course of the exercise.

Stakeholder communications

For businesses using crowdfunding, one of the biggest problems can be communicating and engaging with investors after successful funding. It may be the case that investors are interested in the big updates, but less bothered by the smaller, day-to-day running of the business.

The platforms themselves are split on whether to remain in contact following successful funding. Many are in touch with businesses afterwards, often just to see how they are getting on and improving, and sometimes just for press purposes. While not yet representing significant competition for investment capital in Canada, this is clearly an evolving area and something we will all watch with interest.

Katie McGarry, CPA, CA is a Senior Manager, and Rob Brouwer, FCA is Canadian Managing Partner, Clients and Markets, for KPMG LLP in Canada.