Move over Kickstarter, equity crowdfunding lets you get a piece of the action, not just a lousy T-shirt

By Robert Thompson

Judeh Siwady had Spacefy ready for market in February 2015, but he was looking for a non-traditional means of financing the Toronto-based company he founded in 2014, something that would connect with the current Internet zeitgeist. Spacefy is a variation on Airbnb for larger spaces, aimed at people looking to locate and price everything from rehearsal spaces for their rock band, to recording studios or performance halls. CEO Siwady and his small team spent a few months creating the software and finding the spaces that would make the company work, and by the end of last summer were looking to raise $250,000.

Siwady thought the idea of using equity crowdfunding would be a good fit for his business. In the end, it proved more successful than he and his team envisioned, raising $300,000 through Vancouver-based InvestX Capital Ltd., a platform that links entrepreneurs with access to private-equity funding. “It was big for Spacefy and that’s why we chose crowdfunding,” Siwady says. “We thought about the best way to raise money and get publicity at the same time and that’s why we went this way.”

Spacefy’s method of raising capital was unusual in 2015, but that’s expected to change this year as new securities rules open equity crowdfunding to larger audiences. The equity crowdfunding market, which was pegged at about $40 million in Canada in 2015, is expected to double this year. Supporters of the concept say the new rules solve two issues at once: they open up opportunities for early stage companies to raise much-needed capital, and they also provide investors with the chance to enter the private-equity market, which helps diversify their portfolios at a time when both equities and bonds are suffering.

“The problem for early stage companies is how to find investors,” says Sandi Gilbert, CEO of SeedUps Canada, an online crowd-financing platform. “How do you find those people? That’s where the technology comes in. They can put it in [one of the funding portals] and that brings efficiencies and a lower cost of capital. You can put it online and let thousands of people see your deal.”

Crowdfunding was once considered the bailiwick of sites such as Kickstarter, places where film directors, musicians and inventors went to raise money for their projects. Fans kick in cash, often in exchange for the product that was being created, or an opportunity to get a free T-shirt or credit. But that concept has evolved over the past five years. If you really liked the concept the company was promoting, why not get more than a logoed shirt? What if you could get a piece of the action as well?

That concept of gaining equity while supporting a startup generated a great deal of attention in the U.S. after virtual reality business Oculus VR raised US$2.4 million through a crowdfunding campaign that began in August 2012, only to sell for US$2 billion to Facebook Inc. two years later. Some wondered what might have happened if those who initially backed the company’s Kickstarter campaign had been able to participate in the financial windfall that followed, instead of just getting a t-shirt or a version of the company’s headset for their contributions.

That said, the concept of equity crowdfunding has been on the rise for five years in other countries. In Canada, it has only been available since 2013, with different provinces having specific rules to regulate the practice. However, five provinces, including Ontario and Quebec, were planning to put into place new rules on Jan. 25 that will allow non-accredited investors for the first time to participate in equity crowdsourcing campaigns, albeit only to a maximum of $2,500. Accredited investors — meaning those with net assets of $1 million net related liabilities — will be able to contribute $25,000, with an annual total capped at $50,000.

“This is a fundamental change to Canadian securities law and that isn’t a space that moves very quickly,” says John Wires, a Canadian securities lawyer based in Toronto. “I think this happened quite quickly and there are a lot of unanswered questions, particularly about whether this will work. There isn’t a great global record to go on and there’s no place in the world where you can say this has been a huge success.”

Despite the risks, it will be an investment opportunity some won’t be able to pass up, especially given the moribund performance of Canadian equities. Initially, however, investors need to recognize that investing in startups through equity crowdfunding is a risky proposition. “You shouldn’t be investing if you can’t lose your money,” Gilbert says. “This is for a small percentage — 10 to 15% of your investment portfolio — to put into a company that you understand, where you like their product and that you are close to and can relate to.” Wires takes the caution a step further: “In terms of risk, the needle is in the red with these. You have to be prepared to lose here, and some are going to.”

Gilbert says the companies that successfully use equity crowdfunding aren’t pure startups, but businesses that have already created a product or service and need capital to move to the next stage. Imagine a company that has fully developed its product and now needs to hire a marketing or sales team to generate revenue — that’s what Gilbert envisions. Wires points out that investors who put money into a company through crowdsourcing may also actually reinforce that business’ model and chance of success by showing there is a potential interested market. “It is the ultimate test,” he says. “If 600 people like a product or a company and are willing to put up $2,500 each, they are really validating it at the same time.”

Investing in companies that have clear business plans and objectives should take some of the risk out, but pundits in the space admit many of these companies will not be successful. Critics of crowdfunding suggest fraud and some high-profile failures will likely take the shine off the space. “There are going to be outright failures that are poorly managed and didn’t do what they set out to achieve and there’s going to be fraud,” Wires says. “The question is whether the new rules point the needle in the right position between investor protection and promoting growth. That remains to be seen, but there’s lots of room for rethinking the process.”
Wires points out that Canadians need to look past the hype and excitement and recognize that investing in the private-equity market isn’t the same as the public markets. For one thing, the investments aren’t liquid. “The only way you’re going to get any money out of this company is through a transaction like a sale to someone else, or that the company goes public,” says Craig Asano, executive director of the National Crowdfunding Association of Canada.

But Asano envisions a secondary market being created that allows one to trade out of a crowdfunding deal as the market for these sorts of investments matures. “We expect market-making infrastructure and services to develop in 2016,” he says. “If you are looking at the crystal ball of the future, that’s the natural evolution.”
So who is investing in the sector given the questions that surround it?

“These are armchair dragons,” Asano says. “These are millennial up-and-comers. They are looking at investing and are looking for a dashboard that allows them to connect directly with these companies.”

Wires says it remains to be seen whether companies that use equity crowdfunding will prove to be more successful than businesses that have raised money through traditional venture capital or angel funding. “Will the crowd be better at picking a good transaction or a good company?” he wonders. But he points out that some of the risk could be mitigated through combining rewards-based crowdfunding with its equity counterpart. In other words, a company can offer its developed product to the backer, as well as equity, something the Ontario Securities Commission is willing to allow. “When it is in that context, it is a lot easier for an investor to say, ‘At the very least I’m getting the product, even if the business isn’t successful,” Wires says.

Gilbert says that investors are also likely to act as supporters of their investments, helping market the product or services in the process. “It means you make an investment and you sit back and advocate for that company,” she says. “You’re out for dinner with friends and you tell them they need to download this new app. But you’re going to wait for years to find out what happens with that investment.”

Spacefy’s Siwady says he would tap into the equity crowdfunding market again, despite recognizing some of its shortcomings. He says it took a significant amount of time to prepare all the regulatory filings to hit the crowdfunding market — three months by his count, which was much longer than anticipated — and he now has to keep all of the company’s investors apprised of Spacefy’s development. “But I’d have to do that if we just had traditional investors, so it isn’t that big a deal,” he explains, adding the benefits outweighed the challenges. “Yes, I’d do it again, no question.”

Judging by interest in the concept from both investors and Canadian businesses, 2016 has the potential to see an explosion in the space. But how investors profit from the excitement in the sector may take many years to determine.

View original article here:

Ready to start learning about exciting companies?

Sign up to discover the latest emerging growth companies using Regulation A+!

Click here to sign up