Crowdfunding is a way for individuals and companies to fund a product, company, or venture by raising small amounts of money from many people. The concept is used often by charities, artists, video game developers, technology companies, and politicians to harness the loyalty of a crowd and rally them financially around a shared cause, product, or project.
Now crowdfunding can also be used by companies as a way to raise money for their start-up and sell shares to investors. This is called equity (or securities) crowdfunding. As an investor, you should be aware of the potential risks involved in investing in a start-up.
There are three common types of crowdfunding models:
1. Donation based crowdfunding model
This charitable crowdfunding model allows people to donate money to support a specific cause or project without expecting to receive anything in return.
2. Rewards based crowdfunding model
Individuals or organizations provide some form of “reward” to people who contribute to their project. If funding a tangible project, backers may be rewarded with an item that has a clear monetary value in exchange for their financial support.
3. Equity crowdfunding model
The equity crowdfunding model (also known as securities crowdfunding) is a way for start-up businesses to raise money to fund their early development stages. Equity crowdfunding involves investors backing a small or start-up business in exchange for shares or another eligible security. In return, investors receive securities from the business. This means they may become part owners of the company, as they would if they had purchased a share or stock on an established stock market.
The start-up crowdfunding exemption allows a business to sell shares to investors through an approved “funding portal” (a website that allows investors to find and invest in equity crowdfunding projects) with fewer regulatory and disclosure requirements than would normally be required. For example, they do not need to be registered. Generally in order to be in the business of selling or advising in securities in New Brunswick, an individual or firm must be registered with FCNB. Registration helps protect investors because FCNB will only register firms and individuals if they are properly qualified and meet a certain standard. However, to help early stage start-ups streamline this process, the start-up crowdfunding exemption exists.
Unless the person operating the funding portal is relying on the start-up registration exemption, the funding portal must be registered. Check if the funding portal is registered by visiting www.aretheyregistered.ca or contacting FCNB directly.
The risks involved in crowdfunding
While equity crowdfunding can make local projects more accessible to New Brunswick investors, these projects come with certain risks that investors must be aware of before choosing to invest money. These risks may include:
Risk of Loss
The risk involved when investing in a start-up business is very high compared to investing in an established business with a history of successful operations. If a start-up business is unsuccessful, whatever the cause, you may lose all the money you pay for the investment.
There is no guarantee that the investment will make money, pay dividends or interest. You may not earn any income from this investment.
Securities sold under this exemption are subject to strict resale rules. You may not be able to access to funds when you want, or may never be able to sell this investment.
Because the disclosure and reporting requirements are reduced, you will receive much less information than you would from a registered reporting issuer. You may not be provided with any ongoing information about the investment or the company.
These investments are not reviewed or approved in any way by FCNB or other securities regulator.
The funding portal may not be able to provide you with advice about the investment and whether or not it is a good fit for you. (The funding portal may be able to provide advice if it is operated by a registered dealer).
Limited Legal Rights
You will not have the same rights as if you purchased under a prospectus or through a stock exchange.
How are Investors Protected?
There are certain measures in place to protect investors who choose to invest in an equity crowdfunding offering. These include:
Limiting Investment Amounts
There is a cap on how much an individual investor can invest. This is to protect every-day investors from too great a potential financial loss.
If you change your mind, you have 48 hours to cancel your purchase. You must send a notice to the funding portal. The funding portal must provide you details about how to cancel your purchase.
Risk Acknowledgement Form
The funding portal is required to provide you with a Risk Acknowledgement Form. You must agree that you understand the risks and information in the offering document and complete the form before investing.
Here are some other tips that may help you protect yourself when considering investing in a start-up:
Evaluate the risk
Are you comfortable with the risks and restrictions involved, including the possibility you may lose all of your investment? Do you feel you have enough information to make an informed decision?
Do your homework
Research the company and ensure that you are comfortable with the activities of the company and its employees. Read the offering document and risk warnings and be sure you understand them before subscribing. Review the start-up crowdfunding exemption and be sure that these conditions are met before handing over any money.
Get a second opinion
Discuss the opportunity with a lawyer, accountant, financial professional, or someone with business expertise who is not connected with the investment. This second opinion can help you evaluate the company and the investment and give you an idea of the company’s chances of success