Equity crowdfunding has been in place in most provinces in Canada since the end of January 2016. We thought it would be interesting to see how it is working in practice. As of June 20, 2016, the National Crowdfunding Association of Canada’s Canadian Crowdfunding Directory listed 16 equity portals operating in Canada. Not all of these portals appear to be fully up and running.
We went to several of the portals to see how the crowdfunding offerings were being structured. Our review was not systematic nor is it necessarily representative of the typical equity crowdfunding offering. Instead, we concentrated on offerings for which documents were available and could be reviewed.
We examined 4 offerings that are ongoing. We did not examine real estate offerings, because they generally appear to use their own limited partnership structure.
Of the corporate offerings that we reviewed, 2 were offering standard common shares with voting rights, one was for non-voting common shares and the other was for non-voting preferred shares.
While this is a small sample, it is surprising to see some companies offering voting common shares. At a minimum, this means that these companies will need to send a notice of any shareholders’ meetings to all of the crowdfunding investors. Depending on the jurisdiction in which the company is incorporated, it may also need to send a management proxy circular to all of the shareholders. As an example, the Canada Business Corporations Act only exempts a company from the management proxy circular requirement if it has 50 or less shareholders entitled to vote at the meeting. In contrast, the Ontario Business Corporations Act only requires a management information circular for an offering corporation, generally a company whose shares are listed on a stock exchange or which has filed a prospectus. So, the jurisdiction of incorporation is an important consideration.
The two offerings of non-voting shares did not require the crowdfunding investors to sign a shareholders’ agreement. While this may seem normal for non-voting shares, it may cause difficulties later on. Although the shares are non-voting in general, under the corporate statute they will be entitled to vote on certain fundamental changes, such as certain amendments to the company’s articles or on an amalgamation. In some cases, they may be entitled to vote separately as a class. It was generally anticipated that the crowdfunding investors would be required to sign a shareholders’ agreement or voting trust agreement, giving management the power to vote their shares.
One of the common share offerings did require the crowdfunding investors to sign a minority shareholder agreement. This agreement contains share transfer restrictions, a pre-emptive right in favour of the crowdfunding investors, a drag-along clause, a clause appointing the founder as the investors’ attorney for the purpose of the drag-along clause and a clause requiring the crowdfunding investors to vote in favour of a sale of all or substantially all of the assets of the company if the offer is accepted by the founder and would result in gross proceeds per share at least equal to the subscription price paid by the crowdfunding investors.
Application of Take-Over Bid Rules
The inclusion of the drag along clause is interesting. This would apply in the case of a share purchase transaction. Based on the maximum offering and the minimum subscription for each investor, it appears that the company would have more the 50 shareholders. If this is the case, it would be difficult to see how a share purchase transaction could be structured without having to comply with the take-over bid requirements of Canadian securities laws. Generally, Canadian securities laws contain an exemption from the take-over bid requirements if the company is not a reporting issuer, there is no published market for the shares and it does not have more than 50 shareholders, not counting employees and former employees. If this exemption is not available, the purchaser would need to prepare a formal take-over bid circular, which would be too expensive and time consuming.
As mentioned above, the minority shareholder agreement contains a provision requiring the crowdfunding investors to vote in favour of certain asset sales. While this may help management or the founders to sell the company’s assets, it is probably not the ideal structure for the sale of the business. Usually, it is more advantageous from a tax and other legal perspectives for the shareholders of the company to sell their shares. An asset sale would also require the company to then distribute the net proceeds to the shareholders, which may have its own tax issues.
A more likely structure would probably be to sell the company by way of an amalgamation with the purchaser. This has many of the same advantages as a share purchase, but does not trigger the take-over bid rules. It is surprising that the minority shareholder agreement does not contain a clause requiring the crowdfunding investors to vote in favour of an amalgamation that is approved by the founder and which meets a certain minimum price.
We can expect that the deal structure and documents used in crowdfunding will evolve over time as stakeholders gain experience and see what has worked in previous deals and which issues have been problematic.