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Uncovering the Equity Crowdfunding Opportunities

originally published: 2023-05-05 10:29:49

Alexander Morsink Thank you.                                                                                                                                

Hessie Jones Okay, so let’s talk about 2023. You are in the investment space and as for the state of the market in Canada and the US, there are varying opinions about how deep and how long this recession will last and what it actually will mean. What are your thoughts, and do you have insights from your world that you can tell us?  

Alexander Morsink Certainly, yeah, it’s an important question. It’s at the top of everyone’s mind right now, certainly coming out of the holiday season beginning 2023, everyone’s saying, okay, how do I need to best approach this for my business? And is there going to be a recession? It feels like we’re in a recession, how long is it going to last? All that fun stuff. So, I do feel like we are going to be entering a recession. I wish I had a crystal ball, and I could tell you how long it’s going to last but I don’t. I think the most important thing to do for founders is really to think about the actual impact that that’s going to have on investors and how the impact will be different between Canadian and US investors. Even though there will be a recession in both countries, it will impact differently in each location. Regardless of recession or not, Canadian investors including, accredited investors, angel investors, VCs and equity Crowdfunding investors, act and make decisions differently than investors in the US. So you want to make sure you’re thinking about and seeing the impacts of that recession and how they differ in Canada versus the US. 

Alexander Morsink We’re seeing pretty strong pullback from valuations from angel investors and VCs in Canada. We have seen a similar percentage pullback from VCs and angels in the US. However, the height of valuations that companies were getting from VCs and angels in the US were much higher in 2000 and 2021 than they were in Canada. So, for example, a seed-stage company in Canada might have been raising at between five and eight million valuation in 2021. In the US, they could have been raising at ten or fifteen million. So in the US, there’s been a big pullback to around five to eight million seed stage valuation. But in Canada, there’s been not as big of a pullback, but still a pullback from that five to eight million. So when going out as a founder, make sure you’re paying attention to the type of content and where the content is sourced from when you’re doing your research because looking at, for example, American media and reading about, okay, what the expected valuation might be for a seed round right now, that wouldn’t necessarily align if you went and spoke to a seed stage VC in Canada at the same time. 

Alexander Morsink So you want to make sure you’re aware of where you’re getting your information from.  

Hessie Jones Okay. That’s great, Alexander. Thank you.                                                                        

Hessie Jones Just for everyone who knows, I did a lot of my research for this podcast using media that came from the US. I’m sure Alexander is going to debunk a lot about it. So let’s talk about your favorite topic. Well, it’s kind of your favorite topic because crowdfunding has actually risen significantly. This is a global stat, but I’m sure you’re going to tell me whether it’s actually applicable to Canada. But the global crowdfunding market size was 17.5 billion in 2021. It’s expected to reach a value of 42.9 billion by 2028. There are stats that actually show that more than 50% of crowdfunding campaigns achieve success while over 78% of campaigns succeed in getting more funding than their set goals. So we’ve predominantly seen the rise of new products, one of the kind solutions to everyday problems being funded through some of these sites like Indigogo, Go Fund Me, Start Engine. So let’s start with the basic definition of crowdfunding. How does it differ from what we’ve traditionally seen? Why are companies like Start Engine starting to push the value of equity crowdfunding on their platforms?  

Alexander Morsink Yeah, fantastic. And that’s a great question. It’s one of the first ones that I try to tackle with any company that I’m talking to. So when we’re using the umbrella term crowdfunding, it’s actually referring to three different subtypes of crowdfunding and they are quite different from each other. So the first is donation-based crowdfunding. This is what you think of when you think Indiegogo. This is somebody in the US asking people for donations because sadly, they need to take the dog to the vet or they’re in the US and they don’t have subsidized health care. So they need basically donations from people out of the goodness of their heart to help them go ahead and do something. In that situation, the people who provide the funds are not expecting anything in return. It’s purely a donation. The second category would be rewards based crowdfunding. So this is Kickstarter, where people or companies have a product idea and essentially, they’re asking for your money in exchange for that product that you’ll get later on. So it’s okay I’ve invented a new electric scooter that folds up into a backpack. You know, if you give me $2,000, hopefully in five years, I’ll give you a scooter.  

Alexander Morsink So you’re giving the money under the belief that you’re going to get a sort of physical item or some sort of service in exchange for that item, basically pre purchasing a product that hasn’t been made yet. Equity crowdfunding is the final and third category. With equity crowdfunding, you’re still going out to a broader network of people. They’re still giving money towards a goal or to a business. But with equity crowdfunding, it is exceptionally different from the first two because you are offering partial ownership in your business in exchange for the funds. Because you’re offering ownership, you’re offering the ability to purchase shares in your company. Immediately, it becomes a securities issue and securities being financial assets that hold monetary value. So as soon as you involve that, suddenly it’s highly regulated by the government. The company is potentially paying you investment returns and so it goes from I’m listing on a website and I’m going out to raise some money, it’s going to be relatively easy, and it’ll be kind of self-directed to okay, I’m now preparing my corporation to raise capital broadly in a highly regulated environment. Equity crowdfunding rules in different countries have been created to allow that legally and to allow people to be able to come and support businesses in a relatively streamlined way.  

Alexander Morsink But it is a very different undertaking than doing a Kickstarter campaign. The core mechanics where you’re listing on a platform, you’re going out and talking about it more publicly, those are all pretty similar. But when it comes to what people are getting in exchange and the amount of work that you as a company need to do in advance, equity crowdfunding is quite different from the other two types of crowdfunding.  

Hessie Jones Okay, that’s great because now we’re going to get into the nitty gritty, the questions about what sorts of expectations that a lot of founders will have if they’re going to venture in this area. So can you tell me about how it works and more specifically about what are the expectations and what is the type of commitment that a founder will have?  

Alexander Morsink Certainly! It’s definitely a serious amount of work and a sizable undertaking. One thing that I would want to highlight as well, this might get a little bit dry for a sentence or two, I promise, but we’ll go back to fun stuff in a moment. Because equity crowdfunding is issuing shares, it is a securities-related endeavor and it is regulated. That means companies have to follow securities laws. The long and the short of it is, companies have to follow the securities law based on where their investor lives. So what that means is you as a Canadian company looking to raise from Canadian investors, need to follow Canadian securities law. But if you wanted to raise money from American investors, even though you’re a Canadian company, you would then need to follow American securities law. What that actually means for Canadian companies is Canadian companies incorporated and operating in Canada cannot go and raise capital on US equity crowdfunding platforms. Essentially, it’s highly siloed based on each country, each jurisdiction.  

Alexander Morsink US Companies have to raise on US platforms from US. Investors. Canadian companies have to raise on Canadian platforms from Canadian investors. There isn’t really a lot of cross-border play. So as a Canadian company, it takes considerably more work, legal restructuring and things like that to actually be able to allow yourself to raise from US. Investors on a us. Platform. That’s something really important to keep in mind because when you’re entering the space and you’re trying to do some research, the laws are also different. If you’re reading about how to do equity crowdfunding and you’re a Canadian company and the article says Reg. CF. Or Reg. D, stop reading it. It’s an American article. It’s not applicable to you in any way. It won’t help. And so when a founder is thinking about equity crowdfunding, they need to think about, okay, where am I located, where am I investors located and what laws do I need to follow? The platforms are designed to sort of help you understand and go through that whole process. And so that’s going to be very much involved in the work that’s undertaken. But because this is a securities offering, you are raising capital.  

Alexander Morsink This is not sort of post it and forget it. There’s a considerable amount of work involved, usually two to three months of prep work involving the platform getting everything ready on the legal side. The platform must complete a full due diligence on you before you can even begin raising capital. Certainly, in Canada anyways. So if you think about the amount of due diligence that a VC would do on a company, that’s similar to the amount of due diligence that the platform has to do on you. The difference here is the platform is working as your ally. So for companies that come to raise capital on Equivesto, not only are they going through a due diligence process to make sure they’ve got all their ducks in a row, but anywhere where there’s sort of weakness or area that could use some brushing up we are also doing a lot of that help on the investor readiness side. So we’re going through your financial projections, your business plan, your pitch deck. We’re talking to you about things that could improve, that could strengthen it. We’re helping you determine evaluations and feedback on that. If you’re missing some of the legal structuring documents when you were incorporated or you haven’t issued the right number of shares to yourself and your co-founders, you didn’t properly record that shareholders loan that you did two years ago.  

Alexander Morsink All those sorts of things need to get organized. So equity crowdfunding can actually become a highly focused deep dive into getting your company sort of all shiny and polished for a future VC round. It gets everything super organized and nicely set up so when you do raise later and when you raise for equity crowdfunding, it is all nice and organized. But it is certainly a considerable amount of work and a serious undertaking. So it’s not something that should be done lightly.  

Hessie Jones I think you have already answered my follow-up question. I think instead of loans or VC, which is very difficult to get, there are a lot of companies, and maybe this is more on the US side that have opted for equity crowdfunding. There’s also the perception that it increases the risk of fraud. But from what you’re saying, is that more of an instance that would happen on the US side versus Canada because of the regulations and that you’re able to mitigate the chances that fraud would ever happen within your platform?  

Alexander Morsink Yeah, that’s a great question and it is something important to consider. Obviously, there’s two potential directions of fraud, right? One is the company itself is fraudulent. The other is the person who’s saying that they’re going to give you money isn’t who they say they are and they’re not actually giving you money. So those are the sort of two directions of fraud. In Canada, the legal structure is different than in the United States. So in the United States, equity crowdfunding platforms are essentially listing locations. They have to meet certain requirements to post the deals, but they are not securities dealers. The platforms are not securities dealers. In Canada, the majority of equity crowdfunding platforms are fully licensed as something called an exempt market dealer, which is a securities dealer that focuses on private businesses. Part of what that means is there are regulated requirements that exempt market dealers have to go through before they can allow any investment to take place with an offering that they have and present to investors. So as a platform, we have to complete a full process called ‘Know Your Product’ on any company before we can allow any investments to take place.  

Alexander Morsink So that involves background checks, criminal checks on all the individuals. It involves confirming that the company does legally exist and that the company is sort of signing off and legally promising the things that they’re saying sort of in the documentation. So if the company is saying, we’ve had ten sales so far, then they have to sign off and kind of swear to that, and we’re trying to verify that as well. So part of the work done by the platform is so that you as an individual going on a platform, you know, okay, this company at this moment in time is real. It is doing what they’re saying they’re doing. These people are real people. That’s all been verified. If the company then goes off, like the person says they’re raising money for a purpose and then they go off and use the money for something else, we obviously can’t control what somebody does with the money afterwards. But in terms of the position that they’re in when they’re raising capital, the due diligence is quite extensive. And to be honest, it’s actually much more extensive than the level of due diligence done by most angel groups and other individuals. 

Alexander Morsink So we have a lot of companies that actually are raising privately, so they’re only raising from angels. They’re not doing a crowdfunding round. They will still come and work with us so that we can complete our due diligence process on them. They can leverage the technology, but also they can then go out to their investors that they’re saying, come invest in me and say all of this due diligence work was already done by the platform. So you have that additional security involved. On the investor side, we actually also have to do a similar process. So in the US. They don’t have to do this because they’re not securities dealers. In Canada, securities dealers have to complete a full ‘Know Your Customer’ and suitability assessment on every investor. So every investor who signs up, we’re confirming their identity, we’re collecting their ID, we’re asking them all these questions to make sure we understand who they are and they understand the risks of investing in equity crowdfunding or a private investment round. We’re also moving the money via our secured trust account. Through that process we’re also doing anti-money laundering, anti-terrorist financing checks, all these sort of things as a financial institution.  

Alexander Morsink So the likelihood of fraud is much reduced. Given all these efforts that we’re taking, there’s no way to fully remove potential for fraud. But as a platform, we are legally liable for the information that we’re putting out to investors. So that is a burden that we are taking on.  

Hessie Jones Okay, great. Thank you. That’s amazing. So in terms of, I guess this is the investment in time and for founders who want to do this, what’s expected of them. I think you and I spoke about this offline earlier, I did see instances of founders who actually were part of US equity crowdfunding platforms that are fully transparent in their investor pitch decks. The comments on these platforms are also very transparent and so from that perspective, there’s a lot of time and effort to be able to respond to a lot of these potential or current investors in the questions that they pose. It seems like it can be potentially onerous.  

Alexander Morsink Right? That’s a great question about time involvement because it is a very serious time commitment. In the US the platforms allow live commenting. So the work that you’re referring to is about while the campaign is running, quickly jumping on and answering questions from people so that you don’t have somebody leaving a negative comment on your page and scaring people away. With Canada, and certainly with the way Equivesto works, there’s no live commenting. So if somebody posts a comment, it doesn’t go live right to the page. The comment comes to the platform, we would then answer it first, or we would circle it to the company. And then if we want to make the answer in the question public, we do that after reviewing all of the responses there. Again, as a securities dealer, we have to verify and confirm all the information that’s being shared. For example, if somebody was to ask a question and then the company was to quickly answer the question and say, oh yeah, we’re going to make 200% revenue growth next year, they’re making a promise about the growth of their company which they cannot do that’s unverifiable.  

Alexander Morsink That sort of answer would be uncompliant and that wouldn’t be allowed. So from that perspective, in terms of urgently responding to people’s messages, that’s not necessarily part of the work that would be involved. However, it is still a very serious undertaking. The US platforms refer to equity crowdfunding raises as community raises. They don’t call them equity crowdfunding. Part of the reason why they do that is they’re trying to differentiate equity crowdfunding from the other types of crowdfunding, donation-based and rewards-based. I support that approach because equity crowdfunding is a very serious sort of different type of beast than a donation-based or reward-based campaign. It does take a lot of work from the founder. It is a serious undertaking. The due diligence process and the work to get prepared is going to take a number of weeks. Companies typically spend three to four months working with the platform, getting their campaign ready in advance. Also, equity crowdfunding success is really driven by your extended network and the marketing and the notifying that you’re doing to your extended community. If you’re looking to raise over three or four hundred thousand, about 50% of your raise is going to need to come from angel investors or accredited investors that you’re attracting as well.  

Alexander Morsink There’s all sorts of strategy that goes into building the campaign and the timing and the preparation and who you’re talking to. So it is highly coordinated, highly orchestrated, it is a lot of work, but there are some strong benefits that come with that. You’re building a network of people who really care about your business and you’re finally able to actively talk about and publicly notify people about the fact that you’re raising money, which you can’t do if you’re just raising privately. So it is a serious amount of work, it is a lot of an undertaking, but it can certainly be worth it for founders.  

Hessie Jones Okay, so let’s talk about this in relation to, let’s say, a company who may down the road decide that they want to go for a Series A or they’ve gotten to the point where they’re doing that. So I’ve heard from a few VCs that companies who have gone through equity crowdfunding can have a messy cap table. If you allow, you typically get a VC raise. It’s a very small cap table. Equity crowdfunding, it can grow to, like you said, 50 to maybe 100 or depending on whether or not you’re, US and Canada obviously, right? 

Alexander Morsink Certainly!                                                                                                                                                                 

Hessie Jones Would a company be doing themselves a disservice towards later funding if they have gone through equity crowdfunding in the pre-seed or seed stage?  

Alexander Morsink So the short answer is no. We’ve had a number of companies raised on our platform that have gone on to raise VC capital and every VC that I’ve spoken to in Canada or the US see a previous equity crowdfunding round as a positive. But now let’s talk about the long answer to that question because this is really what’s important for founders. In the US, when you equity crowdfund, you can bring the crowdfunding investors into an SPV. You put them into a singular special-purpose vehicle where they’re held there and that SPV takes one line item on the cap table. That is illegal in Canada! So you cannot raise through equity crowdfunding for an SPV. However, in Canada, most equity crowdfunding rounds are structured where there’s a new share class being created, which is a nonvoting common share class. And the investors are also signing a voting trust. What this means is the investors have no say and no voice in the governance of your company at all. You don’t need to speak to them or ask permission for anything. Of course you give them updates and all that nice stuff, but they don’t engage in the management. 

Alexander Morsink And specifically, about the cap table question, because you’ve created a new share class specifically for this purpose on your main front page of the cap table, that share class can be represented as a single line item. So it would be ECF class A shares and then the percentage ownership as one line. And then on another tab you would have the list of all of the equity crowdfunding investors. So from the perspective of corporate governance and managing the business, which is really the concern of the VC, they want to make sure when decisions need to be made or documents need to be signed, the cap table is organized and easy for people to go out and get those signatures. With the non-voting share class and the voting trust, it’s as if you have one single silent investor with no votes and no sign-off needed. So it doesn’t impact the ability to manage your business for you as a founder or for other investors in the future, including VCs. 

Hessie Jones Okay, so let’s now switch it from the perspective of the founder now to the perspective of a potential investor. So we’ve now democratized the ability for investors to invest like accredited investors through platforms such as yours. So they come in at smaller amounts, it assumes smaller returns, dilution at later stages, and now the fact that they have non-voting shares. So for emerging investors, what do you see as the benefits of actually trying out equity crowdfunding as maybe like the start of their investment journey?

Alexander Morsink Certainly, and I would like to add a little bit of context quickly at the beginning. Equity crowdfunding, I really think of it more as a very extended angel round. So the sort of planned returns, the planned exit, all that sort of stuff is similar to doing an angel round or what angel investors would expect. All that equity crowdfunding is letting people do is participate in your angel round at smaller check sizes. We’re actually seeing a lot of interest from angel investors themselves, existing angels, members of angel networks who are used to writing the $25,000 checks, who don’t want to keep writing $25,000 checks. They want to write $5,000 checks and that aligns them with equity crowdfunding. So we’re seeing, if you think about who is making up the pool of investors that would participate in an equity crowdfunding round, it’s not 99% general public, 1% angel investor. It’s really 50% individuals who would financially qualify as angel investors but might not be a member of an angel group or want to participate in the lower amount or just looking for further diversification in their portfolio. So what’s great about equity crowdfunding though, is that it’s also allowing in the general public. It’s saying, hey, everyone else. Here’s access to this asset class that you never had access to before. 

Alexander Morsink It’s definitely very high risk, there’s low liquidity, you won’t be able to get your investment out for five to seven years. That’s all made very clear. We as a platform have a lot of education about that because we want investors to be very aware. But the benefit is you’re able to invest into a higher risk but much higher potential return asset class. Your returns as a percentage would be the same as a large investor. They’re just smaller because you’re able to write smaller check sizes but you’re getting exposure to an asset class that isn’t directly correlated to the public markets. It also offers potentially higher returns than the public markets and it helps you balance out your investment portfolio potentially a lot more. We’re seeing a lot of individuals who were interested in angel investing but weren’t necessarily millionaires yet, certainly joining in and signing up and interested in getting involved at these earlier stages.  

Hessie Jones Okay, great. One last question because I know we’re running out of time. Does the future of equity crowdfunding threaten the VC model?  

Alexander Morsink That’s a great question. I don’t think that they’re sort of fighting each other. I think they’re very much aligned to help raise capital, more capital for founders. Equity crowdfunding, as the US companies call it, your community raise, really fits in at around the same stage as your angel round. It can move into your sort of series A, where you’re starting to get a bit more VC. But for some companies, if you don’t want to raise from VCs for a specific reason, yes, then you can use equity crowdfunding instead. But for a lot of companies you’re adding equity crowdfunding to your arsenal. You’re doing your sort of friends and family round and then you’re doing your sort of angel round typically actually combined with an equity crowdfunding round and then you’re going out to raise from VCs later. We’re actually seeing a ton of VCs in the US that look to equity crowdfunding and successful equity crowdfunding rounds as a positive sign of success for the company. It’s become, certainly in the US which is a bit more mature than the Canadian market, almost a standard step in the capital raising life cycle for companies.  

Alexander Morsink So I certainly don’t think it’s competitive or sort of counter. It’s really about more capital being available to founders, helping more founders get what they need to succeed, and more companies being successful in the long run.  

Hessie Jones Okay, that’s awesome. I think we’re going to leave it there. Thank you, Alexander, for joining me. 

Alexander Morsink Thank you so much for having me Hessie. This was a lot of fun. Thank you, everyone, for listening in. 

Hessie Jones Thank you. And for everyone else, if you have suggestions for topics that you want us to cover, please email us at [email protected].  An important note, we are currently accepting applications for both incubator 19, as well as our investor readiness program to begin early in February. So please go to our website, altitudeaccelerator.ca for details. In the meantime, please join us next week, same time, same place. I’m Hessie Jones, and in the meantime, have fun and stay safe.

Altitude Accelerator
Altitude Accelerator is a not-for-profit innovation hub and business incubator for Brampton, Mississauga, Caledon, and other communities in Southern Ontario. Altitude Accelerators’ focus is to be a dynamic catalyst for tech companies. We help our companies grow faster and stronger. Our strength is our proven ability to foster growth for companies in Advanced Manufacturing, Internet of Things, Hardware & Software, Cleantech and Life Sciences. Our team consists of more than 100 expert advisors, industry, academic, government partners. The team helps companies in Advanced Manufacturing, Internet of Things, Hardware & Software, Cleantech and Life Sciences to commercialize their products and get them to market faster.

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