Crowdfunding: from novelty to viable capital-raising tool

Crowdfunding is coming of age. What started as a novel way to raise money from large numbers of people to fund projects has evolved into an industry that generated approximately $34 billion worldwide in 2015. In fact, it’s transforming into a feasible tool for start-ups to acquire capital – and securities regulators have taken notice, introducing new regulations that take effect in January 2016.

Crowdfunding works by using web-based platforms to offer start-ups an alternative to traditional funding sources, such as loans. It allows a company to access funds from a large pool of individuals, each investing a small amount, while also testing interest in the concept. In return for their investment, backers receive some sort of reward. This could be in the form of an investment return, some form of patronage, or just a general desire for social participation.

While these new opportunities are allowing entities to access capital, crowdfunding has also introduced new challenges for regulators. There are also some financial reporting implications companies need to be aware of. In order to do that, let’s look at the different types of crowdfunding.

Ask the right questions

There are four main models of crowdfunding. Each carries risks that will drive some of the financial reporting considerations:

• Social/Donation: The recipient raises funds to develop their product or non-profit project, what happens if not enough money is raised? What obligations, if any, does the entity have if the product is not completed, or the model fails?
• Pre-purchase/Reward: A product sample is delivered in return for providing funds for the entity raising funds. What are the conditions for satisfying the revenue-recognition criteria? What sort of right of return exists, if any? Or, if revenue is to be deferred, at what point and on what basis would it be appropriate to recognize revenue?
• Peer-to-peer lending: Borrowers receive money from investors through online platforms,   which has expanded beyond personal loans. What are the repayment terms and how should the loan be classified on the balance sheet?
• Equity securities: Investors obtain an equity stake in a non-public company, begging the question: is the company now a publicly accountable entity (PAE)? Which GAAP do they have to follow?

Enter the regulators

To clear up some of the uncertainty surrounding the regulatory issues of crowdfunding in Canada, regulators in several provinces drafted legislation that go into effect in January 2016. The move opens up the types of crowdfunding available to Canadians.

In November 2015, the securities regulators in Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia finalized multilateral instrument “MI 45-108 Crowdfunding," which introduces a crowdfunding prospectus exemption for issuers and a registration framework for funding portals.

Cap that trade

These funding portals will fulfill certain gatekeeper functions that include reviewing the issuer’s disclosure and obtaining background checks on the issuer and its directors, executive officers and promoters. Accredited investors will be able to invest up to $25,000 per investment, with non-accredited investors limited to $2,500. Entities raising capital will be required to comply with a number of regulations, such as providing  annual financial statements and notice of how the funds were spent.

Right now, we can only speculate the future of crowdfunding, but judging by its exponential growth in the past 4 years, it’s maturing from a novelty into an alternative to raise capital. As these models continue to evolve, it will be crucial for both the securities regulators and financial statement preparers to keep up.