By NCFA Canada | Craig Asano | Last Updated February 11, 2013

Why are SMEs crucial to the Canadian economy?

Small businesses are the lifeblood of the Canadian economy.  From the corner laundry mat to the emerging high tech software company there were a total of 1,138,761 small businesses in 2010 according to Industry Canada.  By definition, SMEs include micro-enterprises (1-4 employees), small businesses (5-100) and medium sized businesses (101-500).

Small businesses play a significant role as a feeder system.  Successful smaller companies eventually move up the ladder, acquire other businesses or assets, and grow into larger public companies.

Small businesses hire 48.3% of the entire workforce while 25% or a quarter of the Canadian population is self employed entrepreneurs.  Put differently, almost one in every two persons is directly affected and reliant on the small business for their livelihood.

In 2009, small business represented 28% of Canada’s total GDP and also accounted for $68 billion in exports, or 25% of Canada’s total export value.  (Source:  CBC News)

Related: Crowdfunding: enabling global entrepreneurship, the future of Canada’s innovation economy - open letter to PM-Designate Trudeau (October 28, 2015)

What is the Funding Environment that SMEs face?

• No clear funding roadmap
• Traditional lending institutions have strict requirements
• Expensive
• Limited
• Funding Gap exists for small capital raises of up to $1-2 million

Today, the vast majority of start-ups and SMEs find it overly difficult to raise small amounts of capital (say <$1-2 million from traditional and existing financial channels to develop their ideas and fuel existing operations.

Start-ups don't have a clear funding roadmap nor strategy and are unfamiliar with the less than transparent financial landscape.

Many small businesses simply don't know where to look (or tap into) to meet their funding needs beyond traditional institutions and mainstream leads.

Traditional institutions and alternative lenders have strict lending requirements that most start-ups do not qualify for.  Many small businesses cannot get a line of credit approved by their bank (or revive credit lines) due to poor sales or insufficient collateral to support their loan requests.

Many small businesses are asked to front money to initiate a funding process or are advised to pay for expensive financial and legal planners to develop detailed business plans and prospectus documents that exceed the budget and viability of many start-ups and SMEs.

Incubators and accelerators are excellent options, however most programs are operating at max capacity and spots on the ‘A team’ are limited.

Venture Capital has been on the decline.  In 2000, $5.9 billion was invested in 1007 Canadian startups, according to Thomson Reuters, compared to just $1.1 billion in 2010 that was raised by 357 Canadian firms representing a decline of -80% in a ten year period.  (Source:  Globe and Mail)

VCs are incentivized to raise to go after the larger deals, which are mismatched with the needs of small business; a funding gap that exists to raise small amounts of capital (i.e. up to $1-2 million) that simply isn’t being met by friends and family networks, angels, VCs and traditional institutions.

Why is it Important to get Start-up, Innovation and Growth Capital to SMEs?

• Innovation
• Jobs
• GDP and Exports
• Sustainability
• Youth Leaders

Fundamentally there’s a strong need to ensure SMEs have the proper access to capital to innovate and develop competitive products/services to bring to Canadian and global markets.

Without a clear funding roadmap for small businesses or an efficient and legally viable capital formation process many business ideas will never come to fruition and the masses will never get to experience what was possible in a Canadian context.

Innovative ideas will be at risk of departing Canada to setup in countries with more supportive funding environments for start-ups (i.e. United States).  Start-up businesses and entrepreneurial culture will start to decline at all levels (i.e. including recent graduates our future leaders).

Canada will continue to slide down global innovation rankings and the economy will suffer as a result negatively impacting job creation and our strategic social-economic advantages.

Next generation entrepreneurial youth will start to believe that owning a business is too challenging and not worth the effort.  They will look to government and big companies for jobs and support but at the same time large corporations are not what they used to be and are cutting jobs to be more competitive and nimble in global markets.

Is Crowdfunding the solution?

• Crowdfunding has evolved from microfinance and crowdsourcing
• Solves access to capital and marketing
• Expand and connect with communities

Crowdfunding represents an emerging financing alternative for SMEs to raise funds through the collection of small contributions from the general public (known as ‘the crowd’) using the internet and social media to leverage the power of online communities to extend a project’s promotion and financing opportunities.

Crowdfunding has its origins in the concept of crowdsourcing, which is the broader concept of an individual reaching a goal by receiving and leveraging small contributions from many parties.

While the non-profit sector was the first to successfully employ crowdfunding in its present online form, the concept of crowdfunding is certainly not new and has evolved from microfinance (providing the basic financial infrastructure and services in countries without a proper banking system in place on a micro scale), micro-lending (loaning small amounts of money to generally poorer people to support small business ventures), peer-to-peer lending (allows people to borrow and loan directly amongst each other at attractive rates) into its current model and term crowdfunding (raising funds from a collection of small contributions or group fundraising).

It comes to no surprise that when Dragon’s Den asked entrepreneurs, “what is your biggest challenge in running a small business?” responders reported the top two reasons were:  Cash flow (51%) and Marketing (21%).

Now imagine a crowdfunding solution that solves both of the two greatest challenges plagued by small businesses in Canada – access to cash and the ability to expand the power and reach of their marketing within existing and new online/offline communities.  That’s what the buzz is all about from an entrepreneur’s perspective.

Disruptive Game Changer

• Access to a new source of capital
• Cost effective, efficient and transparent
• Validate and expand ideas
• Brand, product and service evangelists
• Product development research and validation

Terms like ‘game changing’ and ‘disruptive’ are often used to describe the notion of crowdfunding or what the real capabilities might be.

Crowdfunding challenges traditional financing models that have high barriers of entry and low success rates for most small businesses.

It allows companies to gain access to a brand new capital source from their biggest fans and supporters who not only write a cheque but also bring valuable insights into product development that validate and expand ideas, introduce resource networks and become powerful evangelists who promote a company’s brand, services and products through their networks online and in local circles offline.

It’s important to realize that traditional funding channels won’t be by-passed but rather with the introduction of a legally permitted crowdfunding solution in Canada, companies will have more options and new markets to pitch their projects to in the hopes to meet the financial and non-financial needs of their businesses than ever before.

This will raise eyebrows in financial communities; however crowdfunding fills a gap that currently exists for SMEs looking to raise small amounts of capital in an efficient and cost effective manner, transparently, legally for small raises up to say $1-2 million.

While there have been many multi-million dollar projects funded via crowdfunding platforms (typically for projects focused on gaming, technology or design), the broader financial system is much deeper and richer for companies with high growth potential who naturally find their ideas, management team and companies interacting with financial transactions beyond the scope of crowdfunding markets.

As to where the average financial equity or non-equity crowdfunding raise may lie, time and the regulators have yet to tell (at least here in Canada).  The need is clear and the direction and momentum of crowdfunding support has begun to take a shape of its own.

The reality is that SMEs who are the backbone of the Canadian economy require an unambiguous funding roadmap that encourages efficient capital formation while protecting the various stakeholders in the eco-system through a securities exemption that serves to regulate crowdfunding financial transactions and markets.

What about investor motivations?

• Social
• Product
• Financial

Investors are participating in crowdfunding campaigns at staggering rates, supporting projects well into the night pushing fund raising meters higher until they reach a tipping point of success.  Many portal experts have reported that once a project has reached a certain funding threshold, such as 40-50% (usually via friends/family networks and enthusiasts) there is a much higher probability that the targeted campaign raise will be achieved.  Why do investors ‘jump on board’ and back some projects over another?  Investor motivation can be viewed in a triangular relationship between social, product and financial incentives.

Some investors participate because they are interested in supporting a cause and affecting change in their lives and communities – they are seeking social benefits related to their participation.  They may donate a small amount of funds without any strings attached or be happy to receive a minor reward from the project owners, such as a t-shirt or acknowledgment of their support on the project’s website.  Social backers often support a project because they want to see a dream come to reality and be part of something bigger than themselves.

Others are motivated by the product or business idea itself and want to be as close as possible to the source of its development and usually pre-purchase it as an early adopter (at a discounted rate via a pre-purchase plan).  An example of this is Formlab’s 3D Desktop Printer that raised almost $3m in 30 days from over 2,000 backers.

Backing a project also gives investors a direct link to discussion forums where they can interact with other backers and the owners themselves where they can learn about project updates and even contribute to product development by way of exchanging valuable feedback directly with the creators.

Some of the rewards associated with product driven motivation are creative and include opportunities such as if you invest ‘x’ then we will invite you to our private VIP launch party.  Or if you subscribe to ‘y’ then the owners of the city will fly to the city of your choice for a personal one-to-one session.  The list of creative rewards is endless but with all rewards regardless the motivation type they are tiered such that the greater the ‘spend’ the better the ‘reward’.  Then comes the big one – financial incentives.

Crowdfunding is unique in that it empowers the general public by giving them access to investment opportunities they simply never had before.  They can manage their own profile in a self-directed manner and can choose the platform (website or intermediary) that best suits their interests and appetite for financial return.

Financial returns are of course not guaranteed and like all investments come with varying levels of risk and beyond the standard portal due diligence, investors must perform their own analysis to select the good investments from the bad.

The truth is we’re all connected in more ways than we’d like to admit.  Hats off to technology for advancing social media and creating the online networks, security systems and processes to manage robust videos, documents, online forums and virtual meetings but crowdfunding goes way beyond a technology solution.

Crowdfunding touches a nerve at the core of what makes people tick and how they view and engage and invest their livelihood, time and resources towards causes and projects that they can directly be involved with and share the journey with its creators.

What's going on in the Crowdfunding Industry?

The crowdfunding industry is exploding with entrepreneurs, investors, portal operators, third party service providers and experts from around the world who are all jockeying for position to take advantage of a promising and brand new fundraising channel for SMEs and creative or social projects.

Forms of crowdfunding can be found in every corner of the globe – essentially wherever internet access is available.  Indiegogo, a popular international crowdfunding portal based in the US claims that contributors to hosted projects have come from over 190 different countries spanning every continent in the world.

In 2011, the worldwide crowdfunding industry facilitated over one million successful fundraising campaign offerings equivalent to $1.5 billion dollars.  As of May-2012, globally there were a total of 452 CFPs with analysts projecting the crowdfunding industry to be worth $2.86 billion with 536 projected portals by the end of 2012, according to Massolution’s industry report released in April of this year.

The National Crowdfunding Association of Canada has identified a total of 45 CFP operators as of Jan-2013 with the provincial distribution as follows:  41.3% Ontario, 17.4% BC, 21.7% Quebec, 13% Alberta, 4.3% Nova Scotia and 2.2% New Brunswick (see Canadian Crowdfunding Directory).

Internationally, crowdfunding enthusiasts, special interest groups, organizations, national associations and most recently world crowdfunding federations have been strengthening the reach of their online networks while sharing and expanding their knowledge-base and resources. The global movement to ensure crowdfunding in its many shapes and forms succeeds is the underlying force and enabler advancing these connections, creating momentum and driving the industry forward.

While non-equity forms of crowdfunding are currently thriving all over the world, equity-based crowdfunding models are currently legally permitted in Australia, UK and the Netherlands, France, Belgium, Germany and now the US will soon be added to that list with the passing of the JOBS Act (Jumpstart on Business Start-ups) in April 2012.

Crowdfunding Models

A number of crowdfunding models and hybrids have emerged with the main categories being donation, reward, lending and equity.  A key element of crowdfunding models is that there needs to be a strategic value proposition given to supporters in exchange for their financial and non-financial contributions.

With all crowdfunding models, issuers (fundraisers) are seeking to harness the power of many small contributions from the general public whether ‘the crowd’ is providing financial support, product/service ideation or access to their social networks.

See Canadian Crowdfunding Directory

Platform Types

• General Purpose
• Niche
• Regional
• White Label (off the shelf)
• WordPress Blog Plug-ins
• Customized portals

Crowdfunding platforms come in many different flavours.

General purpose sites take a broad approach and allow a very extensive range of projects to participate allowing prospective backers to browse from large list of general purpose projects.  Perhaps the most successful general CFP is Kickstarter who established a strong first movers advantage.

As of November 2012, Kickstarter has launched a over 76,500+ projects and has managed to raise over $400 million dollars from the general public in funds with a project success rate of 43.82%.  Those are some pretty staggering statistics.  It should be noted that the majority of total funds raised in the global industry is currently dominated by the top 5 to 10 portals in operation.

Niche CFPs are becoming more and more popular and are the future according to many experts in the industry.  Niche portals have the advantage of building communities with participants with similar interests who can band together to support a specific purpose, industry or cause.

Sokap, for example, is an innovative pre-purchase portal with a ‘micro licensing’ twist based in B.C. that specializes in films, movies and books.  Prospective investors can purchase licenses to ‘towns or cities’ (geographically areas) for a calculated fee in exchange for a percentage of revenue based on future sales.

Other niche portals include Picatic for ticketing and event management who effectively pre-sells tickets to an event, which is only held if a certain amount of predetermined tickets are sold thus drastically reducing the risk of hosting an event.

Scolaris supports academic scholarships and smallchangefund is about grassroots community-based projects.

Regional portals that target a physical region or defined area will also play a significant part of the crowdfunding eco-system and will host localized projects that draw support from nearby communities that are directly impacted by the outcome of the project.

Recent trends include white label options for entrepreneurs looking to host their own sites that can purchase operating licenses.  This can be a good solution for those looking to benefit from an existing solution and technical infrastructure with the appropriate checks and balances already in place.

Open source communities have now developed free and premium wordpress plug-ins to bolt-on crowdfunding pages to their existing blogs allowing them to organize and monetize their blog (and underlying community of followers) with full paypal integration.

Lastly, perhaps there is no substitution for customizing your own crowdfunding site giving the start-up owner full control over the design and feature set of the end product.

Crowdfunding Challenges

• Equity crowdfunding isn’t legally permitted in Canada
• Fraud
• Business failures
• Equity crowdfunding portal regulation
• Investor fatigue

As the general public, entrepreneurs, regulators, small businesses, educators, students and industry groups become more aware of the facts about crowdfunding and the impact that it can have at the grassroots level for every small business on every street corner to the highest levels of government and regulation, a groundswell of interest has emerged sparking dialogue and events bringing crowdfunding education, awareness and issues into the spotlight.

One of the primary challenges is that equity-crowdfunding, which is largely viewed as the model with the largest funding potential and thus impact for SMEs is not legally permitted in Canada.

Equity crowdfunding is currently permitted in Australia, UK, Netherlands, France, Belgium, Germany and now the US will soon be added to that list with the passing of the JOBS Act (Jumpstart on Business Start-ups) in April 2012.  Why not Canada?

Other concerns are around the term ‘fraud funding’.  Is the company that we are investing in legitimate and will the portal ensure our funds get dispersed to the proper channels?  Can hackers hijack paypal accounts and credit cards to purchase securities in their own names?

Portals need to be regulated to perform a set of due diligence before allowing investors and issuers on their platform.  They should also be responsible for proactively working with regulators, payment service providers, due diligence providers, and industry associations to actively seek out potential fraud and setup a procedure for reporting fraudulent activity.

Regulating the crowdfunding eco-system and casting a spotlight onto financial transactions will improve transparency, data collection and help monitor cases of fraud in an otherwise less than transparent industry without regulation.

Another concern is the potential higher number of business failures since the process and access to capital will never have been easier.  While this may be true initially for projects funded by the general public or unsophisticated retail investors, the average investment and risk in these securities will be small (i.e. max $2,500) enough to seriously negatively impact investor well-being, and investors will become more savvy at managing their personal portfolios and investment selections over time.

Retail investor groups will be formed supporting an exchange of information, and portals will get better at tightening their rules of which projects are allowed to trade in their markets.

Service providers will begin to ‘tip off’ the hottest deal of the week and the rest will be left to the free market to arrive at an appropriate mix of social and financial risk versus reward.

To what degree should equity crowdfunding portals be regulated?  If equity portals are required to register as dealer-brokers, or a special class thereof, the cost to maintain their license, perform due diligence and comply with regulation simply cannot undermine the business opportunity of being a portal itself.

Equity portals need to be strict with the kinds of projects they allow to trade on their platform.

Investor fatigue is also a concern.  How much disposable income will Canadians actually be able to afford on sponsoring their network’s projects and interests?

Cross border crowdfunding is another issue that requires an accountant’s perspective.  What are the true costs of repatriating funds that have been raised outside of the country back into Canada and what are the best practices?

Issuers trying to game limitations by masking project names and conducting multiple crowdfunding campaigns over a period of time to exceed fund raising caps.

Where do we go from here?

Crowdfunding is a nascent industry with a ton of potential, yet many people are still on the side lines scratching their head.

A recent survey that was predominantly made up of Canadian entrepreneurs indicated that although 87% of them were familiar with the term crowdfunding only 15.4% have ever provided funding to support a project and only 12.8% have sought funding (source:  ideavibes/CATA Aug-Sep 2012 Survey).

Canadians by nature a relatively conservative compared to our more entrepreneurial partners in the south but are no doubt assessing the potential risks/rewards while trying to learn more.

There is an inherent risk that all Canadians bear if regulators delay to initiate a process towards creating an exemption to allow equity crowdfunding models to proceed.

We’ve already seen countless of start-up ideas that were conceived in Canada yet have been attracted to the US or another country to raise funds and cultivate ideas elsewhere.

We’ve even learned about a Canadian equity CFP that once rushed to launch their beta to capture that coveted first movers advantage only to be discouraged with how long the process the legal process is taking and who are now shopping outside of Canada to setup operations to eventually pay themselves and recoup development costs.

Many believe that equity crowdfunding as outlined in the JOBs act will be delayed and not fully realized until Q4-2013.

Canada should continue its course and call to action with provincial securities regulators and develop and progress a working framework for comment and dialogue from industry groups, legal experts and the public at large.

Canada does not need to wait for the US to present its detailed rule book. US industry stakeholders have already had over 6 months of pre-planning and business development lead time; conferences and connections have swept across the country in preparation for the green light in the equity crowdfunding race in the United States.

In Canada, securities regulators have announced the race (see OSC Staff Consultation Paper 45-710) in December 2012 and are how accepting public comment on a proposed equity crowdfunding framework until March 8, 2013 (here).

While the Canadian racetrack looks similar to the US version, the race entrants, fans, and judges are unique to our own Canadian landscape.  Regulators need to identify which corners to lay protective rubber tires on and highlight the toll gates and mandatory pit stops along the way but it’s our own race and backyard.

There are bound to be a few accidents when the race commences but this is to be expected in a nascent industry and can be dealt with accordingly, or we run the risk of our top racers fleeing for larger winning circle prices in the bigger picture.  Does this story sound familiar to you?

It’s not that Canada is standing at a fork in the road and must choose A or B, crowdfunding represents sliding doors that we must prepare ourselves to jump through which will teleport us to just the ‘starting line’ where small businesses, retail investors, non-profits, technology, manufacturing, finance, government and educators, future entrepreneurs can all interact safely with one another in a supportive, vibrant and dynamic, efficient and cost effective capital raising crowdfunding eco-system.

Key Learnings

• SMEs represent the backbone of the Canadian economy and employ almost 50% of the entire workforce.  SMEs need access to capital to continue to innovate and develop businesses which create jobs
• SMEs experience high barriers and challenges when trying to raise small amounts of capital (up to $1-2m)
• Crowdfunding is an emerging funding opportunity for SMEs to raise small amounts of capital from the general public using the internet and social media
• Equity-based crowdfunding models are currently legally permitted in Australia, UK and the Netherlands, France, Belgium, Germany and now the US will soon be added to that list with the passing of the JOBS Act (Jumpstart Our Business Start-ups) in April 2012
• Crowdfunding has gained a lot of momentum in North America and Europe.  Equity crowdfunding is currently legally permitted in Australia, UK, Netherlands, France, Belgium, Germany and now the US will soon be added to that list with the passing of the JOBS Act (Jumpstart Our Business Start-ups) in April 2012 (expected by Q4-2013)

CALL TO ACTION

Canada needs to develop and implement a ‘made in canada’ equity crowdfunding solution or risk losing our best and brightest entrepreneurs overseas who will be driven to seek funding elsewhere, and thus negatively impacting jobs and the Canadian economy as a result.

What you can do to help?

• Participate and engage by joining NCFA Canada's growing network of crowdfunding professionals (see Membership)
• Provide feedback and share your valuable voice by taking 10-15 mins to complete the National Crowdfunding Survey in Canada (survey deadline until February 22, 2013.
• Join us at up-and-coming in-person events, seminars, learninglabs and more...
• Follow-ups on twitter, facebook and subscribe to our newsletter.  Receive company updates and join the discussion group.
• Contact us to learn more about sponsorship opportunities that will allow your company to gain prominence in an emerging crowdfunding industry

The National Crowdfunding Association of Canada is Canada’s Crowdfunding Advocate.  Newly formed, dynamic and inclusive, NCFA Canada works closely with industry groups, government, academia, other business associations and affiliates to create a strong and vibrant crowdfunding industry and voice across Canada.

JOIN today and be a ‘stand out’ in the crowd. Download eBrochure to learn more…

Contact Us
Craig Asano, Executive Director
(416) 618-0254
casano@ncfacanada.org
ncfacanada.org