FrontFundr founder and CEO shares challenges in giving wider retail access to private markets opportunities
For small enterprises that need a modest amount of start-up capital and retail investors who are not wealthy enough to play in the private equity markets, crowdfunding platforms are the perfect matchmaker. And in Canada, there’s no more broad-based network to do that on than FrontFundr.
“The problem for smaller companies in terms of capital raising has always been the offering memorandum requirement for a prospectus exemption,” said Peter-Paul Van Hoeken, founder and CEO of FrontFundr.
For companies that are only looking to raise half a million to a million dollars in capital, Van Hoeken said, that requirement has proven to be disproportionately burdensome. Aside from putting together financial statements for the initial capital raise, they have to present such documents to regulators on an ongoing basis.
In recognition of that, the regulators have opened the door for non-accredited investors to invest in private companies under equity crowdfunding rules. Canada can be considered behind relative to other countries like the US and the UK, and getting started has not been easy because of the lack of a federal securities regulator.
“We have 10 provincial securities regulators that do their best to harmonise, but in this case ended up introducing different crowdfunding rules starting in 2015,” Van Hoeken said.
While FrontFundr has bragging rights as the crowdfunding platform with the largest geographical footprint in Canada, the lack of centralized and uniform regulation has prevented it from covering all provinces. In fact, it wasn’t able to secure a toehold in Ontario, undeniably a key capital-market jurisdiction, until last year.
“Ontario introduced its own crowdfunding rule in 2016, which turned out to require too much work and didn’t produce the expected impact,” Van Hoeken said, explaining that FrontFundr has had to turn down a lot of small companies looking for start-up or scale-up companies in the province because of that.
In early 2019, securities regulators across Canada announced plans to harmonize and come up with a national crowdfunding rule, though Van Hoeken estimated that it could take up to 24 months for the 10 watchdogs to arrive at such a regime. Many small companies and retail investors in Ontario can’t wait that long, so FrontFundr approached the Ontario Securities Commission with a proposal.
“We said ‘why don’t we use the start-up crowdfunding exemption already applied in most other provinces here until there’s a national instrument?’ and the OSC was open to that idea to help the capital markets,” Van Hoeken said. “They essentially gave FrontFundr discretionary approval to use those crowdfunding exemptions in Ontario for our existing client relationships — not just in the province, but also companies in other jurisdictions can now also raise capital in Ontario under that approval.”
With that win, Van Hoeken believes that FrontFundr has paved the way for Ontario to expand its approval for a broader crowdfunding market, which would mean more private market opportunities for investors in the province. Some would ask whether investing outside the public markets is a good idea for retail investors who might not have the right risk tolerance profile for it — a concern which Van Hoeken acknowledges.
“Investment opportunities in private markets are typically risky because they involve early-stage companies,” he said. “They’re not a going concern yet, they may not have proof of concept yet, and there’s no secondary market for shares in those companies yet.”
To mitigate those risks for small investors, FrontFundr believes proper and adequate disclosure is important; the key aspects of investment opportunities must be laid out in simple language free from unnecessary financial jargon. With that, it will be easier for investors to be responsible and inform themselves properly rather than make decisions based purely on blind faith or gutfeel.
Another safety net offered by crowdfunding in particular comes from the ability to invest smaller amounts —a few hundred dollars each — which lets average investors diversify across several modest investments rather than having to risk all their available capital in a single venture.
“Investors also have to be mindful of how much private market exposure they have in their overall portfolio,” Van Hoeken stressed. “Large investors typically cap their investment in private markets at 10%, which is another way to limit that risk. At FrontFundr, an automatic suitability determination is done on each investment through its online platform based on a user’s profile, which includes their risk tolerance and their investing horizon; when it sees that a user has put too much in a particular company, it automatically informs them of that. We help investors evaluate whether an investment is suitable for them, but ultimately, the investors decide.”