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Crowdfunding: A new, innovative way to raise capital – but what does it mean for financial reporting?

Crowdfunding

Posted on November 20, 2015

You have a great idea! For example, a product you’ve developed, or maybe there’s a cause you feel is worth raising charitable donations for. However, you can’t seem to raise the funds you need to propel this idea through conventional sources. So what do you do? Giving up is one option, but another option that has become increasingly popular is crowdfunding. And given the more than $34 billion funding volume it has generated in 2015, crowdfunding is a topic that’s definitely worth talking about!

So what is crowdfunding? Well, as the name suggests, it’s the process of raising funds from a large pool of people. The basic concept is simple: a start-up company needs funds and perhaps wants to ‘test the waters’ for whatever product or concept it’s passionate about and is offering. Donors, on the other hand, simply want a reward. This could take the form of an investment return, some form of patronage, or just a general desire for social participation. Crowdfunding appears to be a mechanism whereby all these objectives are met, and therefore it’s not surprising this funding model has become a growing trend.

Source: 2015CF - Crowdfunding Industry Report

More about crowdfunding

Before getting into some of the relevant financial reporting considerations, we would like to give you a snapshot of what crowdfunding actually is.

It consists of presenting an idea on a crowdfunding platform (such as Kickstarter or Indiegogo) – effectively, people and businesses use the Internet to promote their projects/ideas and obtain funds through a web portal. The basic premise behind crowdfunding platforms is that you are able to raise a large amount of money by reaching a large pool of investors, with each investor usually donating a small sum of money.

Aside from securing funds, many other benefits are attained by using these platforms, for example, early validation of a product or concept, free marketing, free public relations and early access to a loyal customer base. What’s more, many have found that a crowdfunding platform, accompanied by an appropriate crowdfunding model (see below), enables fairly rapid penetration of local and international markets as products and concepts launched in this way have gained take-up at exceptional rates.

Various crowdfunding models exist. In 2015, we have seen that most crowdfunding campaigns fall into one of the following buckets:

Social /Donation – e.g., entities that raise funds to build, sell or distribute their product
Pre-purchase/Reward - e.g., an individual provides a product sample in return for a donation
Peer-to-Peer lending – e.g., the issuing company offers low-interest debt securities
Equity Securities – e.g., holders obtain an equity stake in a non-publicly traded company

So why does it matter for financial reporting? Well, for entities that have already engaged in a crowdfunding campaign, or are considering one, there are some key questions you need to consider if you have to report financial information to stakeholders. What’s more, these questions have started to raise some unique issues when it comes to financial reporting and, in doing so, have sparked the interest of various parties including securities regulators and, of course, the owners of the business themselves.

Financial Reporting Implications

As described above, entities can undertake a number of different types of crowdfunding campaigns that range from a simple donation (without any financial return) to more complex models that involve the entity issuing debt or equity-based instruments.

As we know, understanding the underlying economics is essential in identifying the specific financial reporting implications and how they should be accounted for. Some initial questions to consider would be: what type of entity received the payment (i.e., a charity, not-for-profit, individual, other?) and what, if anything, did the entity promised to give back to the funds provider? Reflecting on the following questions may help you uncover some of the pressure points you may need to consider when working through the financial reporting implications in a particular fact pattern:

Social/Donation – What happens if not enough money is raised? What obligations does the entity have if the product is not completed or the model fails? What sort of right to a refund exists, if any?
Pre-purchase/Reward – Do any multiple element arrangements exist? 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 – Is the loan interest-bearing? What are the repayment terms and how should the loan be classified on the balance sheet? Are there other commitments or obligations that need to be considered (for example, when product incentives are attached to the debt instrument)?
Equity securities – Is the company a publicly accountable entity (PAE)? Which GAAP should they apply? For more information around what type of entity is a PAE, check out the May 2015 IFRS Discussion Group minutes, where this specific issue was discussed.

The above listing is not exhaustive but it should get you thinking about why and how this has become a hot topic in financial reporting.

So what are the Securities regulators saying?

The development of securities regulations regarding these types of investments continues to evolve. However, on November 5, 2015, the securities regulators in Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia published in final form Multilateral Instrument “MI 45-108 Crowdfunding," which introduces a crowdfunding prospectus exemption for issuers and a registration framework for funding portals. MI 45-108 will require issuers to distribute their securities through a registered funding portal. 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.

On a related note, in May 2015, the Canadian securities regulators released multilateral CSA Notice “NI 45-316 - Start-up Crowdfunding Registration and Prospectus Exemptions.” This national instrument also provides guidance for entities that are raising capital in return for an equity-type stake in their business. As a result of this national instrument, certain provinces are providing relief in these securities offerings. For example, in some provinces, the provincial regulator has stipulated that ASPE is an acceptable framework for financial statements.

As a final word for anyone interested in what’s happening south of the border, similar exemptions may apply. On October 30, 2015, the Securities and Exchange Commission (SEC) proposed amendments to existing rules under the Securities Act Rule (147). The amendments will regulate the funding portals that offerings are conducted through, and require that companies provide certain disclosures when raising capital through one of these intermediary platforms.

The future of crowdfunding

Clearly, based on the growth and trends evidenced over the last few years, we have entered a new era of social funding, which isn’t really surprising given the advent of social media, which has changed practically every aspect of our lives. It was only a matter of time before it impacted the financial reporting world as well. Potentially we can expect to see an expansion of crowdfunding and even a retail version of crowdfunding down the road within Canada and in international markets. Suffice it to say that this topic is likely to continue to garner interest – and generate financial reporting questions – in the years to come!

Karen Higgins

Karen Higgins, FCPA, FCA
Partner, National Services

 

Kayla Macfarlane

Kayla Macfarlane, CPA, CA
Senior Manager, National Services

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