Death and Taxes: Why Business Owners Need to Plan the Succession of their Estates and Businesses

March 21, 2013

By Christopher J. Marr

Most people know what a final will is, but many don’t think of it in its appropriate context, as one step of an entire estate plan. What is truly unfortunate, is that many people don’t realize what happens if they die without an estate plan. These considerations are even more important for business owners because of the broad range of options available to them to plan an efficient succession of their business and personal estate.

Estate plan advisors can help guide you through most uncertainties and discomforts of planning for the inevitable, and can help you come up with solutions to the challenges your estate may face. Estate plan advisors for business owners should include financial planners, accountants, lawyers, and business valuators when appropriate.

The primary importance of an estate plan is to help protect your family from the burden of making difficult decisions about your estate while still grieving. It is also important to keep in mind that if you die without a final will, the law assumes you have not made beneficiary choices, or tax elections, leaving your surviving family members to make those decisions without any certainty that they have been left the resources they need to do so.

To make sure your surviving family members have the resources they need after your passing, you have to determine your goals for your estate and succession plan. For example, for your estate, would you like to leave specific items to people, or let everything be sold to pass money onto your heirs? Would you like to make gifts during your lifetime, or is it more appropriate to keep all of your assets throughout your life? Is there anyone that you would like your estate to provide for who can’t handle money, making a trust an appropriate tool?

For your business succession, you will need to consider how long you intend to run your business, in what capacity, and whether you intend to wind-up the business or keep it going. If it’s kept going, considerations will be whether ownership and control stays in your family, if control should pass to professional managers, or if the business should be sold for the best price? If you choose to sell your business during your life, you will have to consider whether you want to maintain a corporation or use your final will to pass your wealth to your family. A business owner may also want to consider an estate freeze during their lifetime to “freeze” the value of their estate at one time, to enhance tax planning.

Just as you should consider the plans of family members when you prepare your own estate plan, a business owner will need to consider the estate and succession plans of the co-owners of their business. Share holder’s agreements and other aspects of co-owned businesses often have an effect on each owner’s estate and succession planning.

Beyond the final will, the other important documents in an estate plan are the powers of attorney, to ensure that someone can act in your place, if you cannot do so for yourself during your lifetime. Similar plans should be made for business owners so that they have a contingency plan to continue their business, if they become unable to do so during their lifetime.

Once an estate or succession plan is made, it should be shared with your executors, family members, and co-owners or managers of your business. Secrecy and surprises in either plan can be disastrous. Most importantly, remember that estate planning is an ongoing process that will change throughout your life, to meet the needs of your life. Reviewing an estate or succession plan every now and again is just another part in the success of the plans.

By Christopher J. Marr

Most people know what a final will is, but many don’t think of it in its appropriate context, as one step of an entire estate plan. What is truly unfortunate, is that many people don’t realize what happens if they die without an estate plan. These considerations are even more important for business owners because of the broad range of options available to them to plan an efficient succession of their business and personal estate.

Stewart McKelvey Tweets

The importance of strategic planning

March 11, 2013

Peter Klohn, head of the Owner-Managed Business practice group and partner in our Saint John office, recently noted the following with respect to the importance of strategic planning to the entrepreneur:

The symbol of financial success on Wall Street is the bull. Unfortunately, I have seen too many entrepreneurs who value the bull’s stubborn persistence over strategic thinking. I’d suggest that successful entrepreneurs are more like mountain goats who can navigate to great heights by planning their route and avoiding obstacles along the way. They see the value of working with, and around, those who stand in their way rather than bowling them over and hoping that the damage caused won’t end the journey. Good carpenters say the key to success is to “measure twice and cut once”. An emphasis on strategic planning for entrepreneurs yields the same positive results.

Despite this, many entrepreneurs don’t begin the strategic planning process in conjunction with developing a business plan for their great idea. It’s unfortunate, but having a great idea and a short-term plan isn’t enough to carry you toward success. Strategic planning, the act of looking not just where your company is now, but where you want your company to be in the medium to long term, and developing a plan outlining how you will get there, will make you more aware of your business’s strengths and weaknesses. This can lead to better evaluation of risk versus reward, stronger decision-making, and can ultimately lead to more success.

Strategic plans should not replace business plans, which ideally would touch on your short to medium term goals for your company. Rather, they complement each other, providing guidance not only in the short term, but well into the future as well.

If you don’t have a strategic plan for your business at the moment, give some thought to developing one. It can be a great way to involve any employees in the future of the company, as well – what better way to get the whole team invested?

For additional general information on strategic planning, check out some of the helpful links below:

Business Development Bank of Canada

Info Entrepreneurs Montreal

Financial Post: A Strategy for Strategic Planning

by Sarah Almon

Peter Klohn, head of the Owner-Managed Business practice group and partner in our Saint John office, recently noted the following with respect to the importance of strategic planning to the entrepreneur:

The symbol of financial success on Wall Street is the bull. Unfortunately, I have seen too many entrepreneurs who value the bull’s stubborn persistence over strategic thinking. I’d suggest that successful entrepreneurs are more like mountain goats who can navigate to great heights by planning their route and avoiding obstacles along the way. They see the value of working with, and around, those who stand in their way rather than bowling them over and hoping that the damage caused won’t end the journey. Good carpenters say the key to success is to “measure twice and cut once”. An emphasis on strategic planning for entrepreneurs yields the same positive results.

Despite this, many entrepreneurs don’t begin the strategic planning process in conjunction with developing a business plan for their great idea.

Social Host Liability – “Eat, Drink and be Wary”.

December 14, 2012

written by Erik Homenick

The Great Canadian Office Christmas Party Season is upon us once again!  Unfortunately, this all too often means only one thing for employers; headaches (and not just of the rum and eggnog persuasion).  Before I start, I’d like to make note that this blog entry is not intended to deter one from throwing a holiday party (who would want that?) but is designed to offer a few safeguards one should consider when planning this year’s party.

Social host liability always garners attention during this festive time of year.  The Supreme Court of Canada first applied the theory in a 1974 case in which a customer drank too much at a bar and got hit by a car while walking home.  The customer brought an action in negligence against the bar for serving him to the point of intoxication and letting him leave.  The Supreme Court found the bar liable for negligence.[1]  

Bars, restaurants and other commercial establishments that serve alcohol have a duty to protect their patrons, but what about one’s duty of care when hosting friends in their home? Or more appropriately, throwing your employees a holiday party?

The most recent pronouncement on social host liability came by way of the decision from the Supreme Court of Canada in Childs v. Desormeaux, [2006] S.C.J. No. 18.  In that case, Desormeaux drove his vehicle into oncoming traffic after leaving a Bring Your Own Beer party held in a private home.  His vehicle collided head-on with another, killing one person and seriously injuring three others.  One of the injured parties brought an action against the hosts of the party seeking damages for injuries sustained.  Both the trial judge and the Court of Appeal concluded, for different reasons, that social hosts of parties do not owe a duty of care to members of the public who may be injured by an intoxicated guest’s conduct.

The Supreme Court of Canada distinguished between a ‘commercial host’ and a ‘social host’ in its decision and determined that a social host is charged with a significantly diminished responsibility compared to that of a commercial host.  The reasons for the distinction include the following:

Guests of a social host do not have a reasonable expectation that their alcohol consumption will be monitored by the social host in the same way that it is expected to be monitored by a commercial host – a commercial host has a greater ability to monitor alcohol consumption because it is actually selling the alcohol to the patrons and is, therefore, expected to observe the quantities of alcohol served.

Commercial hosts are expected to receive special training to assist them in the identification of signs of excessive consumption.

There are specific statutory regulations applicable to commercial establishments which govern their ability to serve alcohol which suggests that they operate in a very different context than private party hosts.

Courts have held that commercial hosts potentially have a financial incentive to over serve and because they can potentially benefit from over consumption it is reasonable that they also assume the risks of over consumption.

In its decision, the Supreme Court of Canada left room for liability where a host’s conduct “implicate[s] him or her in the creation or exacerbation of the risk”, while not going too far by also recognizing that “a person invited to attend a private party does not check their autonomy at the door”.

What you need to know…

If there is a spectrum in the social host liability context, hosting a holiday party for your employees may fall somewhere in between that of a social host’s liability and a commercial host’s liability.  Common sense dictates that an employer fails to meet the requisite standard of care when he or she provides alcohol in the workplace without monitoring the consumption of employees and without taking steps to ensure that employees do not drive while impaired.[2]  Furthermore, when innocent people are harmed, the courts have a natural propensity to seek to hold someone responsible.  If the person most directly responsible is unable to pay, the focus tends to shift to the host (if it can be shown that his/her conduct created or contributed to the risk).

Nevertheless, it is not likely very difficult to discharge an employer’s duty of care and measures an employer should consider for this year’s annual holiday party include:

(a)          Hold parties at non-work locations;

(b)          Use professionally staffed bars instead of ‘grab one yourself’ bars and don’t forget the non-alcoholic beverages;

(c)          Encourage guests to arrange for designated drivers;

(d)          Post the phone numbers of various taxi companies at the party;

(e)          If you notice an inebriated guest planning to drive home, call them a taxi;

(f)           Provide taxi chits or bus tickets and discourage employees from driving their vehicles to the party;

(g)          If you notice a guest becoming intoxicated, ensure that they are not served any more alcohol;

(h)          If an intoxicated guest insists on driving home, call the police;

(i)            Provide free or discounted rooms at a nearby hotel;

(j)            Take out liability insurance;

(k)          Hire experienced servers or bartenders who are trained to monitor alcohol consumption;

As with all of our blog entries, the above does not constitute legal advice.  If you wish to have further information on this subject, feel free to contact Erik Homenick for further information.


[1] Jordan House Ltd. v. Menow, (1974) D.L.R. (3d) 105 (S.C.C.)

[2] Jacobsen v. Nike Canada Ltd. (1996), 17 C.C.E.L. (2d) 90 (B.C. S.C.).

written by Erik Homenick

The Great Canadian Office Christmas Party Season is upon us once again!  Unfortunately, this all too often means only one thing for employers; headaches (and not just of the rum and eggnog persuasion).  Before I start, I’d like to make note that this blog entry is not intended to deter one from throwing a holiday party (who would want that?) but is designed to offer a few safeguards one should consider when planning this year’s party.

Social host liability always garners attention during this festive time of year.  The Supreme Court of Canada first applied the theory in a 1974 case in which a customer drank too much at a bar and got hit by a car while walking home.  The customer brought an action in negligence against the bar for serving him to the point of intoxication and letting him leave.  The Supreme Court found the bar liable for negligence.[1]  

Quick Read & Comment

A quick look at Ordinary, Special and Directors’ Resolutions

November 19, 2012

As we discussed in our previous post, Minutes of a Meeting vs. Written Resolutions, a resolution is a corporate direction to do ‘something’.

There are two types of shareholders resolutions: ordinary and special. In general terms, ordinary resolutions are permitted for routine matters, and special resolutions are required for more important matters, such as a fundamental change. A fundamental change is an addition, deletion or other change to the articles of a corporation; an amalgamation of the corporation with one or more other corporations; or a continuation of the corporation under another jurisdiction. Amending the articles of a corporation, to create a new class of shares for example, is a common example of a fundamental change that will require a special resolution.

An ordinary resolution may be passed by a simple majority of the votes cast by the shareholders who voted in respect of that resolution. In contrast, the passing of a special resolution will require no less than two-thirds of the votes cast by the shareholders who voted in respect of that resolution.

Directors may also pass resolutions. In the event that a directors’ meeting cannot be held, the directors may deal with the business usually carried out at a meeting by way of a director’s resolution that is signed by all of the directors.

As we discussed in our previous post, Minutes of a Meeting vs. Written Resolutions, a resolution is a corporate direction to do ‘something’.

There are two types of shareholders resolutions: ordinary and special. In general terms, ordinary resolutions are permitted for routine matters, and special resolutions are required for more important matters, such as a fundamental change. A fundamental change is an addition, deletion or other change to the articles of a corporation; an amalgamation of the corporation with one or more other corporations; or a continuation of the corporation under another jurisdiction. Amending the articles of a corporation, to create a new class of shares for example, is a common example of a fundamental change that will require a special resolution.

Trade-marks and why corporations should use them

November 14, 2012

Written by Julia Parent.

For a corporation, distinguishing oneself within the market is very important.  One way of protecting your business and products is through the use of trade-marks.  As we explained in our previous post introducing the concept of intellectual property, trade-marks can be words, symbols, or logos that differentiate your corporation from any other (such as McDonalds’ Golden Arches) or words, symbols, or packaging that differentiate your wares from the wares of other corporations in the markets (such as McDonalds’ Big Macs).

Trade-marks, if used correctly, help by indicating the source of a particular product, process or service so that consumers know what they are buying and from whom.

It is important to note that a trade name is different from a trade-mark.  Incorporation of your business under a certain name identifies that you are a corporation, while a trade-mark identifies your business or product as being different from others in the market.  A trade name can be trade-marked (i.e., “eBay Corporation” is a corporate/trade name and “eBay” a trade-mark that identifies a particular online auctioning service). You can read more about trade-marks and trade names in an earlier blog article that we posted on the topic.

Trade-marks can be both registered and non-registered. If a corporation registers a trade-mark, that means that that corporation has the exclusive right to use that trade-mark throughout Canada for a specified amount of time.  Registration of a corporate trade-mark automatically prevents the use of a confusingly similar trade-mark by anyone else in Canada. If a corporation does not register their trade-mark, they have fewer rights.  Courts will generally only recognize a corporation’s right to an unregistered trade-mark in the area where the use and reputation of the trade-mark has been established. It is unlikely that a Court would recognize a Canada-wide unregistered trade-mark.

The products and services of a corporation are its most important assets. Trade-marks, both registered and unregistered, are an effective way of both protecting and promoting your corporation.

This entry is part of a series on Intellectual property. For information, see our entries on:

Written by Julia Parent.

For a corporation, distinguishing oneself within the market is very important.  One way of protecting your business and products is through the use of trade-marks.  As we explained in our previous post introducing the concept of intellectual property, trade-marks can be words, symbols, or logos that differentiate your corporation from any other (such as McDonalds’ Golden Arches) or words, symbols, or packaging that differentiate your wares from the wares of other corporations in the markets (such as McDonalds’ Big Macs).

Trade-marks, if used correctly, help by indicating the source of a particular product, process or service so that consumers know what they are buying and from whom.

Succession Planning: What's Your Plan, Man?

November 13, 2012

Written by Trevor MacDonald and Meaghan Fawcett

A successful business is all about having a plan. Most businesses have long term financial plans and strategies for future growth; but what about preparing for when a key employee in your organization moves on? Succession planning is all about anticipating what may happen in your organizations future. Instead of trying to predict numbers and production levels, you are developing a strategy for those positions that ensure your business is a success. 

So how do you develop a Succession Plan? Well for starters you need to identify those key positions that require such a strategy. A key position is one that is essential to your organization and/or may be difficult to replace due to experience or educational requirements.

Next you need to identify potential successors. This part can be tough. You may want to utilize a performance management tool to determine just who these successors are and which employees have the potential to be in those important positions.

From there you can develop a long term development plan to bridge the gaps between your potential successors and the position requirements. This way you can make sure that when you have to execute your succession plan your successors are ready. You may also want to identify more than one successor, a sort of back-up plan for your back-up plan.

Succession planning is a smart business decision for many reasons, here are just a couple:

  1. It will help you make sure your business maintains its success! We all know how long it takes for a new employee to get up to speed. Multiply that times ten for your leadership positions. A healthy succession plan will help you manoeuvre through those bumpy patches when an employee in a key position moves on. 
  2. Having a succession planning process can help motivate your workforce. It can also help with retention of your “on the rise” employees. When junior employees can see that there is formal succession planning process in place they know the company is investing in their future and has advancement opportunities.

Just like any business plan a poorly executed succession strategy can cause more harm than good. It must be well thought out and maintained. Identifying the wrong successors can lead to all sorts of problems from decreased employee satisfaction to poor company performance. A lack of follow through can lead to distrust. The exact opposite of what a great succession plan can achieve.

 

Written by Trevor MacDonald and Meaghan Fawcett

A successful business is all about having a plan. Most businesses have long term financial plans and strategies for future growth; but what about preparing for when a key employee in your organization moves on? Succession planning is all about anticipating what may happen in your organizations future. Instead of trying to predict numbers and production levels, you are developing a strategy for those positions that ensure your business is a success. 

So how do you develop a Succession Plan? Well for starters you need to identify those key positions that require such a strategy. A key position is one that is essential to your organization and/or may be difficult to replace due to experience or educational requirements.

A Quick Introduction to Copyright Law

November 9, 2012

Written by Sarah Almon

In Canada, copyright is governed by the Copyright Act. Copyright simply refers to a right to copy or perform a work, a right which is generally reserved for the author or owner of the copyright. Copyright does not need to be officially applied for because the right comes into being when the work is created by the author. However, registering your copyright will provide you with evidence of your ownership of the copyright that will stand up in court and make enforcement of the copyright easier.

Many different types of creative works can be copyrighted; according to the Canadian Intellectual Property Office, copyright applies to all original, dramatic, musical, artistic and literary works (including computer programs). It also applies to performances, communication signals and sound recordings. It is important to note, however, that copyright does not protect ideas; it only protects the way the idea is expressed by the author.

So what does someone mean when they say that a work is “copyrighted”? Similarly to patents, discussed in another blog entry, copyright represents a balance between the interests of creators of copyrighted material and the users of that material. Thus, creators can share with the public works that contribute to the cultural and intellectual growth of society (which can in turn trigger the creation of further works which enrich public life), while ensuring that they will be compensated for the use of their works as well. This arrangement is beneficial not only for the creator but also for the public.

Copyright generally subsists for the life of the author, plus 50 years following the death of the author. Works from beyond this time period are considered to be in the public domain and are no longer subject to copyright. Be aware that copyright is not necessarily given the same legal treatment in other countries as it is in Canada, although several international copyright treaties, including the Berne Convention, have regularized the treatment of copyright internationally.

Copyright Infringement

Infringement is defined as the doing of any act that only the owner of the copyright has the right to do, without the consent of that owner. Consent is different from a license. Consent need not be in writing and simply gives permission to do something. A license, particularly an exclusive license, is a grant of an interest in copyright. Infringement does not require that the works compete in the marketplace; it requires only that the infringer do something that only the copyright owner has the right to do.

Infringement of copyright arises when a user does something with or to the work which only the copyright owner can do; this is often in the form of reproducing the work, and a classic example is photocopying a copyrighted text without authorization to do so. However, copyright includes the concept of “fair dealing” where the work is used for the purposes of private study, criticism or review, which can allow users to do things that would amount to an infringement of copyright in other situations. The Supreme Court of Canada in several recent decisions came down even more strongly in favour of robust “users’ rights”; see a column written by Professor Geist of the University of Ottawa for more information. Like other intellectual property rights, owners must enforce their rights against infringers, and common remedies include damages and/or injunctions to prevent unauthorized copying or performance of the work.

For the business owner

Although the owner of the work in the first instance is usually the author, if an employee creates a work in the course of their employment, the owner of the copyright is often the employer. However, if an independent contractor creates the work, the ownership of the copyright will be determined in light of the contract between the contractor and the employer.

Business owners should always be aware of their rights over any original work which can be copyrighted, and take steps to protect that right when it is in the interests of the business to do so. Registering a copyright is relatively simple and inexpensive (entailing a one-time registration fee), and serves as proof both that the work is copyrighted, and as to the identity of the owner of the work, although enforcement of those rights is left up to the owner. As copyright can be assigned or licensed to others (for example to a larger company which is better able to commercially exploit the copyrighted work), these rights can represent a valuable asset to a business as long as there is a market for the work.

For further information, check out the following links:

  • The Intellectual Property Institute of Canada (the professional association concerned with patents, trade-marks, copyright and industrial designs) website on copyright.
  • The Stewart McKelvey IP/IT/Entertainment law blog, The Medium, post on fair dealing by Marc Belliveau.
  • A Globe and Mail column by Tony Wilson about copyright issues that can affect your business.

This post is part of a series on intellectual property. For more information, see:

Written by Sarah Almon

In Canada, copyright is governed by the Copyright Act. Copyright simply refers to a right to copy or perform a work, a right which is generally reserved for the author or owner of the copyright. Copyright does not need to be officially applied for because the right comes into being when the work is created by the author. However, registering your copyright will provide you with evidence of your ownership of the copyright that will stand up in court and make enforcement of the copyright easier.

Many different types of creative works can be copyrighted; according to the Canadian Intellectual Property Office, copyright applies to all original, dramatic, musical, artistic and literary works (including computer programs). It also applies to performances, communication signals and sound recordings. It is important to note, however, that copyright does not protect ideas; it only protects the way the idea is expressed by the author.

New Brunswick Securities Commission FullSail Event on Crowdfunding

November 2, 2012

The New Brunswick Securities Commission is hosting an event on crowdfunding, consisting of a panel discussion and audience Q&A, on November 27th, 2012. The event will be held from 1:30-4:00 p.m. at the Wu Centre, on the University of New Brunswick campus in Fredericton, New Brunswick.

The panel includes representatives from the Canadian Advanced Technology Alliance, Exempt Market Dealer Association, New Brunswick Securities Commission, and Peter Klohn of Stewart McKelvey. The University of New Brunswick will also provide a brief history and an overview of current trends in this area. 

This event is open to the public and provided free of charge. We encourage entrepreneurs considering raising capital, professionals who assist entrepreneurs, academics and students as well as potential investors to attend.

Pre-registration is required.

To register for the event, follow the link on the Securities Commission webpage: NBSC FullSail Crowd Funding Event Page

The New Brunswick Securities Commission is hosting an event on crowdfunding, consisting of a panel discussion and audience Q&A, on November 27th, 2012. The event will be held from 1:30-4:00 p.m. at the Wu Centre, on the University of New Brunswick campus in Fredericton, New Brunswick.

The panel includes representatives from the Canadian Advanced Technology Alliance, Exempt Market Dealer Association, New Brunswick Securities Commission, and Peter Klohn of Stewart McKelvey. The University of New Brunswick will also provide a brief history and an overview of current trends in this area. 

A Primer on Crowdfunding in Canada

November 1, 2012

Written by Sarah Almon

Part 2 in a series of blog entries on crowdfunding.

Crowdfunding, or the act of raising money by appealing to many small investors in the public through social media and the Internet, is not currently legal in Canada, as soliciting money in return for an equity stake in the company would run afoul of securities regulations requiring strict rules of disclosure and registration that are beyond the reach of many new startup companies, as well as limits on the number of investors in a private business. However, recent moves in the United States which have provided a “crowdfunding exemption” to their securities regulations may indicate that Canada will follow suit in future by permitting crowdfunding through an exemption in provincial and territorial securities regulations.

Crowdfunding has increased in importance in recent years, as funding for small-scale entrepreneurial projects available from venture capitalists and angel investors has decreased following the 2008-2009 recession. However, until now in North America, participants in crowdfunding projects were limited by securities laws to receiving only goods or services in return for their financial support, rather than equity in the project. This is a type of crowdfunding by donation, where donors have no expectation of a financial return on their donation, with the promise to receive goods or services from the entrepreneur serving as the only incentive for donating. However, much attention is now being paid to having alternative crowdfunding models permitted in Canada. These alternative models include the “lending model” (“where individuals lend money to a project or company with the expectation that it will be repaid”, and which is similar to the concept of micro-financing; this is the second most popular crowdfunding model in the world, after the donation model) and the “investment model” (also commonly known as the “equity crowdfunding model”, which “resembles a standard equity investment, where an individual receives equity in an entity in return for financing”) [see Canada Media Fund link below, at pages 9 and 12]. However, there are several regulatory hurdles to be overcome in an effort to get equity crowdfunding approved in Canada.

Because crowdfunding falls afoul of securities regulators in New Brunswick, and indeed in Canada as a whole, it is therefore illegal at present for entrepreneurs to offer equity in their company to the public in return for financial support on a crowdfunding website in Canada, as ”[u]nder current laws, there are limited circumstances under which private investors can buy securities in a company without that company issuing an in-depth prospectus used in a traditional initial public offering”, and “[c]urrent laws also prohibit public solicitation of equity investments, which makes the social networking aspect of the crowdfunding concept inherently illegal when equity is being sold” [see Canada Media Fund link below, at page 26]. Without an exemption from these securities regulations for equity crowdfunding, those individuals trading in securities are subject to provincial or territorial securities regulations, including the registration requirement in section 45 and the filing requirement in section 71 of the Securities Act, S.N.B. 2004, c. S-5.5, the fees, requirements and timelines for which are often prohibitive to a small startup.

Despite this, equity crowdfunding is seen by many Canadian business and technology commentators as a way to overcome current funding limitations in Canada. There is great concern amongst technology, business and entrepreneurial  commentators that Canada will be disadvantaged in access to capital in relation to their counterparts in the United States, with the recent legalization of crowdfunding in the Jumpstart Our Business Startups Act (also known as the JOBS Act), prompting a “brain drain” of start-ups moving south of the border to access this new funding source. However, the positives of crowdfunding, in the form of access to capital for small entrepreneurs, need to be balanced against the negatives.  In particular, concerns over ‘fraud funding’ (where scams are perpetrated on crowdfund participants by dishonest people, which is made easier by the reduced disclosure and lessened investor protections which accompany crowdfunding) may be behind the slow regulatory reception in Canada to crowdfunding. Because allowing crowdfunding necessarily means that the investor protection elements in securities legislation and regulations are loosened in order to accommodate many casual, small-time investors, permitting crowdfunding brings with it the danger that these small-scale investors, who may not have the financial knowledge or the means to carry out adequate due diligence to protect their investment, will be defrauded by unscrupulous hustlers.  Furthermore, because many if not most start-ups fail, the risks of business are more and more often being passed on to ordinary small-scale investors, instead of angel investors or venture capitalists whose experience and diversified interests can better absorb the cost of these inevitable failures.

To this end, any exemption for crowdfunding should incorporate protective measures aimed at the type of small, often inexperienced investor that is drawn to crowdfund-type investment opportunities, by requiring some disclosure of the risks as well as rewards of the project, some basic information about the company and what the investments will be used for, and a limitation on the size of the investment (based on income) from potential crowdfunders. Ensuring that some level of investor protection is in place in crowdfunding opportunities may offer the necessary reassurance to provincial and territorial securities regulators that permitting equity crowdfunding will not involve a dereliction of duty on their part toward small and often inexperienced investors.

Managed carefully, crowdfunding could be a valuable tool in the pocket of entrepreneurs; it tends to fill the void for projects needing relatively low amounts of funding, which venture capitalists and angel investors are less likely to provide, particularly in today’s economic climate. However, there does nonetheless need to be some investor protection, given that many potential crowdfund investors will often have no investment experience.

For more information on crowdfunding in Canada, please see the following useful links:

For a business lawyer’s perspective on crowdfunding, see Peter Klohn’s entry on the OMB Blog HERE.

Written by Sarah Almon

Part 2 in a series of blog entries on crowdfunding.

Crowdfunding, or the act of raising money by appealing to many small investors in the public through social media and the Internet, is not currently legal in Canada, as soliciting money in return for an equity stake in the company would run afoul of securities regulations requiring strict rules of disclosure and registration that are beyond the reach of many new startup companies, as well as limits on the number of investors in a private business. However, recent moves in the United States which have provided a “crowdfunding exemption” to their securities regulations may indicate that Canada will follow suit in future by permitting crowdfunding through an exemption in provincial and territorial securities regulations.

A Business Lawyer's Perspective on Crowdfunding

October 31, 2012

Written by Peter Klohn

Part 1 of a series of blog entries on crowdfunding.

A person enters a casino (real or virtual) and places a bet of $1,000 on a single number on a roulette wheel. The player has a general understanding of the game and its outcomes. Within seconds, the participant receives $35,000 or has lost their bet. There are widely diverse opinions about the social value of this transaction and it occurs in an extraordinarily regulated environment which is evolving constantly.

A person signs onto the internet and discovers a request for funds from a commercial enterprise that is in its infancy. On the basis of limited information, money changes hands with a potential for gain or, most likely, since the failure rate of fledging ventures is high, likelihood of total loss. The debate in Canada is ongoing about the social value and proper regulatory environment for transactions in this proposed social media marketplace called “crowd funding”. As yet, the Canadian provincial securities regulators have not weighed in on the topic notwithstanding early regulatory advances in the United States including the passage in April 2012 of the Jumpstart Our Business Startups (JOBS) Act into law.

In New Brunswick, as elsewhere, we suffer from a lack of early stage venture capital and a variety of initiatives are ongoing to respond to this deficiency. The entrepreneurs that I work with are, generally speaking, social media savvy and many, no doubt, would embrace the opportunity to appeal to the “wisdom of the crowd” for financial support. In advising them on considering this group participation, I would caution them about the challenges posed by early public disclosure of the innovation or idea which constitutes the perceived competitive advantage for their enterprise. I would ask them to consider the difficulties in communicating with large numbers of stakeholders and the risks associated with allegations of misunderstandings which rise to the statutory threshold of actionable “misrepresentations’ under existing securities legislation. Entrepreneurs should reflect on the nature of their business and whether it is amenable to collective funding (because of the product, the target market, the scale) or whether strategic, informed investors who can contribute expertise and experience are a necessary first step. In addition, consideration should be given to equity versus non-equity models of crowd funding (where participant investors are given goods or services in lieu of dilutive equity).

Corporate finance is, at least in part, the art of mixing a workable concoction of private capital from various sources, government assistance, conventional and unconventional debt and business specific sources and programs. Crowd funding may well be another new ingredient in the brew but, like any good cook knows, too much in the wrong proportions or the incorrect recipe will yield poor results.

We should welcome the debate and encourage regulatory approval and action which creates a consistent and balanced framework. We shouldn’t however forget that in business, as in casinos, there are winners and losers on every bet.

Written by Peter Klohn

Part 1 of a series of blog entries on crowdfunding.

A person enters a casino (real or virtual) and places a bet of $1,000 on a single number on a roulette wheel. The player has a general understanding of the game and its outcomes. Within seconds, the participant receives $35,000 or has lost their bet. There are widely diverse opinions about the social value of this transaction and it occurs in an extraordinarily regulated environment which is evolving constantly.