ICOs provide more funding than VCs: Implications for Albertan Ventures
With the recent rise of bitcoin’s market value, and the introduction of bitcoin futures trading by the Chicago Mercantile Exchange, cryptocurrency has been in the forefront of financial news. However, you may not be aware to that cryptocurrency-based initial coin offerings (ICOs) have surpassed angel and early stage venture capital funding globally, providing significant access to cash for startup businesses. The explosion of ICOs has cumulatively provided over $3.8 billion of funding to date, with almost all of that taking place in 2017. FAlbertan-based ventures looking to get in on this, it is important to consider how cryptocurrencies are regulated. Failure to do so could result in a mistake that could be fatal to the business.
Blockchain, the technology behind cryptocurrencies, allows for a secure decentralized platform that could have applications for a number of ventures that requires the keeping of unalterable records or transactions. In order to raise money for a startup using a cryptocurrency, the company must engage in an initial coin offering (ICO) or token generation event (TGE). This is the generation and selling of a cryptocurrency that represents something in your business.
Tokens and coins can be tied to a diversity of “things”, such as free merchandise or access to software. However, serious securities law considerations will arise where that “thing” is equity. TechCrunch provides a great break down of how to arrange a token sale to fund your business here, but has limited application to Albertan startups hoping to take advantage of this system, as it only discusses American laws. So how are ICOs treated in Alberta?
Aware of the need to provide some clarification on ICOs in Canada, the Canadian Securities Administrators published, CSA Staff Notice 46-307 on August 24, 2017. This document discusses some of the laws and implications if you want to fund through an ICO.
It first be considered whether the coin/token is a security. Businesses marketing their coins as merely software products may properly be considered securities. For example, for coins that allow access to a video game, it is possible that securities may not be involved and the coins aren’t subject to securities laws. However, if the coin is in any way tied to the future profits or success of a business, it is likely a security. “Many instances” of coins have been found to constitute securities in Canada. You can find some guidance in deciding whether you’re ICO is subject to securities laws by considering the four pronged test. Does the ICO involve:
An answer of “yes” to these four questions will mean that your coin or token is likely a security. If a coin is considered a “security”, a company hoping to engage in an ICO must first file a prospectus, a comprehensive disclosure document that will require significant up front and maintenance costs that should be avoided by startups businesses. Accordingly, a startup looking to fund through an ICO will need to comply with an exemption from the need to file a prospectus.
Prospectus exemptions are contained within NI-406. For instance, the coin could be sold to “accredited investors”. These are people who have met certain financial thresholds such as making $200,000 net income before tax for the last two years, or has over $1,000,000 in financial assets. Because of the nature of an ICO, this may difficult to enforce, but sale to retail investors could possibly be made through an Offering Memorandum, which has specific disclosure requirements and ongoing obligations. Also, coins sold pursuant to one of these exemptions cannot be resold freely, and is subject to significant restrictions on sale.
If a coin is a security, and is sold without compliance to these requirements, investors may have a number of civil remedies against the company issuing the coin, such as right to withdraw from the transaction and damages. If you’re hoping to participate in an ICO, or think it it may be a way for you to raise capital for your business, give some consideration to these requirements, and obtain legal advice to ensure that you can find a way to comply with or get around securities regulations, and ensure that your funding is legitimate.
Alex Grigg is a JD/MBA 2018 Candidate and a caseworker at the BLG Business Venture Clinic.
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Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.