Considerations for Raising Capital in Canada: A Discussion

A common question I receive from clients is “How do I raise capital?”, and the answer starts with finding someone willing to invest in your company.

Most of us are familiar with the idea of company shares: we buy them and sell them in the Stock Market, or as business owners we may have issued shared in a company. However, many business owners fail to appreciate the implications of Canadian securities laws when it comes to issuing shares in their company and taking investment.

First, the basic law in Canada when it comes to the sale of shares or securities in a company is this:  No one can sell a share, or a security, without filing a “Prospectus” with Canada and regulators before selling the share.  A prospectus is an impressively long document that provides a full description of the business of the company, its financial position, and the details of the investment being offered to the investor.  A prospectus includes certifications from executive officers of the company stating that material disclosures in the prospectus are true, and if there are material misstatements in the prospectus, then the executive officers may be individually liable to the investors. 

In other words, a prospectus is a big deal.

For most other companies, they can not afford the time, or cost, to prepare and file a prospectus; which would be a significant impediment to a business raising capital.  This has been addressed by every Province in Canada, through a series of exemptions available for businesses to raise capital without the need for a prospectus: these are referred to as “Prospectus Exemptions”. There are a large number of possible exemptions, but most businesses rely on only 4 or 5. 

Provincial Securities Laws and Regulations

Before we address specific exemptions we should consider which Province’s securities laws apply.  Even though there have been great strides in consolidating and unifying the securities laws and regulations between the provinces, there are still subtle and important differences that can arise within Canada, and therefore understanding which Province’s law applies, is important.

A province’s securities laws and regulations will become relevant to the sale of a security (which we refer to by the more encompassing term of a “distribution of a security”) should it be found that there was a “real and substantial connection” with the province, or a province thereof, to the relevant transaction.  There are several factors considered under Canadian law, with no bright line established for when the “real and substantial connection” test is met for the distribution of a security, though the following are considered to be presumptive (though not determinative) connecting factors that entitle a court (or the provincial securities regulator) to assume jurisdiction over the distribution:

• The issuer of the security is resident in the Province;
• The issuer carries on business in the Province;
• The distribution of the security occurred in the Province; or
• The purchaser is resident in the Province.

Should the distribution of a security occur within the jurisdiction of a province, then absent an exemption, the distribution must be associated with a prospectus filed, received, and approved by the relevant provincial securities regulator.  It is possible that more than one province’s laws apply. Once we have determined the provincial laws that apply, we can turn to which prospectus exemptions may support the business’ capital raising efforts. 

Prospectus Exemptions

There are a number of prospectus exemptions available under Canadian law. One of the most well-known exemptions, applicable to publicly traded companies, is the “continuous disclosure” exemption. This exemption is for companies that prepare, issue, and regularly update the information contained in their prospectus in a public manner.

Instead, most small, private companies rely upon five different exemptions from the prospectus requirements, described in National Instrument 45-106 “Prospectus Exemptions”.  These can be broken into three general categories:

1. Relating to the Nature of the Purchaser

The “Accredited Investor”, “Minimum Amount Investment”, and “Friends, Family and Business Associates” exemptions apply a test to the person acquiring the securities. Respectively, the exemption requires either the investor’s financial status, the nature of their investment (being no less than $150,000.00), or the nature of their relationship to the security issuer.  None of these three exemptions require pre-approval from the securities regulator, but they do require reporting  the distribution within 10 days of the transaction to the securities regulators.  Depending on the exemption relied upon, and the province in which the distribution was deemed to have occurred, an additional “risk acknowledgement form” may be required to be executed by the investor.

2. Relating to the Nature of the Issuer

The “Offering Memorandum” exemption requires the preparation and delivery of an offering memorandum containing prescribed information on the issuer, to the investor at the time of the distribution.  There are restrictions on the amount that may be raised, rights of recission for the investors, and differences in the mandatory content of the memorandum depending on the province in which the distribution must be made.  There are also mandatory reporting obligations, which include providing a copy of the offering memorandum and all associated marketing materials to the relevant regulatory authority(s). 

3. Relating to the Nature of the Purchaser and the Issuer

Finally, the “Private Issuer” exemption requires both the issuing company and the investor to meet select criteria.  Should both the company and the investor meet the criteria, then there is no obligation to file a prospectus and there is no obligation for the issuer to report the transaction to the relevant regulatory authority.  This is an attractive prospectus exemption for many small start-up companies in Canada, given the reduction in costs and time associated with reporting obligations. 

The qualifications for the different exemptions may be summarized as follows (this is a general summary, there may be differences between provinces)

• Accredited Investor
  • Means Test, Income:
    • An individual whose net income before taxes exceeded CDN$200 000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded CDN $300 000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year.
  • Means Test, Assets:
    • an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds CDN $1 000 000;
    • an individual who beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds CDN $5 000 000;
    • an individual who, either alone or with a spouse, has net assets of at least CDN $5 000 000,
    • a person, other than an individual or investment fund, that has net assets of at least CDN $5 000 000 as shown on its most recently prepared financial statements.
  • Or, a person in respect of which all of the owners of interests, direct, indirect or beneficial, except the voting securities required by law to be owned by directors, are persons that are accredited investors.
• Minimum Amount Investment
  • An entity, that is not an individual, purchases securities of value not less than CDN $150,000, and the entity was not created for that purpose.
• Friends Family and Business Associates
  • A director, executive officer or control person of the issuer, or of an affiliate of the issuer,
  • Close family of a director, executive officer or control person of the issuer, or of an affiliate of the issuer,
  • A close family of the spouse of a director, executive officer or control person of the issuer or of an affiliate of the issuer,
  • A close personal friend of a director, executive officer or control person of the issuer, or of an affiliate of the issuer,
  • A close business associate of a director, executive officer or control person of the issuer, or of an affiliate of the issuer,
  • A founder of the issuer or close family of a founder of the issuer,
  • Close family of a founder of the issuer,
  • A person of which a majority of the voting securities are beneficially owned by, or a majority of the directors are, persons described above.
• Private Issuer
  • Corporate test
    • The company has less than 50 shareholders (not counting employees),
    • There are restrictions on the transfer of its securities contained in the constating documents or security holder’s agreements, and
    • It has only ever distributed securities to those who meet the investor test
  • Investor test
    • “Accredited Investors”;
    • friends, family, and business associates, or
    • Persons in which the majority of the voting securities are owned by the above.

Note: the above are general descriptions, and not intended to be relied upon.  There are subtle differences between the definitions of, for example, friends and family between provinces; as well as the test for qualifications under the “Private Issuer” exemption.  Please remember, reference to knowledgeable Canadian legal counsel for relevant distributions for assessment of the availability of the exemption, as well as assistance in preparing the necessary reporting to the appropriate regulatory authority, is highly recommended.