Broadly speaking, a business may raise capital either by borrowing money from financial institutions, friends and family, or by offering securities (e.g., stocks, notes, options, debentures, etc.).
Any time a corporation buys, sells, distributors, trades, or otherwise disposes of securities, it must comply with all applicable securities laws, regardless of whether or not the business is private or publicly listed on a stock exchange.
Securities regulation in Canada is a matter of provincial jurisdiction. In Alberta, securities are regulated by the Alberta Securities Commission. However, a common principle among all Canadian securities regulatory regimes is that, absent an exemption, any distribution of securities requires a prospectus. A prospectus includes specific, detailed disclosure about an issuer's business and the securities being offered. This requirement is intended to provide investors with complete and accurate information so that they can make informed investment decisions. When a business files a prospectus, it will become a reporting issuer.
Filing a prospectus and fulfilling the ongoing disclosure and governance obligations can be expensive and time consuming. Fortunately, there are a variety of exemptions which allow securities to be offered without the time and expense of preparing a prospectus. Therefore, if you are trying to raise capital for your business, it is important to be aware of the common capital raising prospectus exemptions.
Most of the exemptions available are found in National Instrument (NI) 45-106. There are a variety of different prospectus exemptions for different types of transactions. You are free to choose which prospectus exemption you use, provided that you meet the requirements of the exemption.
Below is an overview of a few examples of commonly used capital raising prospectus exemptions relied upon by businesses under Alberta securities law:
Private Issuer Exemption
The Private Issuer Exemption is most commonly relied on by startup businesses. This exemption has two main requirements. First, the issuer must be a “private issuer”, meaning that the issuer cannot be a reporting issuer or an investment fund. To be a private issuer, the issuer must have no more than 50 shareholders (excluding employees and former employees). The corporate documents must also establish a restriction on the free transfer of shares.
Second, the issuer can only sell securities to a specific list of permitted investors as identified in section 2.4 of NI 45-106. Some of the permitted investors on this list include directors, officers and employees of the issuer, close family members (e.g., spouse, parent, child, etc.) of the issuer, close personal friends of the issuer, close business associates of the issuer, and accredited investors.
There are no definitions of the terms “close personal friend” and “close business associate”. However, there must be an established relationship of trust in which the individual knows the principal of the issuer well enough and for long enough, or who has had sufficient prior business dealings with the principal to be able to assess that person's capabilities and to obtain information from them on the investment. Simply belonging to the same club, team, or organization, or being a client or customer, for example, will not make your relationship “close” for the purposes of the Private Issuer Exemption.
In addition to being exempt from the prospectus requirement, the Private Issuer Exemption also exempts issuers from filing a Form-F1 Report of Exempt Distribution with the Alberta Securities Commission and paying the associated filing fee, which is still a requirement of most other prospectus exemptions. However, any distribution to a person or entity that is not a permitted investors will cause the Private Issuer Exemption to be unavailable going forward for that issuer. Moreover, no commissions or finder’s fees may be paid to directors, officers, founders or control persons in connection with a distribution or a trade made under the private issuer exemption, except in connection with a distribution of, or trade to an accredited investor under the Private Issuer Exemption.
While an issuer can sell its securities to many of the same people by relying on the Accredited Investor Exemption or the Family, Friends and Business Associates Exemption, the Private Issuer Exemption affords some additional flexibility by allowing the sale of securities to anyone who is “not the public” and is subject to less restrictions on resale as securities can be transferred among the list of permitted investors.
Family, Friends and Business Associates Exemption
The Family, Friends and Business Associates Exemption applies to anyone mentioned in Section 2.5(1) of NI 45-106 who has a special relationship with the issuer and who is acquiring the securities for their own account, such as:
the issuer’s directors, executive officers, founders and control persons (typically, a holder of 20 per cent of the voting securities);
a specified family member (e.g., spouse, parent, grandparent, brother, sister, child or grandchild of a principal or the principal’s spouse);
a close personal friend; or
a close business associate.
These relationships are relatively narrow and confined. No commissions or finder’s fees can be paid to the principals of the issuer under this exemption. This is because a “close personal friend” should know the principal well enough to be able to assess their capabilities and trustworthiness and to obtain information from them on the investment. Similarly, a “close business associate” should have sufficient prior business dealings with the principal of the issuer to assess that person's capabilities and trustworthiness.
Securities acquired under this exemption are subject to restrictions on resale. Additionally, an issuer that relies on this exemption must file a Form 45-106F1 Report of Exempt Distribution with the Alberta Securities Commission within 10 days.
Accredited Investor
According to the Alberta Securities Commission, the Accredited Investor Exemption is the most frequently used prospectus exemption in Canada. Generally, an accredited investor is considered to be a person who, as a result of their financial resources and knowledge, does not require the protection of a prospectus. Relying on the Accredited Investor Exemption can allow for quicker access to capital since prospectus filing and review requirements do not apply.
Accredited investors are defined by Section 1.1 of NI 45-106 and include institutional investors such as banks, registered dealers and advisers, and certain investment funds. Accredited investors also include high-income and high-net-worth individuals that meet any one of the four following income or asset tests:
an individual whose net income before taxes exceeded $200,000 in each of the 2 most recent calendar years and who reasonably expects to exceed that net income in the current calendar year;
an individual whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the 2 most recent calendar years and who reasonably expects to exceed that net income in the current calendar year;
an individual who, either alone or with a spouse, holds financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $1,000,000; or
an individual who, either alone or with a spouse, has net assets of at least $5,000,000.
If an investor is an individual, the issuer must also obtain a required form of risk acknowledgement unless the individual has net financial assets exceeding $5,000,000. These requirements are intended to establish that such individuals have the resources and sophistication to make investment decisions without a prospectus.
Additionally, an issuer relying on the Accredited Investor Exemption, must file a Form 45-106F1 Report of Exempt Distribution with the Alberta Securities Commission within 10 days, and the securities will be subject to restrictions on resale.
Employees and Consultants Exemption
The Employees and Consultants Exemption is used to sell or otherwise distribute compensation-related securities of the issuer to an issuer’s employees, executive officers, directors, or consultants. This exemption also allows the securities to be distributed or transferred to “permitted assigns” of those individuals such as plan administrators, RRSPs, RRIFs, TFSAs, and holding entities.
Notably, there are certain conditions when distributing securities to consultants:
the consultant must provide consulting, technical, management or other services and cannot be providing services in relation to a distribution;
there must be a written contract for the services; and
the consultant must spend a significant amount of time and attention on the affairs and business of the issuer.
To rely on this exemption, the securities must be acquired “voluntary”. This means that being coerced to buy securities in order to get hired or to keep a job is prohibited. Typically, the issuer will have purchasers execute a certificate to this effect to provide support for relying on this exemption. The securities will generally be subject to restrictions on resale.
When selling securities to directors and executive officers, issuers may prefer this exemption to the Family, Friends, and Business Associates Exemption because there is no requirement to file a Form 45-106F1 Report of Exempt Distribution or pay a fee under this exemption.
$150,000 Minimum Amount Investment Exemption
The Minimum Amount Investment Exemption allows a single issuer to sell securities to any purchaser (that is not an individual) provided that the acquisition cost is at least $150,000. However, the purchaser must pay the entire price of the securities in cash at the time of the trade, and the purchasing entity must not be created or used solely for the purpose of using this exemption.
An issuer that relies on this exemption must file a Form 45-106F1 Report of Exempt Distribution with the Alberta Securities Commission within 10 days. Additionally, securities acquired under this exemption are subject to restrictions on resale.
