Starting a business can be expensive. Once entrepreneurs have put their own money into their business they often start looking for other sources of capital. However, small business owners need to be aware of the laws and regulations designed to protect investors before starting this process.
Prospectuses and Prospectus Exemptions
In Canada a corporation seeking investors needs to prepare and file a prospectus unless they qualify for an exemption. Since filing a prospectus is an expensive and time-consuming process small businesses should explore what prospectus are available.
Luckily for entrepreneurs there are a wide range of prospectus exemptions available. This post will introduce the most common exemption: the private issuer exemption.
The Private Issuer Exemption
Many small businesses have likely already utilized this exemption without even knowing. The private issuer exemption has the lowest regulatory burden of any prospectus exemption, however there are a couple of key requirements to be aware of if a corporation wants to be a private issuer. The first is that the company can have no more than 50 beneficial owners (not counting current and former employees). The number of beneficial owners can be different than the number of shareholders.
The second important requirement is that the corporation’s articles must contain restrictions on transferring shares. This is most often accomplished by having a provision requiring any share transfer be approved by the board of directors. Private issuers can only issue shares to certain persons including: directors, officers, employees and founders of the corporation, an existing shareholder, spouse, parent grandparent, sibling, child or grandchild of the above (but not family members of employees), their close personal friends or close business associates or an accredited investor.
There are many categories of accredited investors but three categories that are most frequently used. The first is an individual who (either along or with a spouse) has financial assets (cash and securities) of $1 million. The second is net assets (financial and other assets) of $5 million. The final common category is an individual income before of $200,000 or combined with a spouse of $300,000 before taxes in each of the 2 most recent calendar years and reasonably expects their income to be above the limit in the current calendar year. Other categories exist but these are the most common.
While companies often begin as a private issuer without legal counsel it can be worth retaining counsel to address specific concerns and to ensure that all potential investors meet the requirements for a corporation to retain private issuer status. A law firm can draft a subscription agreement to protect the corporation and ensure that all investors are qualified. Any corporation with more than 50 beneficial owners or who want to take on investors outside of what is permitted as a private issuer should consult with a securities lawyer. Private placements outside of the private issuer category will also likely require securities filings on SEDAR that a securities lawyer can assist with.