Having considered the various steps enumerated in my last article to improve the strength of your business before seeking angel financing, you now have to arm yourself with an understanding of the private company financing regime in Canada. The first rule is that any time that a company issues shares to founders or investors it must either file a prospectus (a detailed and expensive disclosure document) with a securities commission in the jurisdiction where the investors are located or rely on the exemptions that exist to the prospectus filing requirement. In Ontario there are seven commonly used exemptions as noted below:
- Private insurer;
- Director, executive officer, employee or consultant;
- Family, friends and business associates;
- Minimum investment of $150,000;
- Accredited investor; and
- Offering memorandum.
Reliance on one of the first two exemptions is the most common approach to issuing shares or raising capital in a start up venture since neither a report of the transaction nor filing fees are required to be delivered to the applicable securities commission. In fact, most entrepreneurs have no idea that they are relying on one of these two exemptions when issuing shares of their companies.
There are some basics, however, that issuers should understand.
The private issue exemption can only to be used by companies that (a) have no more than 50 shareholders (excluding current and former employees); (b) include a restriction on the transfer of their shares in a shareholder agreement or in the articles of incorporation; and (c) direct the issuance to certain categories of shareholders. These categories include officers, directors, employees and control persons of the issuer, and immediate family members, close personal friends and business associates of the aforementioned individuals. Additionally, current shareholders of the company and accredited investors are eligible for this exemption.
The second exemption would appear to be a subset of the first exemption but can, in fact, be relied upon even though the company may already have 50 shareholders. Many companies seem to be able to establish themselves within the parameters of these first two exemptions and never require additional financing. It is important to note however that if you do require angel financing, most angel investors qualify as accredited investors and therefore the investment may be made under the private issue exemption. In my next article we will examine the criteria applied to determine who qualifies as an accredited investor.