By Matthew Leask, Associate LBW
Start-ups and Small businesses looking to enter new markets or create new products or services often face challenges raising money to fund their entrepreneurial ventures. At Lancaster, Brooks & Welch LLP we specialize in helping people with great business ideas get off the ground, and proper funding can be major impediment to success for our clients. Due to the complicated system of securities regulation in Ontario, and throughout Canada, it is not as simple as finding investors, and selling them stocks or bonds in a new company. Small business owners and founders of start-ups are often limited to raising money from friends and family, and taking out loans and lines of credit with Canadian banks.
In Ontario, the sale of securities is governed by the Securities Act, R.S.O. 1990 c. S.5 (the “Act”). “Securities” is defined to include many types of investments in a corporation, but typically we are dealing with the purchase of shares in a corporation, or equity financing. In exchange for money, the investor is given a share of the ownership in the company, and will therefore share in its growth, or lack thereof. The Act’s primary purpose is to protect the public by requiring public companies to provide its potential investors with sufficient information to make an informed decision about whether to invest in the company. This is commonly known as the “prospectus requirement.” While the purpose is noble, and necessary, the prospectus requirement has the collateral effect of making it infeasible for small companies to raise money from the public by selling shares. It is simply too costly to prepare a prospectus if you are not a large public company.
The Ontario Securities Commission (“OSC”) is responsible for administering the Act, and over the years has implemented a number of exemptions to the prospectus requirement, to try and help small businesses raise money through equity financing, without having to incur the cost of preparing a prospectus for investors. The most common exemption used by our clients is the private issuer exemption. This exemption allows private companies to sell shares in their corporation to certain groups of people.
In order to take advantage of the private issue exemption the following requirements must apply:
- The corporation must be a Private Issuer; meaning the company’s shares are subject to restrictions on transfer and the corporation has 50 or less shareholders;
- All of the shareholders of a Private Issuer must be:
- A director, officer, employee, founder, or control person of the issuing corporation;
- A spouse, parent, grandparent, brother, sister, child or grandchild of one of the above;
- A close personal friend;
- A close business associate;
- An immediate family member of an existing security holder;
- An existing security holder;
- An accredited investor;
- A person who beneficially owns a majority of the voting securities;
- A trust or estate of which all the beneficiaries or a majority of the trustees or executors are persons described above; or
- A person that is not the public.
This exemption is useful for many corporations, but it also limits the pool of potential investors, and limits the number who can be sold securities. As of January 14, 2016 the OSC finalized and approved a new exemption from the prospectus requirement. NI 45-108 (https://www.osc.gov.on.ca/en/SecuritiesLaw_mi_20160114_45-108_crowdfunding.htm) allows corporations, subject to certain rules, to raise money by selling securities using crowdfunding websites.
Most people are familiar with crowdfunding. Websites like kickstarter have made the idea mainstream and have enabled creative types to raise money for projects by providing incentives such as prizes for fans who invest. Typically, crowdfunding is associated with movies, video games, trendy new products, and charitable fundraising. Under the new rules, crowdfunding enables investors to purchase shares in a small business or start-up over the internet through a registered funding portal. A complete list of registered funding portals is available on the National Crowdfunding Association of Canada’s webpage.
Any member of the public can invest up to $2,500 per investment, up to an annual maximum of $10,000 per year. There are several legal requirements that must be followed by businesses who wish to take advantage of this new exemption. Companies selling shares over the internet must provide investors with a “crowdfunding offering document,” which is a very truncated version of a prospectus, and investors must sign a risk acknowledgement form. Companies must also file an exempt distribution form with the OSC within 10 days of each transaction.
The first step for any new business is to incorporate, and the corporate team at Lancaster, Brooks & Welch LLP can help you with that. There are several other legal considerations that must be assessed prior to taking advantage of equity crowdfunding. Call us at 905-641-1551 to discuss you options.