Graham Erion, Davis LLP
This article will review some of the basic considerations for companies considering raising capital through a private placement. It is by no means an exhaustive review of the law or other matters.
Provincial securities laws in Canada require companies wishing to sell their securities (called ‘issuers’) to the public to provide their investors with a prospectus document that describes the company and the securities they are offering and to sell their securities through a registered dealer. These requirements aim to protect investors by helping them to make more informed investment decisions. However, securities regulators recognize that certain sophisticated investors and those with pre-existing relationships with the issuer do not require the level of disclosure required in a prospectus to make an investment decision. Issuers can therefore raise money by way of a private sale (a private placement) to such investors without incurring the cost and time to prepare and clear a prospectus with regulatory authorities. In addition, provided no one involved in the private placement is in the business of trading in securities in Canada, there is also a registration exemption which provides that there will be no requirement to register as a dealer to place the securities.
The private sale of securities also does not typically entail potentially onerous and detailed disclosure requirements (although circumstances vary) and does not, unless the issuer is already a public company, trigger ongoing public company reporting regulations. Private placements can also allow a company to target a certain class of investors to become their shareholders. This can be particularly helpful to companies before undertaking an initial public offering as having the backing of well-known investors can lend credibility to a company if it eventually goes public.
These advantages have made private placements a popular alternative to a public offering, even for publicly-listed companies who frequently use private placements for more targeted or smaller offerings. Among the downsides to this form of raising capital is that it can be hard for issuers to find suitable investors and once securities have been sold under a private placement there are restrictions on the ability of investors to re-sell the securities to other investors (either pursuant to another exemption (i.e. another accredited investor) or until the issuer files a prospectus, or, in the case of a company that is recognized by a securities regulator as being public (a reporting issuer), the purchaser has held the securities for a period of at least four months). This lack of liquidity can lower the value of privately placed securities relative to a public offering.
Issuers must be able to locate suitable investors to conduct this type of offering. There are various types of investors that can purchase securities without a prospectus requirement, a few of which are as follows. The most widely-known exemption is sales to “accredited investors”, which includes Canadian financial institutions; registered securities advisers/dealers; governments; regulated pension funds; companies with net assets of at least $5 million; and individuals who own (alone or with a spouse) at least $1 million in financial assets or whose net income exceeded $200,000 alone or $300,000 with a spouse in each of the last two years. Private issuers (a defined term) with less than 50 shareholders (not including present and former employees) can also sell securities under a prospectus exemption to certain “permitted investors.” This category includes accredited investors and directors, officers, employees and the founder or controlling person of the company, along with any extended family member, close personal friend or close business associate of these persons. Both public and private companies can also issue securities under a prospectus exemption to any investor who purchases at least $150,000 in a single offering.
Setting the Terms
Once an issuer decides to do an offering, close consideration will need to be given to the type of securities, price and other key terms. Issuers will need to decide if they want to offer debt (including convertible debt) or equity (and if so, whether common shares, preferred shares or warrants, etc.). Issuers should consider the services of a financial advisor and securities lawyer to help structure the pricing and terms of a private placement. For listed companies, restrictions apply on the amount of discount to the current market price permitted in the selling price of the securities offered in the private placement.
Negotiating Key Agreements and Diligence
Once key terms of the offering are set, the issuer should prepare to negotiate and enter into key agreements with their investors. This includes a subscription agreement, which sets out the terms under which investors will subscribe for the securities and invest in the company, among other things. Private companies may also consider entering into a shareholder or similar agreement that will govern the rights that shareholders or other security holders have as to voting, dividends, sales and liquidation, etc. This agreement will also establish certain corporate governance requirements, including shareholder meetings and the nominations of directors and/or officers.
As part of the investment process, issuers should also prepare for investors to conduct their own due diligence on the company prior to any investment.
While a prospectus is not required for an exempt private placement, many issuers deliver to potential investors a document which describes the business of an issuer and can be useful in helping an issuer to market its securities. If such a document is delivered to purchasers in Ontario, it is deemed to be an “Offering Memorandum” under Ontario law and must contain a description of the purchaser’s statutory rights of rescission or damages in the event that the document contains information that is misleading to an investor such as an untrue statement of a material fact or an omission to state a material fact that has been relied upon to the investor’s detriment. This right of action is not available to financial institutions. A copy of the Offering Memorandum must also be delivered to, but is not reviewed by, the applicable provincial securities commission no more than 10 days after the closing of the private placement. In certain provinces other than Ontario, a prescribed form of Offering Memorandum may be used for a prospectus exempt offering to investors that are not accredited.
Regardless of the use of an Offering Memorandum, issuers should always consult with and involve their legal counsel in advance of any offering.
Graham Erion is a lawyer at Davis LLP specializing in securities, corporate finance and securities, mergers and acquisitions and governance matters. For further information please contact Graham at 416-369-5287 or [email protected]
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