Recently released statistics for the year 2008 reveal what was likely painfully obvious to businesses trying to raise capital last year: that 2008 was not a good year for equity financings. With a few exceptions, companies of all sizes and stages of development experienced a difficult year in which to raise equity capital.

The Public Markets

Statistics released by the TSX Group Inc. indicate that the number of initial public offerings ("IPOs") on the TSX fell from 99 in 2007 to 52 in 2008, representing a decrease of 47.5%. Further, while approximately $7.3 billion was raised through IPO financings on the TSX in 2007, approximately $2 billion was raised in 2008, representing a decrease of about 73%. The number of IPOs on the TSX Venture Exchange decreased from 239 in 2007 to 197 in 2008, representing a decrease of about 18%. While the amount of $533 million was raised on the TSXV through IPOs in 2007, approximately $225 million was raised in 2008, representing a decrease of about 58%.

Venture Capital

Statistics compiled by Industry Canada for investment activity by venture capital firms also indicate that 2008 was generally a difficult year for businesses seeking equity financings from such firms. Industry Canada tracks trends in investment activity for venture capital investments in Canada in a quarterly report titled "Venture Capital Monitor". The latest edition of Venture Capital Monitor, covering the third quarter of 2008 (the "Latest Report"), contained, among others, the following interesting findings:

1. Total Investment by venture capital firms in Canada during the first nine months of 2008 was $1 billion, representing a 33% decrease from the $1.5 billion invested by such firms during the same period in 2007;
2. While seed and start-up companies attracted about the same level of venture capital investment in the third quarter of 2008 ($55 million) as in the first two quarters of 2008, it was down 28% from the $76 million such companies raised in the third quarter of 2007;
3. Venture capital investment in Ontario based companies in the third quarter of 2008 was found to be roughly the same as in the previous quarter, but 42% less than the amount invested in the third quarter of 2007;

Staff at Industry Canada responsible for preparing the Venture Capital Monitor advised that the trend over the last several years has been a general decrease in venture capital investments in Canadian companies.

Implications for Early Stage/Start-Up Companies

In addition to venture capital firms, early stage companies also rely on equity financings from "angel investors" (i.e. wealthy individuals who invest their personal funds in such companies, and sometimes also time, energy and know-how). Given the general decrease in venture capital investments in early stage companies, it is the general decrease in venture capital investments in early stage companies, it is important for such companies to be aware of the sources of angel investments and how to obtain such financing. While the angel investment community in Canada is a fragmented one, a quick search on the internet will yield links to several networks in this community. With respect to securing investments from angel investors, such investors generally look for: a company with a competent management team with a vision for the company, a convincing and detailed business plan, and perhaps an opportunity for the angel investor to be involved in the management and development of the company.

Distribution of Securities in Ontario

As an equity financing involves the distribution of securities, it is important that businesses and investors familiarize themselves with applicable securities laws or obtain professional advice in this regard. The distribution of securities in Ontario will generally require the issuing company to provide prospective investors with a prospectus containing detailed information about the company and the securities offered, unless the issuing company relies on an exemption from the prospectus requirement.

The issuance or sale of securities in reliance on an exemption from the prospectus requirement is typically referred to as a "private placement" and the private placement regime in Ontario is governed by National Instrument 45-106, Prospectus and Registration Exemptions ("NI 45-106"). Under NI 45-106, commonly used exemptions from the prospectus requirement in Ontario include the "private issuer" exemption, the "accredited investor" exemption and the "minimum amount investment" exemption.

Private Issuer Exemption

A "private issuer" is defined under NI 45-106 to mean, generally, an issuer that is not a "reporting issuer" and whose securities are subject to restrictions on transfer that are contained in the issuer’s constating documents or security holders’ agreements, and are beneficially owned, directly or indirectly, by not more than 50 persons, exclusive of employees and former employees of the issuer or its affiliates. In addition, a "private issuer" may distribute securities only to the select group of persons enumerated under NI 45-106 to rely on this prospectus exemption.

Accredited Investor Exemption

Under the "accredited investor" exemption under NI 45-106, the prospectus requirement does not apply in respect of a distribution of a security if the purchaser purchases the security as principal and is an "accredited investor". An individual will be considered an "accredited investor" under NI 45-106 if either:

• the individual, either alone or with his spouse, beneficially owns, directly or indirectly, financial assets (as defined in NI 45-106) having an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1 million;
• whose net income before taxes exceeded $200,000 in each of the two most recent calendar years or whose net income before taxes combined with that of a spouse exceeding $300,000 in each of the two most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year;
• or, who, either alone or with a spouse, has net assets of at least $5 million.

Businesses issuing securities in reliance on this exemption typically require the purchaser to execute a certificate indicating how the purchaser qualifies as an "accredited investor".

Minimum Amount Investment Exemption

Under the "minimum amount investment" exemption under NI 45-106, the prospectus requirement does not apply in respect of a distribution of a security to a person if:

• that person purchases as principal;
• the security has an acquisition cost to the purchaser of not less than $150,000 paid in cash at the time of the trade; and
• the trade is in a security of a single issuer.

However, this exemption is not available where a purchasing entity has been created or used solely to purchase or hold securities in reliance on this exemption.

General

Businesses issuing securities or shareholders wishing to sell securities in Ontario may rely on any available prospectus exemption under NI 45-106. The appropriateness of a given exemption will depend on the particular circumstances of the trade.

The above is only a general summary of the prospectus exemptions available under NI 45-106 and is provided for information purposes only. A legal advisor should be consulted to determine the availability and appropriateness of a given prospectus exemption.

Jim Sahdra
Business Law Group
Tel: 905.276.0423
E-mail: jsahdra@kmblaw.com

The comments in this newsletter are of a general nature and are not designed to replace professional advice in specific situations. If you would like extra copies of this newsletter, or you know of anyone who would be interested in joining our mailing list, please contact Cheryl Woolcott at (905) 276-9111.