Raising Capital In The Exempt Market

OSC & The Exempt Market

When looking to grow a business outside of traditional bank financing, business owners often consider granting equity in a corporation as an alternative various debt options such as obtaining a loan or line of credit. While issuing shares in a corporation does not have to occur on a stock exchange, there are securities law restrictions which still apply. In this article, we will walk through some of the basics involved with issuing securities in compliance with the laws in Ontario.

The sale, trade or distribution of securities in Ontario is primarily regulated by the Securities Act (Ontario) (the “Act”) as well as policies and rules created by the Ontario Securities Commission (the “OSC”), the Ontario regulator which administers and enforces the Act together with regulators in other Canadian jurisdictions and self-regulatory bodies. The goal of this system is to provide for a balance between efficient capital markets and protecting investors and their confidence in those capital markets.

The Act creates a closed system with a basic guiding principle: an entity looking to sell, trade or distribute securities (an “Issuer”) must either: (a) file a prospectus with the OSC and comply with the prospectus disclosure rules before they sell, trade or distribute securities (which can be both a costly process and involves ongoing continuous disclosure obligations) or (b) sell, trade or distribute securities pursuant to an exemption from those prospectus disclosure rules. Below we discuss three main exemptions that are often utilized:

1) Accredited Investor – The Accredited Investor exemption (“AI”) typically applies to the sale, trade or distribution of securities to institutional investors (such as financial or governmental institutions, insurance providers, pension funds) or sophisticated individual investors. A sophisticated individual is determined by meeting one of a series of financial asset or income tests which are typically viewed a proxy for the ability to weather the loss of their investment. 

2) Friends Family and Close Business Associates – The Friends Family and Close Business Associates exemption (“FFBA”) applies to the sale, trade or distribution of securities to certain relatives, close personal friends and close business associates of directors, executive officers, control persons and founders of the Issuer. Purchasers under the FFBA exemption should have a close enough relationship to the Issuer and it’s guiding minds they are able to conduct sufficient due diligence to assess their risk. 

3) Offering Memorandum – The Offering Memorandum (“OM”) exemption is a form of middle ground between the prospectus disclosure rules and an exemption. Under this exemption, the OM itself, which contains required disclosure, must be filed with the OSC. The OM is thought to allow the purchaser to make a more informed investment decision and accordingly, investors with less financial assets than under the AI exemption can invest, but with limits. Notably, there is no limit to the amount an AI can invest if the investment is completed under the OM exemption.

The OSC requires, in each case above, that certain reports and filings be completed within strict time periods related to the sale, trade or distribution of securities, which can include a report of exempt distribution or a filing of the OM itself. Further, the Issuer may also be required to maintain a risk acknowledgment form from the purchaser for a prescribed period of time. Additionally the securities distributed pursuant to an exemption above may be subject to various hold or seasoning periods which can impact the liquidity of a purchaser’s investment in the Issuer.

The exempt market allows Issuers to raise capital in more innovative ways and to access a larger investor pool than through traditional financing methods. However, there can be significant compliance costs associated with the sale, trade or distribution of securities not to mention the loss of equity in the Issuer.

We at KMB Law are experienced at drafting the appropriate legal documentation and implementing the filings required to effect the sale, trade or distribution of securities through an exempt distribution, in a cost effective manner than enhances value for you, the client. If you have any questions regarding this or any aspect of your business, please do not hesitate to get in touch with me at 905.276.0431  or kfernandes@kmblaw.com. We are here to help.