Private placements

One common way in which companies expand and develop is by raising capital through the issuance of ‎equity or debt securities. In Canada, absent an exemption, a distribution of securities cannot be made ‎without preparing and qualifying a prospectus with the relevant securities regulators which describes ‎the company and its business in a fairly significant degree of detail. The distribution of securities on an ‎exempt basis is generally referred to as a private placement. This bulletin discusses some of the key ‎features of private placements and summarizes some of the most commonly used prospectus ‎exemptions.

Benefits of a private placement

The process of distributing securities by way of a private placement tends to be more cost effective ‎and time efficient as compared to conducting a public offering by way of a prospectus filing. More ‎specifically, by issuing securities through a private placement offering, companies are exempt from the ‎extensive disclosure requirements involved in prospectus offerings, which can often include the ‎preparation of audited financial statements. Moreover, in contrast to prospectus offerings, the ‎offering materials in a private placement are not generally reviewed by the provincial securities ‎regulators. These features help to provide companies with more flexibility to conduct their offerings ‎and react to market conditions. ‎

Drawbacks of a private placement

In contrast to a prospectus offering, in which securities can be issued to any person or company once a ‎receipt for the prospectus is obtained, companies conducting private placement offerings will need to ‎ensure that their proposed distribution fits within one of the applicable prospectus exemptions ‎available under securities legislation. As a result, companies are somewhat restricted in terms of the ‎investors from whom capital can be raised. ‎

Moreover, securities distributed by way of private placement are generally subject to a restricted ‎trading period, during which investors are unable to freely transfer or resell such securities to other ‎investors. Put another way, during this restricted period, the securities may only be resold by investors ‎in reliance on prospectus exemptions under securities legislation. The applicable restricted period and ‎the limitations imposed on investors vary somewhat depending on which prospectus exemption is ‎relied upon to distribute the securities. ‎

Prospectus exemptions

In order to offer securities without filing a prospectus, entities must rely on one of the exemptions ‎enumerated in securities legislation. Generally, the availability of particular prospectus exemptions ‎will depend on the nature of the entity, the nature of the investor and the type of securities being ‎distributed. The most commonly utilized prospectus exemptions include the following:‎

1.‎ Accredited investor exemption

The accredited investor exemption is set out in section 2.3 of National Instrument 45-106 - Prospectus ‎Exemptions (“NI 45-106”). This prospectus exemption allows for the distribution by an entity of any ‎type of security to an “accredited investor” who purchases the security as principal. ‎

This exemption does not apply if the person purchasing the securities as principal was created, or is ‎being used, solely to purchase or hold securities in reliance on this exemption. The rationale behind ‎this exemption is to provide entities with the ability to distribute securities to certain types of ‎sophisticated investors that are generally considered to be able to make informed investment ‎decisions without the standard prospectus disclosures. ‎

The most common types of accredited investors, as defined under NI 45-106, include:‎

• Investment funds, pension funds, financial institutions, and registered securities dealers; ‎
• Individuals who, either alone or with a spouse, beneficially own financial assets having an ‎aggregate realizable value that, before taxes but net of any relatable liabilities, exceeds ‎‎$1,000,000;‎
• Individuals who beneficially own financial assets having an aggregate realizable value that, ‎before taxes but net of any related liabilities, exceeds $5,000,000; 
• Individuals whose net income before taxes exceeded $200,000 (or with a spouse, exceeded ‎‎$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;‎
• Individuals who, either alone or with a spouse, have net assets of at least $5,000,000; ‎
• Persons, other than individuals or investment funds, that have net assets of at least $5,000,000 ‎as shown on their most recently prepared financial statements; or
• Persons in respect of which all of the owners of interests, direct, indirect or beneficial, except ‎the voting securities required by law to be owned by directors, are persons that are accredited ‎investors. ‎

Entities relying on this exemption are responsible for determining whether an investor meets the ‎definition of accredited investor under securities legislation. In order to do so, certain representations ‎and warranties from the purchaser are typically included in the offering document pursuant to which ‎the securities are offered. ‎

A distribution made pursuant to this exemption requires the filing of a Form 45-106F1 - Report of ‎Exempt Distribution (“45-106F1”) in the jurisdictions where the distribution took place no later than 10 ‎days after the date upon which the distribution occurred. Further, a risk acknowledgment form (“Form ‎‎45-106F9”) must be signed by individual accredited investors (unless an individual with ‎financial assets in excess of $5,000,000) at the same time or prior to signing the agreement to ‎purchase the securities. The entity making the distribution must retain the signed Form 45-106F9 for a ‎period of eight years after the distribution. ‎

‎2.‎ Private issuer exemption

The private issuer exemption is set out in section 2.4(2) of NI 45-106. This prospectus exemption allows ‎for entities that qualify as private issuers to distribute securities to certain permitted persons which ‎purchase the securities as principal without the need to file a prospectus.

In order to qualify as a private issuer, an entity must: (i) not be a reporting issuer or an investment ‎fund; (ii) have restrictions on the transfer of its securities (other than non-convertible debt securities) ‎which are contained in the entity’s constating documents or security holders’ agreements; (iii) not ‎have more than 50 beneficial owners of its securities (excluding employees and former employees); ‎and (iv) have only distributed its securities to permitted persons. ‎

The list of permitted persons includes, but its not limited to:‎

• A director, officer, employee, founder or control person of the entity or its affiliates;‎
• A spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive ‎officer, founder or control person of the entity; ‎
• A close personal friend or a close business associate of a director, executive officer, founder or ‎control person of the entity; ‎
• An existing security holder of the entity; ‎
• An accredited investor; ‎
• A trust or estate of which all of the beneficiaries or a majority of the trustees or executors are ‎permitted persons; and
• A person of which a majority of the voting securities are beneficially owned by, or a majority of ‎the directors are, permitted persons. ‎

As this prospectus exemption does not require the filing of a 45-106F1, this is a commonly used ‎exemption among small, closely-held entities. ‎‎

3.‎ Family, friends and business associates exemption

The family, friends and business associates exemption is set out in section 2.5 of NI 45-106. This ‎prospectus exemption allows for the distribution by an entity of a security to certain permitted ‎persons who purchase the security as principal. The list of permitted persons includes, but is not ‎limited to: ‎ 

• A director, executive officer or control person of the entity or its affiliates;‎
• A spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive ‎officer or control person of the entity; ‎
• A close personal friend of a director, executive officer or control person of the entity; ‎
• A close business associate of a director, executive officer or control person of the entity; ‎
• A founder of the entity or a spouse, parent, grandparent, brother, sister, child, grandchild, ‎close personal friend or close business associate of a founder of the entity;‎
• A parent, grandparent, brother, sister, child or grandchild of a spouse of a founder of the ‎entity;‎
• A person of which a majority of the voting securities are beneficially owned by, or a ‎majority of ‎the directors are, permitted persons; and
• A trust or estate of which all of the beneficiaries or a majority of the trustees or ‎executors are ‎permitted persons.‎

Following the distribution of securities pursuant to the family, friends and business associates ‎exemption, the entity will be required to file a Form 45-106F1 no later than 10 days following the date ‎of distribution. If the distribution is made to an investor resident in Saskatchewan in reliance on such ‎investor being a close personal friend or close business associate of a director, executive officer, ‎control person or founder of the entity, a signed risk acknowledgement in the prescribed form must ‎be obtained from the purchaser. If the distribution is made to an investor resident in Ontario, a signed ‎risk acknowledgement in the prescribed form must be obtained from the investor. The risk ‎acknowledgement forms referred to above must be retained by the entity for a period of eight years ‎following the distribution. ‎‎

4.‎ Minimum amount investment exemption

The minimum amount investment exemption is set out in section 2.10 of NI 45-106. This prospectus ‎exemption allows for the distribution by an entity of a security to a person that is not an individual ‎where the security has an aggregate acquisition cost of a minimum of $150,000, paid in cash at the time ‎of the distribution.

‎This exemption does not apply if the investor does not purchase as principal or was created, or is being ‎used, solely to purchase or hold securities in reliance on this exemption. ‎

As in the case of the accredited investor exemption and family, friends and business associates ‎exemption, the entity will be required to file a Form 45-106F1 no later than 10 days following the date ‎of distribution. ‎

Distributions to foreign purchasers ‎

A number of provincial securities regulators have enacted specific regimes for the distribution of ‎securities to purchasers in foreign jurisdictions. For example, in March 2018, the Ontario Securities ‎Commission enacted OSC Rule 72-503 - Distributions Outside Canada (the “OSC Rule”) which ‎introduced four new prospectus exemptions permitting a distribution of securities outside Canada to ‎occur on a basis that is exempt from the prospectus requirements. The OSC Rule was designed with ‎the goal of facilitating cross-border offerings by doing away with the prospectus requirements where ‎offerings are aimed at investors resident outside of Canada and are made in compliance with the ‎securities law of the foreign jurisdiction. Put another way, so long as the entity has taken reasonable ‎steps to comply with the requirements applicable to the distribution under the securities law of the ‎jurisdiction outside of Canada, the investor is not required to otherwise satisfy the prospectus ‎requirements in Canada.‎

However, as the rules and guidance surrounding distributions into foreign jurisdictions vary by ‎province, entities intending to distribute securities outside of Canada should pay particular attention to ‎the rules of their jurisdiction of incorporation and organization to ensure that they are in compliance. ‎

Conclusion

Private placements offer entities a cost-efficient and expeditious way of raising capital. The specific ‎exemption relied on and the structure of the private placement will depend on the size of the entity, ‎the type of securities offered, the investors interested in purchasing the securities, along with the ‎time frame required to conduct the offering. Any entity interested in pursuing a private placement ‎offering in Canada should contact the undersigned authors to discuss their intentions and goals in ‎accessing capital markets and to determine how to structure the private placement to suit their capital ‎needs. ‎

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