Two developments from Ontario (and to some extent elsewhere) recently have elicited some muted excitement in the venture and junior issuer world towards the end of 2015.
The first is news in early November, 2015 that the Canadian Securities Administrators (the “CSA”) have finalized amendments initially proposed in March of 2014 to National Instrument 45-106 - Prospectus Exemptions (“NI 45-106”). For certain participating jurisdictions this includes, in particular, adoption of (or amendment to) an offering memorandum exemption. This is perhaps exciting news for issuers with a connection to Ontario as this is the first time Ontario will have an offering memorandum type exemption - which seems to come as a surprise to some who thought Ontario always had an offering memorandum exemption available similar to the exemptions applicable in Alberta and British Columbia.
An Offering Memorandum, and an offering memorandum exemption, is intended to permit issuers to raise funding from a wider range of investors than would otherwise be available under exemptions such as the accredited investor exemption by providing investors with an offering memorandum that includes prescribed disclosure that is less comprehensive than what is required in a prospectus and is, therefore, less expensive than filing a prospectus.
Ontario actually did not adopt an offering memorandum exemption when the CSA adopted NI 45-106 in 2009. Alberta, Manitoba, Northwest Territories, Nunavut, Prince Edward Island, Québec, Saskatchewan and Yukon did adopt an offering memorandum exemption in 2009 but, among other things, limited the amounts that could be raised from investors, other than a defined eligible investor, to no more than $10,000. British Columbia, New Brunswick, Nova Scotia and Newfoundland and Labrador also adopted an offering memorandum exemption in 2009 but had no such limit on investments.
This new offering memorandum exemption (expected to come into force in Ontario in January, 2016 and the amendments in Alberta, Saskatchewan, Quebec, New Brunswick and Nova Scotia are expected to come into force in April, 2016) will limit the amounts that can be raised from non-eligible investors in Alberta, Saskatchewan, Ontario, Quebec, New Brunswick and Nova Scotia $10,000; from eligible investors generally to $30,000; and from an eligible investor that is an individual (and that receives advice from a portfolio manager, investment dealer or exempt market dealer that an investment above $30,000 is suitable) to $100,000; over any given twelve-month period. Manitoba, Northwest Territories, Nunavut, Prince Edward Island and Yukon continue to limit the amounts that can be raised from investors, other than a defined eligible investor, to no more than $10,000. British Columbia and Newfoundland and Labrador appear to continue to have no such limit on investments.
In early November, 2015 the securities regulators in Manitoba, Ontario, Québec, New Brunswick and Nova Scotia published a final Multilateral Instrument 45-108 - Crowdfunding (“MI 45-108”) which includes a crowdfunding prospectus exemption and a registration framework for funding portals to facilitate start-up and early-stage issuer fund raising. Yet again, despite the mantra of harmonization and a national regulator, the adoption of MI 45-108 is not exactly ground breaking – since the securities regulators in Manitoba, Québec, New Brunswick and Nova Scotia had already adopted crowdfunding prospectus exemptions and a registration framework for funding portals by way of harmonized blanket orders (as did British Columbia and Saskatchewan – see here).
In Manitoba, Ontario, Québec, New Brunswick and Nova Scotia, a purchaser that is not an accredited investor is subject to an investment limit of $2,500 per distribution, and in Ontario such purchaser is also subject to an annual investment limit of $10,000 for all distributions made in reliance on this new crowdfunding exemption in the same calendar year. In all of Manitoba, Ontario, Québec, New Brunswick and Nova Scotia, an accredited investor is subject to an investment limit of $25,000 per distribution and in Ontario, an accredited investor is also subject to an annual investment limit of $50,000 for all distributions made in reliance on this new crowdfunding exemption in the same calendar year. In Ontario, an investor that is a permitted client (as defined in National Instrument 31-103 - Registration Requirements, Exemptions and Ongoing Registrant Obligations) is not subject to an investment limit.
In late October, 2015 the Alberta Securities Commission and the Nunavut Securities Office published Proposed Multilateral Instrument 45-109 - Prospectus Exemption for Start-up Businesses (“MI 45-109”) – which although not limited to crowdfunding was meant to coordinate with the crowdfunding blanket orders adopted by the securities regulators of British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia. MI 45-109 sets out a proposed prospectus exemption to facilitate capital raising by start-up and early stage companies. Subject to certain conditions, the proposed exemption would allow a start-up or early stage issuers to raise up to $1,000,000 using a streamlined offering document and risk warning. Investors would, however, be permitted to only invest up to $1,500 in an issuer, or $5,000 with the advice of a registered dealer. The comment period expired December 18, 2015.
British Columbia’s crowdfunding exemption, adopted earlier by way of a blanket order, is not immune from restrictions on its use. Issuers are not permitted to raise more than $1,500,000 under that exemption within the 12-month period ending on the last day of the distribution period; the issuer group cannot raise aggregate funds of more than $250,000 per distribution and is restricted to not more than two start-up crowdfunding distributions in a calendar year; and no person participating in such crowdfunding distribution can invest more than $1,500 per distribution.
It is a good thing, to be sure, that Canada almost has a national offering memorandum exemption and, perhaps even more radical, an almost national crowdfunding exemption (US regulators have been debating this for years as well, only recently adopting their own rules relating to crowdfunding). These developments are made even more impressive when considered along with other jurisdiction specific announcements of prospectus exemptions for distributions made through investment dealers and prospectus exemptions for distributions to existing shareholders.
However, notwithstanding any criticism that may be leveled regarding the somewhat less than harmonized rules (which may, at some point, be addressed in the context of the adoption of a National Securities Regulator (see here)), all of these newly minted or proposed prospectus exemptions may not result in much utilization by, and therefore benefit to, Canada’s ailing early stage and junior market issuers.
Why? … the mitigation of perceived risk by way of investment limitations and suitability advice and the attendant perceived costs thereof.
Regulators have made it very clear that many of the new or amended exemptions available are prospectus exemptions for the distribution of securities only, trading in securities still requires consideration and compliance with registration requirements under securities law which since 2009 have very few and very narrow exemptions available. In January, 2013, the British Columbia Securities Commission proposed, by the elimination of the so-called “Northwest Exemption” (to date no action or further announcements have been made), the end to the ability of an issuer in British Columbia to pay any person a finders’ fee for assisting in capital raising unless that person is registered under NI 31-103 as a broker or an exempt market dealer. In fact, in announcing its intent to eliminate the finders’ exemption the British Columbia Securities Commission made their overall impression very clear in stating:
“Investors who are considering investing in private placement securities would be better protected if they purchase securities from a registered dealer. In particular, they would have the benefit of advice about whether a purchase is suitable for them before they invest.”
Further the British Columbia Securities Commission (and I suspect many other jurisdictions) have stepped-up enforcement and compliance actions regarding securities trading registration compliance, making repeated or continuous exempt offerings or any payment to a person related to any trading in securities highly risky unless done through or paid to a person that is registered under NI 31-103 as an investment dealer or exempt market dealer. Many new or amended exemptions are entirely premised on suitability advice; or applicable investment thresholds are altered or waived only with suitability advice. Portfolio managers, investment dealers and exempt market dealers providing suitability advice are themselves subject to regulation, including “know your client” and “know your product” requirements (which likely means a fairly extensive review of an issuer and the issuer’s exempt security to be offered) applicable to all suitability advice to be given by a registrant. With respect to crowdfunding, any offering must be facilitated through a recognized, and regulated, funding portal. The use or involvement of portfolio managers, investment dealers, exempt market dealers or funding portals will require compensation of some sort likely borne by the issuer – directly or indirectly. The terms of that compensation will no doubt vary but if past practice is any indication, the potential for additional costs not otherwise associated with what many junior market issuers considered the atypical “non-brokered private placement” can be assured.
Perhaps indirectly (as many of the new or amended exemptions are subject to offering limits, investment limits, and/or parsing investors between eligible and non-eligible) the anticipated use of these exemptions likely means the need to attract investment interest from either a handful of investment funds or institutional investors (not something easily accomplished by early stage and junior market issuers) or a larger number of potential retail investors. For example, an issuer may only consider the attendant cost of an offering memorandum to be justified if it reasonably can raise $1,000,000. With investment limits of $10,000 that means at least 100 final investors – which likely means getting an offering document in the hands of hundreds of potential retail investors. With the pending elimination of finders this will likely mean greater reliance on registrants, which will mean compensation in fees and/or commissions borne directly or indirectly by the issuer for the services provided or rendered by portfolio managers, investment dealers or exempt market dealers.
In good capital markets demand for early stage investment is typically high, the success of junior market offerings is typically all but assured and the participating issuers seldom raise too much concern over associated fees or commissions in anticipation of funding well in excess of any fees or commissions paid or accrued. In poor capital markets demand for early stage investment is all too often weak and successful junior market offerings, particularly larger offerings, rare. Junior market issuers, often short of cash, become cautious of the expense and reluctant to undertake the risk of more formal offering processes or offering documents; and a race to low cost options often results.
It can reasonably be argued that if stronger junior capital markets return we will see simply a return to more use of the less restricted (by way of who or how much) but more expensive prospectus or brokered private placement offering. As long as weaker junior capital markets persist many junior issuers will remain opportunistic – looking to raise the most money as quickly; definitively; and at the lowest cost as possible – perhaps through the continued liberal use of the accredited investor exemption or through the sale of securities directly to principals (i.e., directors, officers and control persons) or their family members, close personal friends and close business associates. The complexities, limitations, procedures and perceived costs of many of the new or amended prospectus exemptions will likely mean – perhaps unfortunately – that their use will be rare and their benefit limited.
By no means should this be interpreted as a critique. Securities regulators in all jurisdictions face an unenviable task of exercising their mandate while seeking a compromise to the often conflicting self-interests of issuers, investors, registrants, professionals, service providers and governments (and the regulators themselves) that make up the corporate finance and investment community. However the recent announcements of new and amended prospectus exemptions may be, in the end, a simple case of a jack of all trades, master of none. Perhaps that was the intent.
Does not constitute legal or other advice and must not be used as a substitute for legal advice from a qualified legal professional in your jurisdiction who has been fully informed of your specific circumstances. Information may not be up-dated subsequent to its initial publication and may therefore be out of date at the time it is read or viewed. Always consult a qualified legal professional in your jurisdiction.