Application of Securities Laws to Private Companies: Part I
Alright, readers! It's time to delve into a very, very dry (but important) subject: securities laws!
It is a common misconception that securities laws do not apply to privately-held companies. In fact, securities laws apply to all entities that distribute securities, regardless of whether they are listed on a stock exchange. Every issuer of securities (and yes, shares count as securities), must comply with securities laws from the moment of their incorporation or formation.
In our next two articles, we'll give you the scoop on what you need to know to make sure your private company is complying with securities regulations. In this month's post, we’ll break down the registration and prospectus requirements in BC and give you an overview of the common exemptions from the prospectus requirement. We'll also touch on the documentation and filing requirements that go with those exemptions. In next month's post, we’ll get into the nuts and bolts of those exemptions and break down the requirements for each.
Registration and Prospectus Requirements
The two basic requirements underlying securities laws in British Columbia are:
1. Registration, requiring every person who is in the business of trading securities to be registered with the British Columbia Securities Commission (the BCSC); and
2. Prospectus, requiring every person who distributes new securities being issued for the first time to file and obtain a receipt for a prospectus, which discloses all material information about the issuer and the securities being sold.
In BC, a “person” has a broad meaning, including an individual, corporation, partnership, trust, fund, association, or any other organization. “Securities” also has a broad meaning, including common and preferred shares, options, warrants, debentures, notes, limited partnership units, memberships in co-operative associations, or units in a resort property.
These requirements are intended to protect the public by ensuring that people selling securities are knowledgeable enough to properly advise investors and that investors receive sufficient information to allow them to make informed investment decisions.
Every issuer of securities must comply with the registration and prospectus requirements or rely on an exemption from those requirements each time they issue securities.
Common Exemptions from Prospectus Requirement
In an effort to balance its mandate of protecting investors with the desire to foster fair and efficient capital markets, the BCSC has created several exemptions from the registration and prospectus requirements. The most relevant exemptions for privately-held companies are the exemptions from the prospectus requirement. These include the following:
Private Issuer Exemption
Family, friends, and business associates exemption
Employee, director, officer, and consultant exemption
Accredited investor exemption
Offering memorandum exemption
Start-up crowdfunding exemption
The good news is that most of the provincial securities commissions across Canada have adopted uniform policies (called National Instruments) so that the criteria for these exemptions are the same. We'll get into the nuts and bolts of those criteria in our next post.
Any issuer intending to distribute securities under a prospectus exemption must ensure that the purchasers meet the requirements for that exemption; and if a purchaser resides outside of BC, then the issuer must also ensure there is an available exemption in the province or state where the purchaser lives.
Issuers intending to rely on one of these exemptions (other than the offering memorandum exemption or the crowdfunding exemption, which have their own documentation requirements) must have a written agreement (subscription agreement) with each purchaser that includes language confirming that the purchaser meets the specific requirements of a prospectus exemption and that the purchaser is not receiving prospectus-level disclosure about the company and its business.
With the exception of the private issuer and the employee, director, officer, and consultant exemptions, an issuer must file and prepare a report of exempt distribution with the BCSC each time it uses any of the exemptions listed above. In addition, if an issuer uses the offering memorandum exemption or the startup crowdfunding exemption, it must file a copy of the offering memorandum or offering document with the BCSC. Additional filings may be required in other jurisdictions if securities are sold to purchasers outside of BC.
It is important for private and early-stage businesses to consider relevant securities laws and comply with the registration and prospectus requirements or rely on an exemption from those requirements. The best course of action is to work with your lawyer from the beginning to identify and address any potential securities issues before they arise, as well as to ensure that appropriate documentation is in place. Reactive legal advice is always more expensive than proactive legal advice. And trust us on this one, you don’t want the BC Securities Commission to be the reason you need reactive legal advice!