Private Placement Market
The private placement market is an important source of funding in our province. Both private and public companies use it to raise money from investors. While the vast majority are investment funds and public companies like mining and utilities, many are start-up businesses, which pose a high risk to retail investors. The private placement market is also called the “exempt” market because those who use it do so under exemptions from securities laws that regulate public market companies.
Exemptions companies typically use to sell securities to individuals
1. Private issuer exemption
A company that meets the definition of a private issuer may sell its securities to fewer than 50 qualified shareholders—that is: directors, officers, or major shareholders of the company; close family, friends, or business associates of a principal; accredited investors; and current shareholders.
2. Close relatives, friends, and business associates exemption
A company may sell its securities to you without an offering memorandum or other disclosure if you are a close relative, close friend, or a close business associate of a director, executive officer, or major shareholder (a “principal”) of the company. The definition of who qualifies under this rule is very strict:
- A close relative is defined as a spouse, parent, grandparent, sibling, child, grandchild, or in-law. You don’t qualify as a close family member simply because you are a cousin of a principal.
- A close friend is someone who has known a principal of the company for enough time to be able to judge that person’s capabilities and trustworthiness. The relationship must be direct. It’s not enough to belong to the same organization, association, or religious group, or to be a friend-of-a-friend of a principal.
- A close business associate is someone who has enough prior business dealings with a company principal to be able to make a sound judgment about that person’s capabilities and trustworthiness. You don’t qualify just because you are a customer or former client, and definitely not if you’re someone who has been approached to invest after a brief acquaintance with a principal.
3. Accredited investor exemption
A company may sell its securities to you without an offering memorandum or other disclosure if you qualify as an “accredited investor”. This means you have at least one of the following financial qualifications, or qualify in some other way:
- At least $1 million in financial assets (cash and marketable securities) before taxes, net of any debts. Neither your home nor any other real estate you own are considered financial assets.
- Net income before taxes of more than $200,000 consistently over the past two years ($300,000 when combined with a spouse’s net income).
- Net assets of at least $5 million.
If you qualify to buy securities under the above categories of accredited investor, the company must have you sign a risk acknowledgement form that describes, in plain language, the categories of individual accredited investor and identifies the key risks associated with purchasing securities in the private placement market.
4. Offering memorandum exemption
A company may sell its securities to anyone using the Offering Memorandum (OM) exemption. An OM is a legal document like a prospectus, but much shorter and less detailed. It must describe the company’s business, provide annual financial statements, discuss the relevant risks, and tell how the company will use the money it raises. And it must be filed with a regulator. Securities laws require companies in the private placement market to file their OM after the financing, not before approaching investors.
If you purchase shares under the OM exemption, the company must give you—and you must sign—a Risk Acknowledgement form. This is to ensure that investors have no illusions about the risks they are about to undertake. Consider it a warning sign if the seller tells you that the risk acknowledgement form is merely a formality and you should just sign it. Instead, read it carefully, and give yourself additional time before you commit.
Additional reading: If you are seriously considering a private placement market investment, and you receive an OM, we strongly recommend you supplement your reading with Guidance for Preparing and Filing an Offering Memorandum under National Instrument 45-106. Although a regulatory document for companies, it’s useful for investors because it sets out common problems that Canadian regulators find with OMs. Consider it a warning sign if an OM you have been given has any of the problems set out in the guidance.
A note on the $150,000 investment exemption
A company cannot use this exemption to sell securities to individuals. Companies can only use this exemption to sell securities to non-individuals (corporations, investment funds, etc.). If somebody offers you, or someone you know, securities under this exemption, you should contact the BC Securities Commission immediately.
Is this company worth investing in?
Always do your homework—a lot of homework—before deciding. Without the prospectus or ongoing disclosure that regulators require from public companies, you yourself will have to gather information about the company to make an informed decision. Be sure to find out as much as possible about its management team, financial situation, viability as a business, and financing activity. And remember that sometimes the best investment you make is the one you walk away from.
Get the full legal names of the company’s directors and officers. Be skeptical of company documents claiming that these people have held certain positions elsewhere if specific details are not included. Conduct a background check to see if they were ever disciplined for bad business practices. Look them up on the internet and social media sites like LinkedIn and Facebook. If anything you learn leaves you feeling uncomfortable, listen to your instincts and don’t invest.
Anyone who wants you to invest in a private company, even a start-up, should be able to provide you with a comprehensive set of financial statements showing the company’s financial position, operating history, and cash flow. Ideally, these should be audited financial statements. If not, they should include at a minimum a balance sheet, income statement, statement of changes in financial position, and detailed supporting notes.
You will also want to know for what purpose the company is raising money and whether its planned fundraising is adequate to cover those costs. Is there a “minimum offering” amount? If not, then the company can spend the money as it comes in, rather than waiting for the full amount to be raised. Be cautious about “final closing dates”. Companies you don’t want to invest in may extend the closing date again and again, sometimes indefinitely.
Viability as a business
Make sure you receive detailed information about the company. Watch for unsupportable claims about the investment’s strengths and speculation about future results. There may be fine print, in the form of explanatory notes, and it’s important that you read and understand it all before you decide to invest. What’s the business plan? How will the company grow? How will it make money, and within what period? No revenue potential means no return on your investment.
Remember that securities laws do not require companies in the private placement market to provide ongoing disclosure. However, provincial and federal corporate laws, require annual financial disclosure, which all investors are entitled to receive.
Beware of the promise that the shares will soon be listed on a stock exchange. Going public can be a long and expensive process. Many companies that apply are not accepted and it’s illegal for a company to say it will soon be listed on an exchange.
BC companies and companies from another jurisdiction using any exemption to sell securities in British Columbia must file an exempt distribution report with the BC Securities Commission within 10 days after they have raised the capital. Go to the BCSC website before you invest to gain insight into the company by reviewing its exempt distribution reports for previous capital raising. After you invest check to make sure that the financing was carried out as the company said it would be.
Access exempt distribution reports by going to the BCSC public website, choosing “Jump to: exempt distributions” and entering the name of the company.
Learn more about private placement investing and Get the Guide.