Start-up companies
When you invest in a start-up company, the only “sure thing” is your risk. It is exceptionally important to do background research when investing in start-up companies and to ensure that the potential investment fits your investment strategy and investment objectives.
Investing in risky businesses
Most companies raise capital legally and honestly. They file a prospectus with the BC Securities Commission and sell their securities through a registered dealer. Many start-ups are legally exempt from these requirements because they meet specific criteria set out by law. However, some companies don’t play by the rules.
When it comes to buying and selling stock, people usually think of stock brokers, stock exchanges and public companies. But many shares are sold outside of stock exchanges, and without the advice of a broker or financial adviser, by companies that are not public. In BC, millions of these securities are issued every year, mostly by start-up companies.
Often, investors are approached by promoters to “get in on the ground floor” and provide “seed capital” to new ventures. These salespeople promise fast profits as soon as the company goes public or the “sure-fire money maker” takes off. These claims are red flags that an investment opportunity may be too good to be true and many investors end up losing their hard-earned money.
Take a look at a few examples of illegal sales of securities in private start-up ventures that the BC Securities Commission has pursued in recent years.
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Securities of start-up companies
When any company wants to raise money by selling its securities, it must follow the rules of the Securities Act. This applies to both public companies, which are listed on a stock exchange or quotation service, and private companies, which are not.
When you are asked to put your money into a business opportunity in which the success of the business depends on others, you are purchasing a security. People often think of securities as shares, but these investments also take many other forms, such as bonds, debentures, promissory notes, loan agreements, limited partnership units, mortgage interests and investment contracts.
Most start-up companies are private. This means that their securities do not trade on the open market and you cannot sell them if you change your mind or need your cash back. Also, private companies are not required to disclose information on their operations and financial situation to regulators and the public. Therefore, if you invest in a private company, you will probably not be kept informed of how it is doing and what has happened to your investment unless you can get this information from the company on your own.
You can learn how to do background checks and use our risk test to assess whether investing in high-risk start-up companies is a good match for your level of risk tolerance.
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Check out an investment before risking your money
Make sure you understand what rule the company is relying on to sell its securities to you
Are you being supplied with an offering memorandum? If not, do you fall within the specific categories of investor from whom a company can raise money without providing an offering memorandum? Ask the company what rule for raising money they're using to sell securities to you and assess whether you fit into that category as defined by law.
Ask for an offering memorandum and read it
Before you invest, you should understand the investment. An offering memorandum provides factual information that you can evaluate and verify. If you are unsure of what this document should look like you can contact the BC Securities Commission.
Ask questions
If you do not receive an offering memorandum, try to find out as much information as possible about the investment. For example, ask about the background of the company’s principals and their experience in the particular industry. Even if you are related to one of the principals, ask about the others involved in the business and do background research on them. Ask if there are financial statements that can help you and your adviser judge how the business is managed. If the company’s representatives dismiss your questions or do not give you satisfactory answers, consider this a red flag and stay away from the investment.
Read the risk warning and subscription agreement forms carefully
The risk warning form that accompanies an offering memorandum and the subscription agreement you must sign before investing your money are not just pieces of paper. They are key legal documents designed for your protection. It is very important to read these carefully and understand their implications before you sign.
Get independent advice
Don’t rely on the opinion of the company’s representatives about whether this is an appropriate investment for you, even if they are close friends or family members. Consult with an independent financial adviser, lawyer or accountant or with a trusted friend or relative who can be relied on to give you an objective opinion.
Don’t invest more than you can afford to lose
Investing in start-up companies is very risky. Even if a company has good intentions and follows all the rules in selling its securities, there is no guarantee it will be successful.
Remember that high potential means high risk
Investments in private start-up ventures are usually based on the anticipation of significant future returns. But even large, well-established companies cannot predict their financial future. Keep in mind that “if it sounds too good to be true, it probably is.”
Do some checking of your own
It is easy to check on a company and its representatives to see if they have had previous securities violations. Read our background checks section to learn how to determine if the company or any of its principals or representatives have been disciplined for securities violations in the past. Another measure you can take is to find out where the company is incorporated and verify that it has a legitimate physical location.
Be aware that you may never be able to sell your shares in a private company
Securities of private companies are not traded on the public market. Therefore, it will be difficult, or impossible, to get your money back if you need it or change your mind about the investment.
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Examples of securities violations with start-up companies
In recent years the BC Securities Commission has taken enforcement action in a number of cases related to the illegal sale of start-up company securities. Take a look at a few examples of illegal sales of securities in private start-up ventures.
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