Private Placement Market
Both private and public companies use the private placement market to raise money from investors. It is an important source of funding for BC companies and entrepreneurs. This market is also called the “exempt market” because those who use it do so under exemptions from the requirement under securities law to file a prospectus when issuing securities.
Exemptions Private Companies Typically use to Sell Securities to Investors
Companies using the private placement market to raise capital typically graduate from one exemption type to another as they grow. There are five exemptions that private companies typically use to sell securities to investors.
Private Issuer Exemption
A company that meets the definition of a private issuer may sell its securities to qualified shareholders—that is: directors, officers, or major shareholders (“principals” of the company; close family, friends, or business associates of a principal; accredited investors; and current shareholders).
Companies using this exemption are not required to file any reports with the BC Securities Commission (BCSC) until they exceed the 50-shareholder limit or sell shares to an unqualified investor.
Family, Friends, & Business Associates Exemption
A company may sell its securities to you if you are a close relative, close friend, or a close business associate of a director, executive officer, or major shareholder of the company. The definition of who qualifies under this rule is very strict:
- A close relative is a spouse, parent, grandparent, sibling, child, grandchild, or in-law.
- 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, to be a friend-of-a-friend, or be connected through some form of social media.
- A close business associate is someone who has enough prior business dealings with a company principal to be able to judge that person’s capabilities and trustworthiness. You don’t qualify just because you are a customer, client, co-worker, or colleague.
Accredited Investor Exemption
A company may sell its securities to you if you qualify as an “accredited investor”.
To qualify as an accredited investor, an individual must have at least one of the following financial qualifications:
- At least $1 million in financial assets (cash and 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. Net assets exclude all liabilities.
If you qualify to buy securities under the above categories of an accredited investor, you will be asked to sign a 45-106F9 Form for Individual Accredited Investors that describes, in plain language, the categories of individual accredited investors and identifies the key risks associated with purchasing securities in the private placement market. You must confirm that you understand the risk of the investment and the exemption that applies to you.
Start-up Crowdfunding Exemption
Start-up companies and small businesses can use this exemption to raise money from anyone, even if they do not have an existing relationship with a director, executive officer, or major shareholder of the company or are not an accredited investor.
To raise money through start-up crowdfunding, a company must first complete an offering document outlining its idea and make it available online through a funding portal. The offering document contains basic information about the project, including the minimum amount of money that needs to be raised to proceed, and the deadline for raising this minimum amount.
The maximum a business can raise from each investor for a project is $2,500. However, you can invest up to $10,000 if the offering is being conducted through a registered dealer and the dealer has determined that the investment is suitable for you. The company is required to file the offering document with the BCSC, but the BCSC does not review it before it goes to investors.
Before you invest, you will be asked to confirm that you have read and understood the offering document and the risks of the investment you are about to undertake. Pay attention! These investments are risky and you could lose your entire investment.
For more information, you may also want to see the below section entitled “How to Determine if a Company is Worth Investing in?”
Offering Memorandum (OM) Exemption
A company may sell its securities to anyone using the 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. The company is required to file the OM with the BCSC, but the BCSC does not review it before it goes to investors.
If you purchase shares under the OM exemption, you will be asked to sign the 45-106F4 Risk Acknowledgement Form, which describes in plain language the risks of the investment and how to exercise the withdrawal right. You also have a right to cancel your purchase by delivering a notice to the issuer before midnight on the second business day after you agree to purchase the securities.
How to Determine if a Company is Worth Investing in?
Always do your homework before deciding. Without the prospectus or ongoing disclosure that regulators require from public companies, you will have to gather information about the company to make an informed decision yourself. Be sure to find out as much as possible about its management team, financial situation, viability as a business, and financing activity.
Research the Management Team
Get the full legal names of the company’s directors and officers. Conduct a background check to see if they were ever disciplined for bad business practices. If anything you learn leaves you feeling uncomfortable, get a second opinion, or don’t invest.
Understand the Financial Situation
Anyone who wants you to invest in a private company should be able to provide you with a comprehensive set of financial statements showing the company’s financial position, operating history, and cash flow, unless the company is less than a year old.
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”. You may not want to invest in a company that keeps extending its “final” closing date.
Determine Business Viability
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 private companies to provide ongoing disclosure. However, except in certain limited circumstances, 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, and many companies that apply are not accepted.
Check Financing Activity
Companies using most of these exemptions to sell securities to BC investors must file an exempt distribution report with the BCSC after they have raised the capital. A company using the private issuer exemption is not required to file an exempt distribution report.
Go to the BCSC website before you invest to gain insight into the company by reviewing its Exempt Distribution Reports for previous capital raising. If a company has raised a lot of capital in the past, you may want to ask how that capital was used to advance the company’s business plan. After you invest, check to make sure that the financing was carried out as the company said it would be.