Beware of investing in private companies

Lately the Vancouver Sun has been publishing a series of articles about a company, which privately raised more than $220 million from 3,375 investors over a 33-year period to finance the development of the Gallowai Bull River property in southeastern BC. Most of these individuals were able to invest under the “accredited investor” exemption.

The exempt market generally applies to the sales of securities to investors without a prospectus and the advice of a registered dealer. Recently, investors in this project filed a petition in B.C. Supreme Court alleging that the president of the company, Ross Stanfield, has operated the project in a manner oppressive to minority shareholders.

It is obviously a long and difficult story, which I won’t go into today. Read the articles by David Baines in the Vancouver Sun where you will get more information.

Many of those investing in Gallowai Bull River did so under very different rules for the exempt market than are in place today.

Today the rules are highly harmonized among Canadian provinces. In general, “accredited investors” must have an annual income of $200,000 for two years. Their financial assets must be more than $1million (not including real estate) or $5 million overall.

Today, when investors buy through an offering memorandum, there is a very clear statement in the form of a “warning” given to investors in private companies. It prominently advises that these types of investments are risky and high returns are illiquid.

Investments offered by private companies are not required to give the same ongoing disclosure (financial statements, press releases or material change reports) as public companies do. In this case, you are largely on your own, without the investor protections that are required with a public company.

The securities are usually not listed on any stock exchange, which means your ability to resell them to liquidate your investment are extremely limited, if not impossible.

Here is the most important piece of advice to give to people considering an investment in a private company: Read the offering memorandum’s risk disclosure. Then consult a person who is not participating in the deal, e.g. lawyer, banker accountant, financial adviser or someone with business acumen, before making any decision to participate in the investment.

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