When starting a business in Canada, you will need different types of financing in order to run and keep your business operational. Although it is most common for business owners to turn to a bank for financing, there are actually various types of funding which can be advantageous.
There is Private Placement Financing, for instance. This is a common financing alternative for emerging companies that want to raise capital by issuing or selling securities.
Ontario securities law generally requires that any security being offered to the public by a company must be done under a prospectus. However, through private placement financing, that requirement can be by-passed. It does not involve a public offering and is therefore exempt from prospectus requirements.
In a private placement, or an exempt offering, both the offering and sale of debt or equity securities (promissory notes, a simple agreement for future equity (SAFE), options and warrants) is made between a business, or issuer, and a select number of investors.
Are you considering private placement financing for your company? If so, we have an overview on what you should know about the process in general.
Private Placement and Exempt Offering – Advantages
Public and private companies issue in the private placement market for a variety of reasons. For small businesses, private placement can provide an ideal work around in cases where meeting the requirements of a public offering is not possible.
Certain prospectus exemptions can be used to sell different securities in the exempt market, such as debt, equity, asset-backed securities, investment funds, and derivatives.
Private placement financing is also financially ideal. It provides small businesses with access to long-term capital, sets the business up for building diverse financing resources, and can help to expand the business’ financing capacity.
Private placements are offered only to a small pool of accredited investors. These are investors who do not have to register with the Securities and Exchange Commission (SEC). They are also investors who own financial assets generally exceeding at least $200,000.
Because securities are sold only to accredited investors who are familiar with making investments, exempt offerings allow the Issuer to avoid the liabilities that are more common with prospectus offerings.
In addition, exempt offerings can save the business expenses normally spent on preparing and filing a prospectus and the time inevitably consumed while undergoing reviews by regulation authorities. The process is generally much quicker than that of setting up an IPO.
Because prospectus requirements are not needed with private placement financing, it means smaller companies can remain private with less disclosure requirements.
Exemptions from the Prospectus Requirement – Examples
A prospectus exemption from securities laws is required since securities laws apply to private companies as well, not just public ones.
There are various exemptions from the prospectus requirement that are available to an emerging corporation and that are available to Canadian and foreign companies. Some examples include:
- Family, Friends and Business Associates
- Accredited Investor
- Eligibility Requirements for the Investor
- Filing Requirements
- Minimum Amount $150,000
In the case of sales made under the above exemptions, an emerging corporation that is a private issuer must file Form 45-106F1 with the applicable securities commission within ten days.
Some other commonly used private placement exemptions:
- Private Issuer
- Employee, Executive Officer, Director and Consultant
- Offering Memorandum Exemption
- Petroleum, Natural Gas and Mining Properties Exemption
- Additional Investment in Investment Fund Exemption
- Existing Security Holder Exemption
- Asset Acquisition Exemption
Note that certain prospectus exemptions above may require companies to provide documentation on offerings and/or ongoing disclosures. The structure of an exempt offering ultimately depends upon a few factors. This commonly includes the type of securities being offered, the prospectus exemptions being relied upon, and the time frame involved.
How to Secure Private Placement Financing
Although every case is unique, there is a general process and a number of requirements that must be met when securing private placement financing.
Documentation and Process
Documents that are most commonly used for private placement in Canada include:
- A business plan
- An information memorandum
- Notes from meetings between the company and company counsel regarding corporate housekeeping
- An engagement letter
- Preliminary negotiations
- Terms of the offering
The process, itself, is made up of a few major steps:
- Draft the offering document
- Conduct due diligence
- Draft and negotiate key agreements
- Comply with Canadian stock exchange requirements
- Close the offering
- Closing Memorandum
While the listing above may seem simple, each stage in the process requires meticulous review, detailed paperwork, and careful planning. You should consult a corporate or financial lawyer to ensure that you are meeting all requirements, drafting documents accurately, and are appropriately negotiating terms and agreements that are beneficial to all parties.
Prospectus Exempt Financing – What to Consider
Now that you know the general framework and documents required of setting up private placement financing, you should start thinking carefully about each aspect of the process. Below are some things to keep in mind with prospectus exempt financing:
- Accurate records: Emerging corporations should maintain a complete and accurate record of issued and outstanding securities. This prevents business disputes and is essential during the due diligence process.
- Terms of financing: Take into consideration factors of financing such as pricing and conversion. Determine if the financing terms will generate conflicts with shareholder agreements or the articles of the corporation. Such factors could affect future financings and transactions of the company.
- Shareholders’ Agreement: Consider any preemptive or other rights and changes that may impact existing security holders. They may need to be negotiated or may affect the timing or other factors of the financing, and should be in the shareholders’ agreement.
- Non-disclosure agreement: A non-disclosure agreement should be obtained if the purchaser is going to perform due diligence on the issuer.
- Distributing information: You should determine what information, warranties, and representations will be made and distributed to potential purchasers.
- Offering memorandum: Your offering memorandum should align with rules relating to the use of an offering memorandum, and it should be in compliance with the applicable requirements.
- Term sheet: Ensure that the emerging corporation issues a term sheet and makes presentations only.
- Valuation: It is possible that an investor may require a valuation. This is usually done to determine the purchase price of the securities being offered. You should consider how this will be performed: on what basis, who will provide it, how much it will cost, who will be paying for the valuation, etc.
- Reselling securities: Certain conditions must be met for securities sold under a prospectus exemption. Ensure that the resale conditions include sufficient disclosure within the marketplace for subsequent purchasers.
If you are starting a business in Canada and need guidance or have questions about securing private placement financing for your company, contact one of our securities lawyers for a free consultation.