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Raising Money In the Secondary Market

13/05/2011


At some point, public companies will be faced with the need to raise capital in order to finance acquisitions or growth, or simply to fund ongoing operations. This will most often be achieved by issuing shares from treasury of the company. Unless the company can rely on an exemption, regulatory authorities in Canada generally require companies to issue these securities through a registered securities dealer, and to file a prospectus. The prospectus is a lengthy, detailed disclosure document containing information about the company issuing the securities, and is intended to provide prospective investors with all the information they need to make informed investment decisions.

Advantages/Disadvantages

Raising capital through a prospectus provides benefits to both the company and potential investors. For example, the company is able to offer its securities to a wide base of potential investors, who are usually able to benefit from the liquidity of free trading shares immediately upon closing of the prospectus. However, there are also some significant downsides. A prospectus can be very time consuming and expensive, involving underwriters, accountants, lawyers and often technical experts throughout the process, and the company is required to engage an investment dealer to sell the securities on their behalf, which usually involves more fees and commissions payable to the dealer. In addition, if the general public is not receptive to the prospectus, this significant expenditure of time and energy may not produce the desired financing results. Thus, it is not a particularly attractive option to companies who are only offering shares to a small number of investors.

Options

There are some alternatives to the long form prospectus for companies meeting certain requirements, as follows:

Short form prospectus

A short form prospectus is a condensed form of prospectus that is designed to reduce the time and expense associated with filing a standard long form prospectus, and provides some relief to companies which have an up to date continuous disclosure record and are in good standing with the exchange. Relatively junior venture issuers have been able to take advantage of the relaxed rules and can use the short form prospectus to widely distribute their securities to the public. The simplified document includes a description of the securities being distributed and how the proceeds will be used, with most of the other information about the company being incorporated by reference to continuous disclosure documents already filed and available to the public, such as financial statements and technical reports.

Exemptions

In some cases, companies can avoid the prospectus process all together by utilizing an exemption provided by the securities regulators. Issuing securities through an exemption, often referred to as a "private placement", can be an attractive option as the process is usually less time consuming, less expensive and less onerous than meeting the prospectus requirements. Typically there is a lower level of involvement from regulators on the premise that the investor does not require the protection of a registrant and full disclosure provided by prospectus. As a result of these exemptions, private placements have become the favoured method of raising capital by junior public companies.

The most common exemptions utilized by public companies are:

Accredited investor exemption
The "accredited investor" exemption allows companies to raise any amount of money from any person who meets certain criteria.

Accredited investors include:

  • Canadian financial institutions,
  • Canadian governments,
  • mutual funds,
  • certain types of pension funds and charities, and
  • high net worth individuals who meet specific financial parameters around net income and net worth.

Companies are not required to provide accredited investors with an offering memorandum or other disclosure documents, as the investor is presumed to have sufficient resources to be able to evaluate the investment.

Friends, family and business associates exemption
The "friends, family and business associates" exemption enables companies to sell securities in any amount directly to those with certain relationships to the company and its directors, senior officers and control persons. Direct family members, close personal friends, and close business associates of these directors, senior officers and control persons are eligible to participate in an issuance under this exemption. There is no restriction on the number of people or amount of money included in this type of private placement, and no commission or finder's fees may be paid to any insider.

Minimum investment exemption
The "minimum investment" exemption can be used in situations where one investor, acting as principal, is willing to purchase a minimum of $150,000 of securities of the company. As in the accredited investor exemption, the investor is assumed to have enough financial sophistication to evaluate the risks of the investment.

Offering memorandum exemption
Under the "offering memorandum" exemption, a company can sell any amount of securities to anyone, regardless of their relationship or investor status. However, the company is required to obtain a signed risk acknowledgement form from the investor, and to provide them with an offering memorandum which incorporates by reference documents which have previously been filed with the regulators, such as financial statements and technical reports. The offering memorandum is intended to provide enough information about the risk attached to the investment to enable the investor to make an informed decision. Under this exemption, the investor has the right to cancel his investment and immediately obtain a refund for up to two days after agreeing to and paying for the investment. Investors also have rights to recourse against the company officers, directors and promoters under an offering memorandum should there be a misrepresentation included in the document. While the document is not reviewed or vetted by the securities regulators, a copy of the offering memorandum must be filed within 10 days of the issuance.

In Conclusion

The benefit to issuing companies utilizing one of these exemptions is clear. However, there are also advantages and disadvantages to the investor. The securities purchased are generally subject to resale restrictions, such as a four month hold period, and therefore they are not typically as liquid as those acquired through a prospectus. However, while they are subject to pricing restrictions by the securities regulators, most private placements are issued at prices that are discounted from market prices. These discounts are intended to compensate the purchaser for this illiquidity. In addition, investors participating in a private placement are usually not subject to commissions on the purchase.

In an effort to harmonize and consolidate the various prospectus and registration exemptions across Canada, National Instrument 45-106 – Prospectus and Registration Exemptions came into effect in all provinces and territories in 2005. However, differences still exist and applications can vary between jurisdictions. For example, Ontario has not adopted the "offering memorandum" or "friends, family and business associates" exemptions, while the "founder, control persons and family" exemption is available there. It is extremely important for companies to evaluate whether a specific exemption applies in their jurisdiction. In addition, the onus is on companies to ensure investors comply with the criteria stipulated for each of the exemptions. The consequences of incorrectly issuing shares under any one of the exemptions could be severe, ranging from penalties and fines, to cease trade orders, to the requirement to prepare and issue a long form prospectus in retrospect.

Companies should seek advice from a competent advisor with experience in their respective province or territory.

*This article has been prepared for informational purposes only and is not intended for any other purpose. We do not assume any responsibility or liability for losses occasioned by you in reliance on this information. We would be pleased to discuss with you the issues raised within the context of your particular circumstances. Please contact your local MNP Public Companies advisor.