Private & Early Stage Businesses

Do Securities Laws Apply to Me?

 
 

There is a common misconception that securities laws only apply to incorporated companies listed on stock exchanges. Actually, securities laws apply to any issuer, incorporated or unincorporated, including those not listed on a stock exchange.

Securities laws apply to all issuers from the moment of their incorporation or formation. Forming an organization usually involves issuing securities to the owner(s) or founder(s). As you will see later, securities regulations specify how these securities can be issued.

The misconception that securities laws only apply to public companies results in many start-up and early stage issuers unintentionally breaking the law. If you are a director, senior officer or owner of any issuer at its early stage of development, this booklet will provide you with a general understanding of securities regulation. It will also provide you with some simple guidance on how your organization can comply with securities laws in British Columbia.

Overview of BC Securities Laws

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Our mission to ensure a fair and efficient securities market that warrants public confidence while fostering a dynamic and competitive securities industry in British Columbia. We do this by regulating the trading of all securities in BC through the Securities Act, rules, regulations, policies and instruments.

There are two basic requirements underlying our securities laws:

  1. Registration Every person who "trades" (sells) securities must be registered (licensed) with the Commission. This requirement is intended to ensure that people selling securities are knowledgeable and able to properly advise investors.
  2. Prospectus Every person who "distributes" (trades) previously unissued securities (i.e., new securities being issued for the first time) must file and obtain a receipt for a prospectus with the Commission. A prospectus is a comprehensive document that discloses all material information about the issuer and the securities being sold. This requirement ensures that investors receive sufficient information to allow them to make an informed investment decision.

Both these requirements refer to a person. In BC, the term "person" has a broad legal meaning that includes an individual, corporation, partnership, party, trust, fund, association, or any other organization.

The term security also has a broad legal meaning. It includes:

  • common and preferred shares
  • options, warrants and other convertible instruments
  • debentures, notes and other instruments of indebtedness
  • limited partnership units
  • memberships in co-operative associations
  • units in a resort property (sharing in the rental profits for the whole building or property)

BC securities legislation contains many provisions that apply only to reporting issuers. A reporting issuer includes any issuer that has:

  • filed a prospectus and obtained a receipt for it from the Commission
  • merged with a reporting issuer by a business combination or takeover bid
  • previously had its securities listed on a BC stock exchange
  • received an order from the Commission designating it a reporting issuer

A reporting issuer must provide information about its affairs on a regular basis to the Commission, its security holders and the investing public. If your organization is not a reporting issuer, you do not have to comply with the public disclosure requirements. Every issuer must comply with the registration and prospectus requirements or be able to rely on an exemption from those requirements. If you do not comply with the requirements and you are not able to rely on an exemption from them, you are violating BC securities laws. This may result in penalties such as severe fines or the shutdown of your operations.

The Commission recognizes that the prospectus and registration requirements, which serve to protect the investing public, are not always necessary. For example, people who are related to the principals of an issuer may not need the information provided in a prospectus before they buy securities. For these reasons, the Commission provides exemptions - exceptions by which individuals and companies are freed from registration and prospectus obligations. You can use these exemptions to create your organization, reward your employees, raise money to finance the development of your business, and reorganize or sell your business.

Exemptions You Can Use to Fund Your Business

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The Commission provides a number of exemptions from the registration and prospectus requirements. These include:

  • private issuer exemption
  • family, friends and business associates exemption
  • employee, director, officer and consultant exemption
  • accredited investor exemption
  • $150,000 exemption
  • offering memorandum exemption

You do not have to apply to the Commission to use any of these exemptions. You do have to ensure that you meet all of the conditions of the exemption.

In most cases, if you rely upon an exemption, you must file a report of exempt distribution with the Commission within 10 days of selling the securities. See Filing Requirements below.

If you issue securities using these exemptions, the securities are subject to resale restrictions. This means that the securities may not be resold (transferred) unless certain conditions are met. In almost all cases, the securities are subject to a "seasoning period" or a "hold period" - a specified period of time during which the purchaser cannot sell the securities.

Private Issuer Exemption

If you have already formed a company, limited partnership, trust or co-operative association, you probably relied on the private issuer exemption without even knowing it. After forming your organization, you may need additional financing in order to continue your operations. By using the private issuer exemption, you can issue securities to form your organization and you can sell securities in any amount without any disclosure, provided these trades are only to the following:

  • directors, officers, employees or control persons of the issuer
  • family members (spouse, parent, grandparent, sister, brother or child) of the directors, senior officers or control persons, close personal friends or close business associates of the directors, senior officers or control persons
  • current security holders
  • family members of the selling security holder
  • accredited investors

You do not have to report the use of the private issuer exemption to the Commission. However, you should keep a record of all the persons you have sold securities to and note how they fit the terms of the exemption.

It is a good idea to have each purchaser sign a purchase agreement for the securities. The purchase agreement should set out the number of securities bought, the amount paid for the securities and the relationship of the purchaser to the issuer or whether the purchaser is an accredited investor. For example, for the parent of a director, the purchase agreement should include a statement that the purchaser is the father or mother of the director. You should also ensure that the purchaser signs the purchase agreement. This precaution can help you if the purchaser ever decides to make a complaint to the Commission.

A private issuer means a person that:

  • is not a reporting issuer, mutual fund or pooled fund
  • has less than 50 security holders, excluding employees and former employees
  • has restrictions on the transfer of its securities in its articles, memorandum, bylaws or its shareholders agreement
  • has sold its securities only to the persons in the bulleted list

The terms "close personal friend ", "close business associate" and "accredited investor" are described in detail later in this material.

If you issue or sell securities using the private issuer exemption, the purchaser should be aware that the securities are subject to resale restrictions. These resale restrictions are outlined in the issuer's articles, memorandum, bylaws or its shareholders' agreement. Generally, this means that the purchasers must obtain approval from the private issuer's board of directors before selling their securities.

The securities also are subject to resale restrictions under securities laws. For a private issuer, this means that the securities have an indefinite seasoning period whereby the purchasers cannot sell them unless they rely on an exemption. The purchasers can always rely on the private issuer exemption to release their securities from this seasoning period, provided the issuer is still a private issuer and they sell their securities to one of the persons listed in the exemption. For example, purchasers could sell their securities to the wife of the president of the company, their own father or to an accredited investor as long as the issuer remains a private issuer.

Many issuers remain private issuers and never have to use any other exemption. But if you no longer fit the private issuer criteria, you cannot use this exemption. Perhaps you have more than 50 security holders, excluding employees and former employees. Perhaps you have sold securities to someone not listed in the private issuer exemption. Once you lose your private issuer status, you cannot regain it. For this reason, it is important that you keep track of the number of your security holders and ensure that you sell securities only to the group listed in the exemption.

What happens if you lose your private issuer status?

Do you have to file a prospectus and "go public" immediately? Do you automatically become a reporting issuer?

No. Many issuers aren't private issuers but never become reporting issuers. Many issuers intend to become public companies in the future, but aren't ready for that step yet. The following exemptions are available for an issuer that is in the "non-private, non-reporting" phase of development.

In fact, these exemptions are available for any type of issuer, whether they are reporting or non-reporting. However, if a private issuer uses these exemptions, it may unintentionally lose its private issuer status. Also, any issuer using these exemptions must file a report of exempt distribution with the Commission.

Family, Friends & Business Associates Exemption

Under this exemption, you can sell securities in any amount without providing any disclosure to the following:

  • a director, senior officer or control person of the issuer
  • a family member (spouse, parent, grandparent, brother, sister or child) of a director, senior officer or control person of the issuer
  • a close personal friend or close business associate of a director, senior officer or control person of the issuer

There is no limit on the number of purchasers or the amount of money that can be raised using this exemption. However, if you use this exemption to sell to a large number of purchasers, the Commission may question whether all of the purchasers are really family, close personal friends or close business associates.

A close personal friend is someone who has known the director, senior officer, or control person of the issuer for a sufficient period of time to be able to assess that person's capabilities and trustworthiness.

Someone is not a close personal friend simply because they belong to the same organization, association or religious group as the director. Nor is someone a close personal friend simply because they are a client or former client of a registrant or former registrant.

A close business associate is someone who has had sufficient prior business dealings with the director, senior officer or control person of the issuer, to be able to assess that person's capabilities and trustworthiness.

Someone who is introduced to the senior officer, or solicited by the senior officer to purchase securities, is not a close business associate. He or she is a member of the public. You cannot rely on this exemption to sell to this type of business contact. This does not mean that you can't sell securities to them, you just need to find another exemption to do so.

Accredited Investor Exemption

Under the accredited investor exemption, you can sell securities to an accredited investor in any amount without providing any disclosure about the issuer. There is no limit on the number of purchasers or the amount that can be raised using the accredited investor exemption.

An accredited investor includes:

  • financial institutions
  • registered advisers or dealers
  • pension funds
  • mutual funds selling only under a prospectus or to accredited investors or persons buying at least $150,000 of securities 
  • corporations, limited partnerships, trusts or estates having net assets of at least $5 million
  • individuals who have at least $1 million in financial assets (cash and securities) before taxes. (In calculating an individual's financial assets, any outstanding loans incurred to acquire those assets must be deducted.)
  • individuals whose net income before taxes exceeds $200,000 (or $300,000 combined income with spouse) in each of the two most recent years and who reasonably expects to exceed that net income in the current year
  • individuals who have at least $5 million in net assets 

$150,000 Exemption

Under the $150,000 exemption, you can sell securities to anyone without providing any disclosure to the purchaser, provided the purchaser buys at least $150,000 worth of securities.

Employee, Director, Officer & Consultant Exemption

Under this exemption, an issuer can sell securities in any amount without providing any disclosure to its employees, directors, senior officers or consultants, provided the purchaser is buying the security voluntarily. This means that the purchaser has not been persuaded to buy the security due to a promise that he or she will be, or will continue to be, employed, appointed or engaged by the issuer.

A consultant is an individual that provides consulting, technical, management or other services to the issuer under a written contract and spends a significant amount of time and attention on the affairs and business of the issuer.

Offering Memorandum Exemption

The offering memorandum exemption allows an issuer to sell its securities to anyone, regardless of their relationship, wealth or the amount of securities purchased.

This exemption can only be used by an issuer selling its own securities. A security holder who wants to sell cannot use it.

Under this exemption, the issuer can sell securities in any amount to anyone provided, before the purchaser signs the agreement to purchase the securities, the issuer:

  • obtains a signed risk acknowledgement form from the purchaser, and
  • delivers an offering memorandum, prepared in the required form, to the purchaser

Note that you must file the offering memorandum with the Commission within 10 days of selling the securities.

What is a risk acknowledgement form?
The risk acknowledgement form is required by BC's securities laws. It is a clear, blunt statement of the risks associated with investing in securities when they are sold under an exemption. It is only two pages - short enough to ensure that purchasers read it. It states in bold print immediately above where the purchaser is required to sign: "I acknowledge that this is a risky investment and that I could lose all the money I invest."

The issuer must give a copy of the signed risk acknowledgement to the purchaser immediately after it has been signed.

What is the required form of offering memorandum?
There are two forms of offering memorandum specified under securities laws. Reporting issuers who have filed an annual information form (AIF) with the Commission can rely on a short form document, Form 45-106F3 - For financial years beginning on or after January 1, 2011, that incorporates the reporting issuer's public disclosure record.

A non-reporting issuer must use a long form of offering memorandum, Form 45-106F2 - For financial years beginning on or after January 1, 2011, that contains seven key elements:

  1. Term sheet - a one-page description of the offering.
  2. Use of proceeds - a table showing how the money will be used.
  3. A description of the issuer and its business - including the issuer's structure, business objectives, management, share capital, and reporting obligations.
  4. A description of any special features of the securities being offered, including whether someone is being paid to sell the securities and what resale restrictions apply to the securities.
  5. Risk factors - a description of the risks associated with the issuer and its business that may negatively impact the ability of the issuer to accomplish its objectives and the risks associated with the securities that may prevent the purchaser from selling or realizing any profits.
  6. A description of the rights available to purchasers specified under securities laws (including the purchaser's right to cancel the purchase agreement and the right of action if the offering memorandum contains a misrepresentation.)
  7. Financial statements prepared in accordance with Canadian generally accepted accounting principles. Interim financial statements can be prepared by management; an independent review by a qualified accountant is not required. Annual financial statements must be audited. 

The offering memorandum must contain a certificate that states: "This offering memorandum does not contain a misrepresentation." A misrepresentation is an untrue statement of a material fact or an omission to state a material fact.

This statement in the certificate must be true when the offering memorandum is given to the purchaser AND when the purchaser signs the purchase agreement.

For example, if you give the offering memorandum to a potential purchaser and he or she does not immediately decide to purchase the securities but comes back three months later to purchase, you must ask yourself whether the offering memorandum is still accurate. Has there been a material change that has affected your business? If there has, then you must give the purchaser an updated offering memorandum that includes the new information before they acquire the securities.

The certificate must be signed by:

  • the issuer's chief executive officer and chief financial officer
  • the directors of the issuer
  • any promoter of the issuer

What are a purchaser's rights under the offering memorandum exemption?

Under the offering memorandum exemption, purchasers have the right to cancel the purchase for two business days after the purchaser signs the purchase agreement. This is not two business days after the closing date or the date the purchaser gets the certificates representing the securities. It is two business days after the purchaser has agreed to buy the securities and has written the cheque and given it to the issuer.

During this two-business day cancellation period, you must hold the purchase funds in trust for the purchaser. This ensures that the funds are available for return to the purchaser if the purchaser exercises their right to cancel the agreement. Therefore, you should hold the purchaser's cheque without cashing it until the cancellation period has expired.

Under the offering memorandum exemption, purchasers also have a right of action if there is a misrepresentation in the offering memorandum. If the offering memorandum contains a misrepresentation, the purchaser can sue for rescission (to cancel the agreement) or sue for damages. The purchaser can sue not only the issuer, but also all the directors of the issuer on the date of the offering memorandum and those officers and promoters of the issuer who signed the offering memorandum. The purchaser's right of action for rescission is available for 180 days after signing the purchase agreement. The right of action for damages is available for 180 days after the purchaser learns of the misrepresentation or three years after signing the purchase agreement, whichever is earlier.

Advertising & Soliciting Purchasers

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No commission or finder's fees may be paid to a director, senior officer, founder, or control person of an issuer in connection with a trade under the private issuer exemption, (except a trade to an accredited investor) or under the family, friends, and business associates exemption.

Other than this, there are no other restrictions on advertising or soliciting for purchasers under any of the exemptions listed above. Nor are there any restrictions about using registrants or finders to solicit (find) purchasers. You can retain someone to find purchasers for you and pay them a commission or finder's fee. However, you must ensure that the purchaser meets the requirements of the exemption that you are relying on to sell the securities. Therefore, if you advertise to find purchasers (other than accredited investors) when relying on the private issuer or family, friends and business associates exemption, it suggests that the required relationship to use the exemption does not exist.

Although there are no restrictions on advertising or soliciting when using these exemptions, you should be aware that BC securities laws prohibit making a misrepresentation or conducting unfair practices when trading in securities.

Unfair practices include:

  • putting unreasonable pressure on a person to purchase, hold or sell a security
  • taking advantage of a person's inability or incapacity to reasonably protect his or her own interest due to a physical or mental infirmity, ignorance, illiteracy, age or inability to understand any matter relating to a decision to purchase, hold or sell a security
  • imposing terms or conditions that make a transaction unfair

If you make a misrepresentation or conduct unfair practices, you have broken BC's securities laws. This could result in a fine up to $1 million or imprisonment for up to three years or both.

Dealer Registration Requirements

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Every person who is in the business of trading or advising must be registered (licensed) with the Commission.

Your small businesses may be exempt from the requirement to register as a dealer if you are “not in the business of trading”. In order to qualify for this exemption you must have an active business unrelated to the sale of securities. This registration exemption applies to officers, directors and employees of your small business that are involved in raising money through the sale of your securities, unless they:

  • are principally employed to sell your securities
  • spend most of their time selling your securities
  • are paid to sell your securities

If your small business pays someone else to sell your securities, they may be “in the business of trading” and need to be registered.

Resale Restrictions

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If you issue or sell securities using any of the exemptions listed in this material, the securities are subject to resale restrictions. This means that the securities cannot be sold by the purchaser unless certain requirements are met. This includes not selling the securities for a specific hold or seasoning period. To resell their securities, a purchaser can rely on any of the exemptions listed in this material except for the employee, director, officer and consultant exemption and the offering memorandum exemption, which are only available to issuers when issuing their securities.

In addition, if you are a private issuer, the securities that you issue or sell are subject to resale restrictions outlined in the private issuer's articles, memorandum, bylaws or its shareholders' agreement. Generally, this means that the purchasers must obtain approval from the private issuer's board of directors before selling their securities.

Filing Requirements

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With the exception of the private issuer and the employee, director, officer, and consultant exemptions, each time an issuer uses any of the exemptions listed in this material, the issuer must file on or before the 10th day after the distribution, with the Commission, a report of the exempt distribution, Form 45-106F6. In addition, if an issuer uses the offering memorandum exemption, it must file, with the Commission, a copy of the offering memorandum on or before the 10th day after the distribution.

Further Information

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You can find further information about any of the exemptions and forms in the Securities Law & Policy section of the website, or you can call the Commission's inquiries line at 604-899-6854 or toll-free at   1-800-373-6393 (BC & Alberta only).

To assist you in finding the right information on our website, the instruments containing the exemptions and the specified forms are linked below:

National Instrument 45-106 Prospectus and Registration Exemptions

  • Private issuer exemption
  • Family, friends and business associates exemption
  • Accredited investor
  • Offering memorandum exemption
  • $150,000 exemption 

National Instrument 45-102 Resale of Securities

  • Resale restrictions when using exemptions

This material has been prepared by the British Columbia Securities Commission to summarize key aspects of the securities law requirements for private and early stage businesses. It should not be considered legal advice. Interpretations and comments contained in this booklet do not replace or modify any provisions of the Securities Act, its regulations, or rules. In order to fully comply with securities laws, readers should consult legal counsel experienced in securities law for advice.

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