Financing the Start-up Company
Written by Viviana Heather

Securities regulation in Canada is a matter of provincial jurisdiction, where it governs every issuance of securities by a growth company. The legal requirements concerning securities offering are substantially the same between the provinces. As a result, there are two bedrock principles in the Canadian securities regime: (a) no one may buy or sell shares unless a registered dealer (in other words, an investment bank) is involved in the sale; and (b) a prospectus must be used every time a corporation distributes its shares to investors.[1] However, growth companies will unlikely raise early financing under this system due to the high costs associated with a prospectus and retaining a registered dealer.[2] This blog post provides an overview of the exemptions from prospectus requirements.

The Private Issuer Exemption
This exemption is invariably the exemption applied to startups and small issuers for the initial distribution of shares to their business partners. The private issuer exemption requires the following:

1. The company cannot be a reporting issuer;
2. The articles, by-laws or unanimous shareholder agreements must restrict the transfer of securities;
3. No more than 50 people, excluding current and former employees, can hold designated securities;
4. The company has not distributed its shares to the public; and
5. No commission may be paid to a third party for any sale of shares, except to an accredited investor.[3]
   
   

The Family, Friends and Business Associates Exemption
This exemption is similar to the Private Issuer Exemption. Eventually, a company will cease to be a private issuer because they have too many shareholders or they distribute shares to the public (which violates the requirements under 3 and 4 of the Private Issuer Exemption).[4] The individuals that fall under this exemption include:

1. “Family” members: spouse, parent, grandparent, brother, sister or child of a director, officer or control person.[5]
   1. A control person is any person who owns a sufficient number of voting securities of a company to affect a material change or the person owns or controls more than 20 percent of a company’s voting shares.[6]
2. “Close personal friend”: the individual knows the director, executive officer, founder or control person well enough that there is time to be in a position to assess their capabilities and trustworthiness.[7] Courts have suggested it involves a relationship of length and intimacy.[8]
3. “Close business associate”: an individual who has had sufficient prior business dealings with a director, executive officer, founder or control person of the issuer to be in a position to assess their capabilities and trustworthiness.[9]
   
   

The Accredited Investor Exemption
This exemption is usually used by angel and venture capital investors. While there are different categories of accredited investors, the most commonly used ones are as follows:

1. Individuals with net financial assets in excess of $1 million;
2. Individuals whose net income
   1. before taxes exceeds $200,000 in each of the two most recent years or
   2. combined with that of a spouse exceeded $300,000 in each of the two most recent years
      1. and in either case, reasonably expect to exceed that net income level in the current year;
3. A person or company that, either alone or with a spouse, has net assets of at least $15 million.[10]
   
   

The Offering Memorandum Exemption
This prospectus exemption is available in every province, but there are significant differences in how it operates.[11] The general concept is that the exemption allows a company to raise money from any person so long as that person is provided with an offering memorandum in a prescribed form prior to agreeing to purchase the security.[12] The offering memorandum discloses basic information about the issuer, its business, financial status and management, terms of the offering, and it describes the securities that are to be sold.[13]

The Employee Exemption
This exemption is typically not used as a financing mechanism, but NI 45-106 provides an exemption for trades by an issuer with its employees, directors, senior officers and those consultants that spend a “significant amount” of time working with the company.[14] However, these individuals are also covered in other exemptions such as the Private Issuer Exemption and the Family, Friends and Business Associates Exemption.

The Minimum Amount Investment
All provinces subscribe to this exemption, which provides for an exemption from prospectus requirements where an investor acquires more than $150k worth of securities.[15]

Conclusion
To make an offering of securities in Canada without using a prospectus and involving a registered dealer, a growth company must rely on a prospectus exemption in order to finance their enterprise.

Viviana Heather is a member of the BLG Business Venture Clinic and is a 3rd year student at the University of Calgary Faculty of Law

Footnotes
[1] Securities Act (Alberta), s 75; Bryce C Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (LexisNexis Canada, 2018) at 252 [Tingle].
[2] Tingle, ibid.
[3] Prospectus and Registration Exemptions, NI 45-106, s 2.4 [NI 45-106]; Ibid at 254.
[4] Tingle, supra note 1 at 255.
[5] NI 45-106, supra note 3.
[6] It is a rebuttable presumption. See Securities Act (Alberta), s 1(1).
[7] NI 45-106, supra note 3.
[8] See e.g. Re Brittain, 1993 CarswellSask417 (WL Can), 2 CCL 109 (SK Securities Commission).
[9] NI 45-106, supra note 3.
[10] Ibid.
[11] Tingle, supra note 1 at 258.
[12] Ibid.
[13] Ibid.
[14] Ibid at 260.
[15] Ibid at 261.

CSA Regulatory Sandbox
Written by Nikolas Kalantzis

If your start-up is in the business of trading or advising securities you are subject to Canadian securities laws and must register under the Alberta Securities Commission (ASC). Securities may include stocks in a company, corporate bonds, profit-sharing agreements, shares in an investment fund, or investment contracts. And yes, according to CSA Staff Notice 21-327, when cryptocurrencies are traded on a platform they are also considered a security.

Spurred into action by the QuadrigaCX fiasco, securities regulators across Canada have now stepped up their game to more closely regulate financial technology (fintech) start-ups and cryptocurrencies (crypto) while still allowing some innovation and experimentation in the market. In doing so, the ASC has created a Financial Innovation in the Capital Markets unit in partnership with the Canadian Securities Administrators (CSA) and have released a regulatory Sandbox to exempt fintech start-ups from certain securities regulations.

What is the Sandbox?
The Sandbox is a coordinated relief initiative to allow fintech start-ups the chance to apply their ideas and test their products on the securities market. The CSA allows relief across Canada subject to local regulators. It is also in collaboration with international fintech networks allowing international testing of their innovative product or service.

A regulatory sandbox can be defined as a “safe space” that allows start-ups to work in “a limited capacity and receive regulatory relief from traditional rules” such as waivers or no-action letters (Clements 2019, 8). This provides the necessary regulatory oversight that promotes start-ups to work more precisely than the traditional Silicon Valley tech start-ups of the “move-fast-and-break-things” ethos (Clements 2019, 9). As such, financial markets and consumers are still protected while allowing Canadian start-ups the chance to innovate and grow.

Who’s Allowed In?
Applicants must be a fintech start-up or business with an innovative product, service, or application. Fintech itself has a wide net that covers processes, products, technology, and innovations that materially effect financial markets, business transactions, or financial systems (Clements 2019, 3). This may include more efficient ways to trade securities, promote financially underserved markets, enhance customer-user experiences, and reduce transaction costs. While the CSA is not explicit in defining fintech, your start-up should likely fit into this area to operate within the Sandbox.

To date, crypto and crypto trading platforms makeup the majority of the Sandbox. The ASC defines crypto as generally referring to coins or tokens that are digitally represented assets produced by cryptography or blockchain technology. The CSA puts out an online decisions list of the various decisions or recommendations to applicants of the Sandbox. Before applying, interested fintech start-ups may want to consider these decisions to see the types of relief previously requested and the responses that the regulators gave.

The Rest of the Playground
Fintech is a new an exciting place with many growing start-ups. But outside the safe space of the Sandbox, fintech start-ups are likely subject to many regulatory requirements under Alberta’s Securities Act. This may include filing a prospectus, dealer registration, continuous disclosure, and market manipulation conditions among others. Fintech start-ups who are not registered with the ASC or another jurisdiction’s regulator may not have the normal safeguards in place such as trustworthy record keeping, confidentiality protections, fair pricing mechanisms, disclosure of fees, and risk warnings.

Hop-in!
If you have more questions about the Sandbox or just want to discuss the legal options for your fintech start-up please contact the BLG Business Venture Clinic. You can also contact the ASC directly at: regtechsandbox@asc.ca

Nikolas Kalantzis is a member of the BLG Business Venture Clinic and is a 2nd year student at the Faculty of Law, University of Calgary.

Sources:
Clements, Ryan 2019. “Regulating Fintech in Canada and the United States: Comparison, Challenges and Opportunities”: View of Regulating Fintech in Canada and the United States: Comparison, Challenges and Opportunities (ucalgary.ca)
CSA Regulatory Sandbox - Canadian Securities Administrators (securities-administrators.ca)
Financial innovation in the capital markets | ASC (albertasecurities.com)
Securities Act, RSA 2000, c S-4, <https://canlii.ca/t/5541x> retrieved on 2021-10-25.