Written by Masooda Bidar, JD Candidate 2027
Note: The information below is for general information only and does not constitute legal advice. Its application will depend on the circumstances of each situation.
Most startups need capital long before they are ready to access the public markets. However, under Canadian securities laws, a company that distributes securities is generally required to provide investors with a prospectus containing detailed information about the business, the securities being offered, and the risks associated with the investment.
For many early-stage companies, preparing a prospectus is simply not realistic. It can be expensive, time-consuming, and may impose a regulatory burden that is disproportionate to the amount of capital being raised. To address this reality, Canadian securities laws provide a number of prospectus exemptions, which allow companies to raise capital without preparing and filing a prospectus.¹
Broadly speaking, the prospectus exemptions most commonly used to raise capital fall into one of three categories:
The investors are sufficiently wealthy or sophisticated to understand and evaluate the risks of the investment and bear the potential loss.
The investors have a relationship of trust with the company's principals and make their investment decision, at least in part, because of that relationship.
The investors receive alternative disclosure that may be less comprehensive than a prospectus, often accompanied by investment limits intended to reduce risk.²
One of the most important exemptions available to startups is the private issuer exemption under National Instrument 45-106 Prospectus Exemptions ("NI 45-106"). To qualify as a private issuer, however, a corporation must satisfy a number of conditions. Among other requirements, its securities must be beneficially owned by no more than fifty persons (excluding employees and former employees), and those securities must be subject to restrictions on transfer contained in the issuer's constating documents or a security holders' agreement.³ For many startups, maintaining private issuer status is important because it provides a straightforward and cost-effective mechanism for raising capital during the company's earliest stages.
What makes the private issuer exemption particularly attractive is that it largely operates in the background. Unlike many other prospectus exemptions, there is generally no exemption report to file, no filing fee to pay, and no requirement to notify securities regulators that the exemption has been used. As a result, founders may rely on the exemption without ever consciously thinking about it as a securities law exemption. This practical reality creates an important problem. If founders do not realize they are relying on the exemption, they may also overlook some of its technical requirements. One of those requirements is that transfer restrictions be contained in the issuer's constating documents or a security holders' agreement. At first glance, this requirement appears straightforward. Upon closer inspection, however, it raises an important question: what exactly counts as a constating document?
The Hidden Risk: "Constating Documents"
The challenge is that NI 45-106 does not define the term "constating documents."
In corporate law, constating documents are generally understood as the documents that establish a corporation and govern its fundamental affairs. Under the Canada Business Corporations Act ("CBCA"), this concept is commonly understood to include a corporation's articles of incorporation, bylaws, and unanimous shareholder agreement.⁴ Articles of incorporation establish the corporation and set out its fundamental characteristics, bylaws govern its internal procedures, and unanimous shareholder agreements may allocate management powers and define relationships among shareholders.⁵
From a corporate-law perspective, there may appear to be little uncertainty regarding what constitutes a corporation's constating documents. However, the private issuer exemption is not found in corporate legislation. Rather, it is found in securities legislation, and NI 45-106 does not expressly define the term or identify which documents qualify for purposes of satisfying the exemption.⁶
For many startups, this issue may never arise during day-to-day operations. However, it can become more significant during a financing, acquisition, or due diligence review, when investors and their counsel examine whether the company has continuously satisfied the requirements of the exemption relied upon for previous securities issuances. At that stage, questions about whether a transfer restriction was located in the appropriate document may create uncertainty.
Why Articles of Incorporation May Be the Safer Choice
Articles of incorporation are generally regarded as the corporation's foundational governing document. In fact, both the Canada Business Corporations Act ("CBCA") and the Alberta Business Corporations Act ("ABCA") expressly contemplate that restrictions on the transfer of shares may be included in a corporation's articles.⁷
This is significant because transfer restrictions are not merely permitted in the articles; they are specifically identified by corporate legislation as a matter appropriately addressed there. By contrast, bylaws serve a different function. They operate as the corporation's internal rulebook, governing matters such as shareholder meetings, director elections, and corporate procedures.⁸ Unlike articles of incorporation, bylaws are not mandatory under either the CBCA or the ABCA and may be amended as the corporation evolves and its governance needs change.⁹
Because transfer restrictions are expressly contemplated in the articles and because articles form part of the corporation's foundational structure, placing transfer restrictions in the articles may provide founders with greater certainty that the requirement has been satisfied. From a practical perspective, articles are also less likely to be amended or overlooked than internal governance documents that change as the corporation grows.
This does not mean that bylaws cannot qualify as constating documents. Rather, where a transfer restriction is fundamental to maintaining private issuer status, founders may wish to place that restriction in the document most clearly associated with the corporation's legal structure.
Takeaways
The private issuer exemption remains one of the most valuable fundraising tools available to early-stage companies. Yet qualifying for the exemption requires more than simply limiting who may purchase shares. Because NI 45-106 requires transfer restrictions to be contained in the issuer's constating documents or a security holders' agreement, founders should consider whether the location of those restrictions could create avoidable uncertainty in the future.
Although reasonable arguments may exist that bylaws form part of a corporation's constating documents, articles of incorporation represent the clearest and least controversial location for transfer restrictions. By placing those restrictions directly in the articles, startups may strengthen their reliance on the private issuer exemption and reduce the risk of future compliance questions during financings, acquisitions, and due diligence reviews.
Endnotes:
1. Alberta Securities Commission, Intro to Raising Capital Using Prospectus Exemptions, online: <https://www.asc.ca/en/small-business/intro-to-raising-capital-using-prospectus-exemptions>.
2. Ibid.
3. National Instrument 45-106, Prospectus Exemptions, s 2.4(1)(b).
4. Sarah Dallyn, “Constating Documents: What are they and why you should care about them?” (13 January 2024), Business Venture Clinic Blog.
5. Ibid.
6. National Instrument 45-106, Prospectus Exemptions, s 2.4(1)(b)(i).
7. Canada Business Corporations Act, RSC 1985, c C-44, s 6(1)(c); Business Corporations Act, RSA 2000, c B-9, s 6(1)(c).
8. Dallyn, supra note 4.
9. Ibid; see also Canada Business Corporations Act, RSC 1985, c C-44, ss 103-106; Business Corporations Act, RSA 2000, c B-9, ss 103-106.
