Securities may not commonly be offered for sale in Canada without providing a prospectus to potential investors. A prospectus is a formal legal document, which is required by and filed with the appropriate securities regulatory authorities, that provides substantive details about a particular investment offering, which is offered for sale to the public.
A prospectus is required to contain certain the facts about a company and its securities that a purchaser reasonably needs, to allow them to make an informed investment decision. The information typically required is as follows (non-exhaustive list):
- the company’s financial statements;
- the business carried on by the company including certain disclosures with respect to any material contracts of the company;
- the industry and markets in which the company operates, and any notable trends;
- the officers and directors of the company, their background, and relevant experience;
- the principal security holders of the company;
- any material transactions (including any significant acquisitions or dispositions) of the company in the previous 3 years;
- any particular risk factors associated with the business; and
- how the company intends to use the proceeds of the offering.
The purpose of the general prospectus requirement is to protect investors – the ultimate goal being to provide them with sufficient material information about the issuer, so that they can make an informed investment decision in respect to the securities that are being offered. However, it would be highly inefficient and significantly costly to require a prospectus for all transactions, and all types of purchasers. Therefore, securities legislation has allowed for certain exemptions, in particular, for private placements that issuers may rely upon. Although some provinces continue to retain their own exemptions, the majority have been harmonized by National Instrument 45-106 (“NI 45-106”).
NI 45-106 provides a range of prospectus exemptions for both public and private issuers. The most frequently used exemptions are the following:
- “Accredited investor”;
- “Minimum amount investment”;
- “Employee, executive officer, director and consultant”;
- “Offering memorandum”; and
- “Private issuer”
Accredited Investor Exemption
The “accredited investor” exemption is set out in s. 2.3 of NI 45-106 and provides an exemption for purchasers of the securities that qualify as “accredited investors”. There is a presumption that purchasers who qualify as “accredited investors” have a certain level of financial sophistication and full material disclosure is not required for them to make an investment decision.
An individual qualifies as an accredited investor if he or she:
- has net assets of at least $5 million, either alone or together with a spouse (para. (l) of “accredited investor” definition in NI 45-106;
- beneficially owns financial assets having an aggregate realizable value that before taxes, but net of any related liabilities, exceeding $1 million, either alone or with a spouse (para. (j) of “accredited investor” definition in NI 45-106);
- beneficially owns financial assets having an aggregate realizable value that before taxes, but net of any related liabilities, exceeding $5,000,000 (para. (j.1) of “accredited investor” definition in NI 45-106); or
- had a net income before taxes of more than $200,000 in each of the two most recent calendar years or a net income before taxes combined with that of a spouse of more than $300,000 in each of the two most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year (para. (k) of “accredited investor” definition in NI 45-106).
Minimum Amount Exemption
The “minimum amount investment” exemption is set out in s. 2.3 of NI 45-106 and provides an exemption from the prospectus requirement for a distribution of securities to any person (that is not an individual) that purchases securities of a single issuer that have an acquisition cost to the purchaser of a minimum of $150,000 at the time of the distribution.
This exemption is not available if the purchaser was created or is used solely to purchase or hold securities under this exemption (NI 45-106, s. 2.10(2)). The example is whereby a newly formed company with 15 shareholders is set up with the intention of purchasing $150,000 worth of securities under the minimum amount investment exemption. Each shareholder of the newly formed company contributes $10,000.
The “employee, executive officer, director and consultant” exemption set out in s. 2.24 of NI 45-106 provides an exemption from the prospectus requirement for distributions by an issuer to its employees, directors, executive officers, and consultants.
For this exemption, a “consultant” means a person, other than an employee, executive officer, or director of the issuer or of a related entity of the issuer, that:
- is engaged to provide services to the issuer or a related entity of the issuer, other than services provided in relation to a distribution;
- provides the services under a written contract with the issuer or a related entity of the issuer; and
- spends or will spend a significant amount of time and attention on the affairs and business of the issuer or a related entity of the issuer; and includes:
- for an individual consultant, a corporation of which the individual consultant is an employee or shareholder, and a partnership of which the individual consultant is an employee or partner; and
- for a consultant that is not an individual, an employee, executive officer, or director of the consultant, provided that the individual employee, executive officer or director spends or will spend a significant amount of time and attention on the affairs and business of the issuer or a related entity of the issuer (NI 45-106, s. 2.22).
Offering Memorandum Exemption
Subject to jurisdictional availability, the offering memorandum exemption in s. 2.9 of NI 45-106 allows an issuer to sell its securities to a wider range of purchasers. Individuals need not be accredited investors, and the issuer may be a reporting issuer.
Section 2.9 of NI 45-106 sets out the requirements for the use of the “offering memorandum” exemption in each Canadian jurisdiction:
- the requirements for British Columbia, Newfoundland and Labrador are set out in s. 2.9(1) of NI 45-106;
- a set of narrower requirements for Manitoba, the Northwest Territories, Nunavut, Prince Edward Island, and Yukon Territory are set out in section 2.9(2) of NI 45-106; and
- a set of still narrower requirements for Alberta, New Brunswick, Nova Scotia, Ontario, Québec, and Saskatchewan are set out in s. 2.9(2.1) of NI 45-106.
Each jurisdiction in which the offering memorandum exemption is to be relied upon requires that:
- purchase the offered securities as principal — not for the benefit of others; and
- at the same time or prior to the purchaser signing an agreement to purchase the securities, the purchaser:
- is provided with an offering memorandum, in compliance with certain requirements set out in NI 45-106; and
- signs a risk acknowledgement in a prescribed form (NI 45-106, ss. 2.9(1), 2.9(2), and 2.9(2.1)).
These basic requirements apply in British Columbia, Newfoundland and Labrador (NI 45-106, s. 2.9(1)), and additional jurisdiction-specific requirements apply to the other provinces and territories.
General Offering Memorandum Requirements
An offering memorandum must comply with one of the two required forms:
- Form 45-106F3: Offering Memorandum for Qualifying Issuers (if the company is a qualifying issuer); or
- Form 45-106F2: Offering Memorandum for Non-Qualifying Issuers (used by all other issuers).
A “qualifying issuer” is generally defined as a reporting issuer that has filed an annual information form under NI 51-102 and has met all its other continuous disclosure obligations (NI 45-106, s. 1.1).
Contractual Right to Cancel
The offering memorandum must provide a contractual right to cancel the agreement to purchase the security not later than midnight on the second business day after the purchaser signs the agreement. During this period, the issuer must arrange for the consideration to be held in trust on behalf of the purchaser (NI 45-106, s. 2.9(16)).
Contractual Right of Action
The offering memorandum must contain a contractual right of action against the issuer for rescission or damages if the securities legislation of the jurisdiction in which the purchaser is resident does not provide a statutory right of action for misrepresentation in an offering memorandum delivered under s. 2.9 of NI 45-106.
Private Issuer Exemption
The “private issuer” exemption set out in s. 2.4 of NI 45-106 allows “private issuers” to distribute securities to a select group of investors without having to comply with the prospectus requirements. The exemption is available in all the provinces and territories of Canada.
A private issuer is defined very specifically in NI 45-106. As noted in 45-106CP, a private issuer can distribute securities only to the persons enumerated under the private issuer exemption (s. 2.4(2) of NI 45-106 and reproduced below). If a private issuer distributes securities to a person not listed in s. 2.4(2), even under another exemption, it will no longer be a private issuer and will not be able to continue to use the private issuer prospectus exemption.
A “private issuer” is an issuer:
- that is not a reporting issuer or an investment fund (as defined under the provincial securities acts);
- whose securities, other than non-convertible debt securities, are subject to restrictions on transfer that are contained in the issuer’s constating documents or security holders’ agreements;
- whose securities are beneficially owned, directly or indirectly, by not more than 50 persons, not including employees and former employees of the issuer or its affiliates; and
- that has only distributed securities to a select group of persons purchasing the securities as principal — not for the benefit of others — provided that such person was not created solely to make use of the exemption:
- a director, officer, employee, founder or control person of the issuer;
- a director, officer or employee of an affiliate of the issuer;
- a spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive officer, founder or control person of the issuer;
- a parent, grandparent, brother, sister, child or grandchild of the spouse of a director, executive officer, founder or control person of the issuer;
- a close personal friend of a director, executive officer, founder or control person of the issuer (“Close Personal Friend”) (see further discussion below);
- a close business associate of a director, executive officer, founder or control person of the issuer (“Close Business Associate”) (see further discussion below);
- a spouse, parent, grandparent, brother, sister or child of the selling security holder or of the selling security holder’s spouse;
- an existing security holder of the issuer;
- an accredited investor;
- a person of which a majority of the voting securities are beneficially owned by, or a majority of the directors are, persons described in paras. (a) to (i);
- a trust or estate of which all of the beneficiaries or a majority of the trustees or executors are persons described in paras. (a) to (i); or
- a person that is not the public (see further discussion below) (NI 45-106, s. 2.4(1)).
Part of the Public
Whether a person is a part of the public will be determined on the particular facts of each case, based on the tests that have developed under the relevant case law. A person who intends to distribute or trade securities, in reliance upon the private issuer prospectus exemption to a person not listed in paras. 4(a)-(j) above will have to satisfy itself that the distribution of, or trade in, the security is not to the public (45-106CP, s. 3.6(1)).
Close Personal Friend
A Close Personal Friend is an individual who knows the director, executive officer, founder, or control person of the issuer selling the securities well enough and has known them for a sufficient period to be able to evaluate their competences and trustworthiness and to obtain information from them with respect to the investment.
An individual will not be considered a Close Personal Friend simply because the individual is a relative, co-worker, colleague or associate at the same workplace, a member of the same club, organization, association or religious group, a client, customer, former client, or former customer, a mere acquaintance, or connected through some form of social media, such as Facebook, Twitter or LinkedIn (45-106CP, s. 2.7).
Close Business Associate
A Close Business Associate is an individual who has had sufficient prior business dealings with a director, executive officer, founder, or control person of the issuer selling the securities to be able to assess their capabilities and trustworthiness and to obtain information from them with respect to the investment.
Jason Grewal, Esq.
Barrister & Solicitor
 National Instrument 41-101: General Prospectus Requirements (for long form prospectuses); and National Instrument 44-101: Short Form Prospectus Distributions (for short form prospectuses).