How a Small Business May Obtain Equity Financing

Business Law

You just started up your new small business and, after having put your own money into the business, you find that you need significantly more funding to hire employees, purchase equipment, rent an office, create a website, etc. Accordingly, you seek financing from your parents and immediate family members to ‘buy in’ to your business venture. But when that funding has all but exhausted, and you still require additional funding, what do you do?

You could get a bank loan but, as with all debt instruments, the company will have to repay the principal on maturity together with accrued interest, and the bank will want the company to pledge all of the company’s assets as collateral for the debt and have you sign a personal guarantee.

Alternatively, if your small business is a company, you may consider issuing shares. The issue of shares is known as ‘equity financing’. By issuing shares, your investors can participate in the growth of the company, and your company will not be obliged to repay the funds back to the investors (note: assuming such shares do not carry certain rights entitling the holder to be repaid their investment, or to receive a certain dividend rate).

To the investor, this is ‘risk capital’, as there is no guaranteed return on the investment (ie. your company may never make a profit, and therefore, no earnings may ever be distributed to the shareholders). There are a number of ways that you can structure what types of shares to issue to investors – ie., those without voting but having participating rights, those with preferential dividends, etc. A separate article can be written about this topic.

The purpose of this Article is to highlight how a small business may obtain equity financing in compliance with applicable securities laws. You may have heard of the concept of ‘crowdfunding’. Crowdfunding emerged as a way for large numbers of people to provide small amounts of on-line financial support to other people or organizations. Although forms of commercial crowdfunding are specifically permitted by securities legislation in Australia and the United Kingdom, it is not in Canada yet. Accordingly, in Canada, you must comply with the current ‘exemptions’ under Canadian securities law. Exemptions from what? See below.

The Prospectus Requirement

In Canada, if you want to sell your securities (ie., shares) to the public, the general rule is that you need to file a prospectus and have it receipted by the relevant provincial securities commission (the “Prospectus Requirement”). Preparing and filing a prospectus is a very time consuming and costly endeavour, and so it is better to rely on an exemption from the Prospectus Requirement where possible. This is where it becomes very important to get a Canadian securities lawyer for advice. The following is a brief description of certain exemptions from the Prospectus Requirement that a small business may rely on.

The “Private Issuer” Exemption

The most important exemption for a new small business is the “private issuer” exemption. Your small business is a “private issuer” if you have less than 50 security holders (excluding employees) and your incorporation documents (eg. your articles) contain restrictions on the transfer of securities. As a private issuer, some of the key types of people you can raise money from are:

  • Your directors, officers, employees, and major shareholders
  • Close family members of your directors, senior officers, or major shareholders. Close family members include a spouse, parent, grandparent, sibling, child, grandchild or certain in-laws (your spouse’s parent, grandparent, brother and sister)
  • Close friends of your directors, senior officers, or major shareholders. A close friend is someone who has known the relevant director, senior officer or major shareholder for enough time to be able to judge their capabilities and trustworthiness. The relationship must be direct (that is, a close friend of your close friend is not your close friend). A person is also not your close friend simply because they belong to the same organization, association, or religious group.
  • Close business associates of your directors, senior officers, or major shareholders. A close business associate is someone who has had enough prior business dealings with your directors, senior officers or major shareholders to be able to make a sound judgment about their capabilities and trustworthiness. A person is not a close business associate simply because they are a customer or former client. A person is also not a close business associate if you have approached them to invest after only a brief acquaintance.
  • Accredited investors. An accredited investor includes a person who meets at least one of the following financial qualification tests, or qualifies in some other way:
    • financial assets (cash and marketable securities) before taxes and net of any debts of at least $1 million, held either alone or with a spouse. “Financial assets” in this context does not include any real estate (including the person’s residential home)
    • Net income before taxes of more than $200,000 over the past two years ($300,000 when combined with a spouse’s net income) with the reasonable expectation to meet or exceed such level in the current year
    • Net assets, either alone or with a spouse, of at least $5 million
    • If the person is not an investment fund or an individual (ie., the investor is a corporation), that person has net assets of at least $5 million as shown on its most recently prepared financial statements

You must take certain precautions to ensure that any of the above mentioned persons meet the qualifying criteria. Generally, you should require investors to certify in their subscription agreements that they meet the qualifying criteria, and the certification should be as specific as possible – ie., identifying the relationship the investor has with the relevant director, senior officer of major shareholder, or identifying the particular category of ‘accredited investor’. However, you are not protected from simply relying on such certifications if you know, or reasonably ought to have known, that a person does not qualify in any particular category.There have been cases where the British Columbia Securities Commission has investigated and punished issuers for invalidly relying on prospectus exemptions (see Solara Technologies Inc. and William Dorn Beattie, 2010 BCSECCOM 357)).

In order to maintain the “private issuer” status, you must ensure that no securities are ever issued or transferred to any person who is not on the enumerated list of persons to whom a “private issuer” may distribute its securities (note: the above list is only a summary, and not an exhaustive list). If your business ceases to meet the definition of a “private issuer”, you must use another exemption for all subsequent sales of your securities. The best thing about being a private issuer is that you do not have to file a report with the British Columbia Securities Commission for any sales of your securities, called an “Exempt Distribution Report”. Generally, if you rely on the other exemptions, you will have to file an Exempt Distribution Report within 10 days after the sale of your securities.

Exemptions if your small business is no longer a Private Issuer

Once your business is no longer a private issuer (for example, if you have more than 50 security holders), you must find other exemptions from the Prospectus Requirement to raise money. If you are no longer a private issuer, there are other exemptions available for you to sell to all of the people discussed under the private issuer exemption above (directors, officers and employees, family, friends and business associates and accredited investors). Two other common exemptions are as follows:

$150,000 investment exemption Your small business may sell its securities to any person if the person invests $150,000, and pays cash at the time of the trade.

Offering Memorandum exemption Your small business may also raise any amount of money from anyone using the Offering Memorandum (OM) exemption. An OM is a legal document like a prospectus but much shorter and less detailed. It must describe your business and management including the relevant risks, and tell how your business will use the money it raises. It must also include audited annual financial statements. Your small business must also give any purchaser under the OM exemption a Risk Acknowledgement form and make sure the purchaser signs it. You do not need BCSC approval before you use an OM, but it must be filed with the BCSC within 10 days of each sale under the OM.

The Registration Requirement

You should also be aware that in British Columbia (as with the other provinces of Canada), the sale of your securities will trigger the requirement to be a registered dealer (the “Registration Requirement”) unless you are “not in the business of trading” securities. In order to qualify for this exemption, you must have an active business unrelated to the sale of securities. This exemption from the Registration Requirement applies to officers, directors and employees of your small business that are involved in raising money through the sale of your securities, so long as:

  • they are not principally employed to sell your securities;
  • they do not spend most of their time selling your securities; or
  • they are not 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 therefore need to be registered.


A breach of the Securities Act will be an offence and the accused could be liable to a fine of up to $3,000,000 and/or three years’ imprisonment. Any employee, officer or director of a company who authorizes or permits the company to commit an offence under the Act can be held liable for the same offence.

The securities commissions also have extensive powers to make orders, such as cease trading and barring individuals from acting as directors and officers or engaging in investor relations activities. Also, the securities commissions have the power to require a company that has issued its securities without a proper prospectus exemption to rescind the transaction, enabling the investor to get its money back. More and more investors are taking advantage of this by complaining to the securities commissions, which has resulted in orders for rescission. In light of the foregoing, whenever you are considering selling your securities to investors, you should always consult with a securities lawyer.

Securities Law
Lindsay Kenney LLP – Vancouver Law Firm