Selling Your Shares
This is a series of columns that appear in Okanagan Business Magazine.
“My company has reached a critical stage of its development and I would like to raise some money, can I sell shares to anyone that is willing to buy?”
Before you sell shares in your company, you would be wise to get some advice on the effects of the Securities Act (the “Act”). The purpose of the Act is to require a company to provide a certain level of disclosure of information about itself to people who may potentially invest money in that company. The penalties for breaching the Act are harsh, so it is important to know what the rules are before you make mistakes in trying to attract investment.
In general terms, the Act creates a regulatory scheme which applies its rules to anything it defines as a “distribution” of a “security”. There are many things the average person would never think of as a “security” which fall under this definition in the Act, such as a land mortgage, the granting of security for a debt, or the sale of shares in a private company.
The Act states that a company wanting to distribute a security will need to meet two requirements. Firstly, it will need to distribute its securities using the services of a person registered to deal in securities under the Act (the “registration requirement”). Secondly, the company will need to create a complex document known as a prospectus (the “prospectus requirement”). The regulatory scheme is known as a closed system meaning it applies to every distribution of a security, whether or not from a private company, unless the company can find a specific exemption from the registration and prospectus requirements.
The prospectus must be filed with the B.C. Securities Commission who must approve the contents of the document before it can be used. Usually, the Securities Commission will require revisions and additions to a prospectus several times until they are satisfied with the contents. The level of complexity and thoroughness involved in creating an approved prospectus means that it is not practical for most small companies to use in seeking investors, unless the amount of money being sought is well into the millions of dollars. The process of obtaining approval can be both extremely time consuming and costly, typically taking between six and nine months, and costing between $50,000.00 and $100,000.00 for the various fees and services needed to properly prepare, file and publish a prospectus.
At first glance the regime of the Act appears impractical. Fortunately, it allows for certain practical exemptions in limited circumstances from the registration and prospectus requirements. To qualify, however, certain rules and procedures must be strictly followed.
The Act allows certain outright exemptions for transactions that would seem to the lay person to be quite logical. If these transactions follow the structure set out in the Act, then there will be no need to have any filings made pursuant to the Act or to sell the investment through a registered salesperson. The key characteristics of these outright exemptions usually relate to type of investor who will buy the investment, and the type and amount of the investment being sold. Unfortunately, these transactions would usually be appropriate for “one-time” or special situations, and not very well suited to generally attracting investors.
There is also a middle-ground between an outright exemption and the need to file a prospectus. This process involves what is commonly called a private placement, and allows a company to access monies from a broader range of investors than would be possible using the more limited outright exemptions discussed above.
The Act provides that if your company is not a reporting company, then it may sell an investment using a document called an offering memorandum and by following strict rules about the selling and advertising for that investment.
An offering memorandum is a document which has to be completed in a specific form and with specific content, designed to disclose material information about the company. It is not as complex and detailed as a prospectus and does not require the approval of the Securities Commission for filing. As with a prospectus, it still must comply with the Act, however it is up to the company to make sure it does. It describes the investment in detail, the exemptions being used under the Act, and usually requires the company to include audited financial statements.
Once this document is completed, it can be used to attract a broader range of investors, but they are still limited to less than those that can be accessed using a prospectus. Once monies have been received for the investment sold using the offering memorandum, the company must report the distribution to the Securities Commission, even if that company is a private company.
The costs of completing the offering memorandum and making the necessary filings with the Securities Commission are significantly less than those required with preparing and filing a prospectus, however they can still amount to $10,000 to $15,000. For that reason, when someone decides to look for private placement monies, it makes sense for those investments to be for more than nominal amounts.
So the answer is, unless you create and file a prospectus, you cannot freely sell an investment in your company. Alternatively, you may sell an investment in your company to a very select group of investors, without doing anything other than making sure the type of investor and the investment fall within certain limited exemptions. Lastly, you could market your investment to a wider class and worth of investors by creating and using an offering memorandum with the proper legal advice.
It should be noted that the impact of the law on any given situation depends upon each individual’s circumstances and the opinions contained in this article should not be relied on for assessing anyone’s legal position. Advice should be obtained directly from our business law lawyers regarding your particular situation.