Enhanced Access to Private Equity


In recent times the marketplace has provided a very difficult environment for companies in any industry to raise private equity capital, and this has been the case particularly for technology companies. A further difficulty has been the restrictive regulatory environment that constrained issuers from raising public funds without the use of a prospectus-a cumbersome, costly and time-consuming document.

For many private and junior public technology companies, private placements are the single most important source of capital for the development of their businesses. Without access to private equity, many companies will not have the resources necessary to execute their business plans.

In recognition of this dilemma, and in order to stimulate investment in the junior market, the Alberta and British Columbia Securities Commissions, (ASC)/(BCSC), have introduced a regime proposed for further extension across many other provinces and territories, in the form of Multilateral Instrument 45-103, which provides less restrictive methods for issuers to raise private placement equity funds and expands investment opportunities. These new exemptions from the prospectus and registration requirements permit issuers to offer securities to "accredited investors"; to an expanded class of family, friends and business associates; and to any investor who receives a simplified offering memorandum.

The new exemptions are intended to replace the more restrictive private placement legislation, which enabled issuers access to only a narrow group of subscribers based primarily on the quantum of their individual investments and their connections to promoters of the issuer. Multilateral Instrument 45-103 has been proposed for adoption in Manitoba, Newfoundland and Labrador, Northwest Territories, Nova Scotia, Nunavut, Prince Edward Island and Saskatchewan (the "notice jurisdictions") and decision with respect to implementation in these jurisdictions is expected early in 2003.

Background
In November 2000, in response to industry calls for better access to junior public and private markets, Alberta and B.C. announced a private placement exemption harmonization project. Ontario had just published its draft private placement rule changes in September 2000 and there was considerable concern on the part of the ASC and BCSC that the new proposals in Ontario were not suitable for the small to mid-sized business as they contained too many limitations and did not address access to middle income investors. Several focus group meetings were held in Calgary and Vancouver between December 2000 and January 2002 at which market participants' opinions were sought. After a lengthy period of consultation, the new private placement rules were implemented on March 30, 2002 in Alberta and April 3, 2002 in B.C. Once implemented in Alberta and B.C., the securities regulatory authorities in each of the notice jurisdictions published Multilateral Instrument 45-103 for comment, with a few small jurisdictionally specific differences.

Exemptions Affected
The old private placement exemptions that are most affected are as follows:
. The "$97,000 or 'Sophisticated Purchaser' Exemption" under which investors were able to subscribe to private placement securities if their purchase was of a value in excess of $97,000 (in Alberta and B.C.). In B.C., issuers could also raise capital from an unlimited number of sophisticated purchasers if the minimum price paid per subscriber was in excess of $25,000 and the investors received an offering memorandum, described below;
. The "Close Friends, Family and Business Associates Exemption" under which close friends, family members and business associates of a promoter of the issuer were able to invest in any increment; and
. The "Offering Memorandum or 'Seed Capital' Exemption" under which the issuer could create a fairly complex disclosure document that could then be used to seek investments from up to 50 subscribers (49 subscribers in B.C.) in any investment amount once per year. Issuers could not advertise the offering (unless subscribers invested greater than $97,000 each) and, if a commission was to paid to an agent of the issuer using an offering memorandum, the agent needed to be a registered dealer.

New Exemptions
Accredited Investor
The accredited investor designation was modelled after the similar exemption adopted in Ontario in Ontario Securities Commission (OSC) Rule 45-501 (in November 2001) and is intended to replace the old financial institution exemption, $97,000 exemption and exempt purchaser exemption. As an "accredited investor":
i) the investor has no minimum or maximum purchase amount per investment;
ii) the investor may receive any material describing the company and its business (except for forecasts and projections) in order to assist with their investment decision;
iii) if disclosure provided, there is no prescribed form or mandated rights of action;
iv) advertising to attract accredited investors is permitted; and
v) the ability to invest is not limited to trades from the issuer-trades can be from anyone to an accredited investor.
Accredited investors include financial institutions, government agencies, corporations and certain other entities with net assets of at least $5 million, and individuals who (alone or with spouse) have net liquid assets of over $1 million or whose net income before taxes in each of the last two years exceeded $200,000 (or $300,000 jointly with spouse) and who have a reasonable expectation of exceeding that level in the current year.

Close Friends, Family and Business Associates
Under Multilateral Instrument 45-103, the new and more flexible "close friends, family and business associates" exemption maintains many of the qualities of the old exemption, with a few important changes to expand its applicability. Under the new exemption:
i) there is no limit on the number of purchasers that may utilize the exemption;
ii) the relationship of close friend, close business associate or family member is with any directors, senior officers or control persons of the issuer or an affiliate of the issuer (as opposed to with a "promoter" as in the older rules);
iii) the exemption can be used for trades by anyone to one of the specified parties;
iv) they are able to receive any material describing the company and its business (except for forecasts and projections) in order to assist with their investment decision; and
v) if disclosure is provided, there is no prescribed form or mandated rights of action.

For the sake of clarity, Multilateral Instrument 45-103 defines "family" as a spouse, parent, grandparent, brother, sister or child of the persons mentioned above and a "control person" is an individual that holds greater than 10 per cent of the issued and outstanding voting securities of the company. "Close personal friends" are defined as individuals who have "known the director, officer or control person of the company for a sufficient period of time to be in a position to assess the capabilities and trustworthiness of the director, officer or control person." "Close business associates" are defined as individuals who have "had sufficient prior business dealing with the director, officer or control person of the company to be in a position to assess the capabilities and trustworthiness of the director, officer or control person."

Offering Memorandum
Of all the revisions to the private placement rules identified in Multilateral Instrument 45-103, the one that promises to have the most significant impact on the ability for technology and other emerging companies to raise capital, is the new offering memorandum (OM) exemption. The OM exemption permits an issuer to raise capital relatively freely (with no restrictions on type of investor or amount of investment) so long as a prescribed form of OM is delivered to the investors. Under the new OM exemption:
i) the investor has no minimum or maximum purchase amount per investment;
ii) there is no minimum or maximum number of purchasers;
iii) there is no limit on the number of offerings using an OM that may be closed each year;
iv) there is no requirement of "sophistication";
v) there is a simple, easy to follow form that requires "business plan" rather than "prospectus" level disclosure; and
vi) there are no restrictions on payment of commissions to non-registrants (i.e., anyone may be paid a commission for the sale of securities using an OM except for directors, officers and control persons of the company).

However, in order to protect the investor from unscrupulous companies or promoters, the BCSC and ASC have added the following requirements:
i) a blunt risk acknowledgement form must be completed by each subscriber acknowledging the riskiness and inherent restrictions of the investment;
ii) the OM must be executed by the CEO and CFO, by directors of the company and the promoters of the company and these individuals will be liable to the subscriber for damages or rescission if the OM contains a misrepresentation (for which the limitation period has been increased to three years);
iii) a two-day withdrawal right has been introduced, similar to the rights that apply in a prospectus offering. As a result, the subscriber has two days from the date of execution of the subscription agreement within which they may rescind their subscription; and
iv) for Alberta residents, maximum investment under an OM is $10,000 unless the purchaser is an "eligible investor". An "eligible" investor is one who has obtained advice from a registrant, is an accredited investor or is an individual with net assets (alone or with spouse) exceeding $400,000 or net income before taxes in the last two years of $75,000 alone or $125,000 with spouse and a reasonable expectation of exceeding that level in the current year. Unlike the "accredited investor" criteria, the net assets calculation for the purpose of qualifying as an "eligible investor" includes real estate.

Although the securities acquired under these new rules are subject to resale restrictions, these rules should be very attractive to private issuers, reporting issuers and investors alike. The simplified form of offering memorandum and the relaxed investment requirements should reduce the issuer's time and cost involved in raising capital and will greatly expand the number of investors who can participate in private financings.

Conclusion
To date, the new exemptions have been extremely well-received by the investment communities in both Alberta and B.C. and it is expected that, with minor additions, in early 2003 the Multilateral Instrument 45-103 will be assisting residents and business people in many other Canadian provinces and territories raise much needed private investment funds. The new capital raising exemptions come at a time when many technology companies have more critical need for access to capital. The liberalization of these rules comes as a breath of fresh air for an industry that has been constrained by the post dot-com bubble world.


Martin P.J. Kratz is head of the technology practice group at Bennett Jones LLP and author or co-author of Internet Law, Canadian Intellectual Property Law, Protection of Copyright and Industrial Design, Obtaining Patents, Information Systems Security, The Computer Virus Crisis and Information Systems.
Scott Reeves is a senior associate in the public markets and technology practice groups at Bennett Jones and co-lead instructor of the financing section of the Osgoode Hall Law School LLM programme in e-business. This column is intended to convey brief, timely but only general information and does not constitute legal advice.