Raising Capital for Small Businesses

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6th Feb 2015

In 2013, $8.7 billion was raised in the exempt market in Alberta by 600 Alberta-based companies (ASC 2014 Capital Market Review). The exempt market is a valuable resource for small businesses that want to expand their business by raising capital from investors but are not large enough to justify the expense and complexity of a public offering. This article will explain what the exempt market is and how a small business can raise capital without meeting all the onerous requirements of a public offering.

What is the exempt market?

The securities commissions recognize that it is very expensive and complex to take a company public and that it is not cost effective for many small businesses that need capital to become public companies. To accommodate small businesses in raising capital, the securities commission provides exemptions from some (but not all) of its requirements so that small businesses can raise capital from investors in a cost effective manner. The “exempt market” is the part of the capital market where these exemptions are used.

In securities regulation, corporations or other organizations that are raising money are referred to as “issuers”. Issuers normally raise capital in the following stages:

1. Founders, family and friends. Initially, the founders of a business provide all of the equity capital from their personal savings. Family and friends of the founders may contribute some of their savings to a business; however an exemption may not be available for every “friend” or family member.

2. Angel Investors. Angel investors provide capital in the very early stages of a business and are not usually involved in managing the business. As there is a very high risk of their entire investment being lost, a high return is expected. Angel investors are generally “accredited investors”.

3. Venture capital and private equity. Venture capital and private equity funds provide capital to businesses that require more capital than family, friends and angel investors can provide but which do not wish to incur the costs of a public offering.

4. Public Offering. Raising capital from the general public.

All of these stages of raising capital (including from family and friends) are subject to securities regulations. This means that, unless an exemption is available, all securities regulation requirements must be met. When raising funds in stages 1, 2 and 3, the issuer can rely on specific exemptions from some securities requirements; however the onus is on the issuer to prove to the securities commissions that an exemption was available and that all of the requirements for the exemption were met by the issuer.

What is a security?

Securities regulation requirements are not limited to shares but also apply to loans and any other arrangements that fall within the definition of “security”. The definition of “security” is very broad and includes the following:

1. The types of securities that are defined in the Securities Act which includes shares, bonds, royalties, futures, units in a trust limited partnership, and many other types of investments.

2. Any document, instrument or writing commonly known as a “security”.

3. An “investment contract” which contains arrangements that may not be commonly known as securities, and has included golf memberships, beavers, chinchillas and whisky.

An investment contract includes any arrangement where:

1. a person invests money in a common enterprise;

2. that person expects to profit; and

3. the expected profit is wholly or partly the result of the efforts of another person.

Requirements to issue a security and common exemptions

The two fundamental requirements for issuing a security are:

1. Prospectus. Preparing a prospectus and having it approved by the Securities Commission before issuing any securities.

2. Registered Dealer. All securities issued to investors must be distributed through a registered dealer.

A prospectus is a disclosure document which outlines the risks of investing in the issuer and usually must include audited financial statements. As it can be expensive and time consuming to prepare a prospectus and a registered dealer may require a minimum amount of capital to be raised, it is not cost effective for a small business to meet these requirements.

Securities are regulated by the provinces in Canada which means that an issuer must comply with the securities regulations of each province in which the securities are promoted. It may be necessary for a prospectus to be approved by more than one securities commission and for an issuer to retain more than one dealer.

It is possible for a small business based in Alberta to issue securities to investors without the necessity of preparing a prospectus or selling through a registered dealer by relying on common exemptions; provided that the issuer meets all of the requirements of each exemption relied on.

Private Issuer. Closely-held corporations are generally allowed to issue securities to a limited number of investors without filing a prospectus, provided certain requirements are met. This exemption is relied on by many small businesspeople that may not realise that they are subject to securities regulations at all.

Accredited Investor. Investors that meet certain requirements based on income, net worth or investment knowledge are considered to be sophisticated enough to ask their own questions about investments without relying on information provided by the issuer. These investors are referred to as “accredited investors”. Issuers may be able to issue securities to accredited investors without filing a prospectus.

Close Family, Friends and Business Associates. An issuer may be able to issue securities to close family, friends and business associates of founders, directors and other other persons without issuing a prospectus if certain requirements are met. The securities commission has been increasing its scrutiny on this exemption recently and takes the position that an investor is not a close friend or business associate merely because the investor goes to your church, participates in a social organization, is a current or former client, is a co-worker, or is connected through social media (e.g. Facebook or Twitter). This exemption is based on a subjective criteria and must be assessed on a case-by-case basis.

Offering Memorandum. An offering memorandum is a disclosure document similar to a prospectus but may be less expensive to prepare because it contains less information and does not need pre-approval by the securities commissions. That being said, an offering memorandum is generally required to contain audited financial statements so this is not a cost-effective alternative for a business that does not already have audited financial statements.

Business Trigger. An issuer may not have to use a registered dealer to issue securities if the issuer is not in the business of trading or advising. Whether an issuer is in the business of trading or advising is based on subjective criteria and must be assessed on a case-by-case basis. An issuer that is raising capital for legitimate business reasons may still be considered to be in the business of trading or advising.

Northwest Exemption. The securities commissions in the western provinces currently provide an exemption from the registration requirement when certain prospectus exemptions are relied on, no advise is given to investors and a number of other requirements are met.

The common prospectus and registration exemptions are under continuing review by the securities commissions and the availability and requirements of any exemption will vary from time to time.

Resale Restrictions

Securities that are issued under a prospectus exemption are subject to “resale restrictions” which prevent the purchasers from selling their securities until certain requirements have been met. If the conditions are not met, the purchasers will only be able to sell their securities if they rely on certain prospectus exemptions. Different resale restrictions apply in Manitoba.


Failing to issue a prospectus or use a registered dealer when required to do so, which includes purporting to rely on an exemption when the requirements were not actually met, carries a number of serious consequences. Any directors or officers of the issuer may also be subject to these consequences.

Failure to comply with securities regulations may result in:

1. Rescission. The issuer may be required to return funds to investors, which may result in the issuer being unable to meet contractual requirements thereby resulting in further costs to the issuer.

2. Orders banning directors or officers of the issuer from trading in securities or acting as a director of any corporation or legal entity. This is broad enough to prevent an individual from using a holding or professional corporation.

3. The securities commissions may subject the issuer or its directors or officers to fines, orders to repay money to investors or, in some situations, jail time. The Securities Act provides that penalties include fines up to the greater of $5 million or 3 time the profit made from the contravention in addition to repay sums to investors and up to 5 years in jail.

4. Investors may launch a civil suit against the issuer and its directors and officers which may include claims for expected profits.

5. The issuer and its directors and officers may be charged criminally.


If raising capital could help your business or you would like any more information on raising capital, please contact John King at jrking@petersonpurvislaw.ca

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