In connection with its Exempt Market Review, the Ontario Securities Commission (OSC) is publishing for a 90-day comment period proposals for four new prospectus exemptions in Ontario (the Proposed Prospectus Exemptions):
- an offering memorandum (OM) prospectus exemption (the OM Exemption),
- a family, friends and business associates prospectus exemption (the FFBA Exemption),
- a prospectus exemption for distributions by a reporting issuer to its existing security holders (the Existing Security Holder Exemption), and
- a crowdfunding prospectus exemption (the CF Exemption).
Expanded OSC Exempt Market Review
The Exempt Market Review was originally focused on the accredited investor prospectus exemption in section 2.3 of NI 45-106 – Prospectus and Registration Exemptions (the AI Exemption) and the minimum amount investment prospectus exemption in section 2.10 of NI 45-106 (the MA Exemption).
As a result of the feedback received during the original Exempt Market Review, the OSC decided to expand its review to consider ways to facilitate greater access to capital through the exempt market, particularly for start-ups and small andmedium-size enterprises (SMEs), while maintaining appropriate investor protection.
The OM Exemption was proposed to support the capital raising needs of issuers that are moving beyond the early stages of development. In order to facilitate harmonization, this exemption is based on the existing OM exemption in section 2.9(2) of NI 45-106, which is currently unavailable in Ontario. It is expected that the OM Exemption will provide enhanced opportunities for exempt market dealers to be involved in start- up and SME financings.
The OSC believes that start-ups and other early-stage issuers could benefit from greater access to capital from their network of family, close personal friends and close business associates than is currently permitted under Ontario securities law. This exemption is based on the existing FFBA Exemption in subsection 2.5(1) of NI 45-106, which is currently unavailable in Ontario.
Many SMEs continue to face capital raising challenges after they have become reporting issuers and are listed on a stock exchange. Furthermore, retail security holders generally have less opportunity to invest in primary offerings by listed issuers, even if they have already made an investment decision to acquire the issuer’s securities in the secondary market. It is anticipated that the Existing Security Holder Exemption will help to address these issues.
For a more detailed discussion on the corresponding exemption adopted by other CSA jurisdictions (other than Newfoundland), please refer to our bulletin here.
Crowdfunding has quickly become an important new method of raising capital through the internet. To date, it has generally been used to raise money for specific projects and does not generally involve the issuance of securities. It is believed that crowdfunding through an appropriately regulated internet portal can be a viable method for start-ups and SMEs to raise capital.
The proposed crowdfunding securities regulatory framework has two main components:
- the CF Exemption; and
- a set of crowdfunding internet portal requirements.
Recognizing that the crowdfunding model has found significant followings, particularly in areas of perceived market inefficiencies, other CSA jurisdictions are proposing corresponding exemptions. For a discussion of the exemption being proposed by Quebec, Saskatchewan, New Brunswick, Manitoba and Nova Scotia, please refer to our bulletin here.
The Proposed Prospectus Exemptions would increase investment opportunities for non-accredited investors who currently have very limited access to the exempt market.
Issuers that want to raise money across Canada currently face higher funding costs because capital raising rules in the exempt market are not harmonized across the provinces. Many issuers in Ontario are limited to raising capital under the AI Exemption or MA Exemption.
The most significant of the Proposed Prospectus Exemptions are likely to be the OM Exemption and CF Exemption in terms of impact on capital raising.
The OM Exemption has been long anticipated and brings Ontario, where more than 96% of the investors do not meet the test of the current AI Exemption1, in line with the rest of Canada. In our experience, some companies have been reluctant to avail themselves to the OM exemptions in other provinces in part because of its unavailability in Ontario. This proposed exemption, if implemented, will likely change the cost/benefit analysis of the OM exemptions across Canada, and open up a large pool of potential financing for cash strapped issuers. Despite there being a lack of the OM Exemption, 60% of the Canadian exempt market funding comes from Ontario2, where more than 90% of such funding is currently done by way of the AI Exemption, with the MA Exemption making up the bulk of the remaining amounts3.
For the CF Exemption, reporting issuers that rely on this exemption are not expected to incur any additional compliance costs. However, non-reporting issuers relying on the CF Exemption will be subject to certain ongoing disclosure requirements. Although the anticipated costs of these requirements should be significantly less than disclosure obligations for a reporting issuer, they may be higher than the cost of raising funds through other prospectus exemptions such as the AI Exemption, the MA Exemption or the FFBA Exemption, which are also available for non-reporting issuers.
The most significant ongoing expenditure for non-reporting issuers would involve its preparation of annual financial
statements. Issuers would need to provide annual financials at point of sale if they have had incurred any expenditures and would have to provide them on an annual basis to investors. The annual financial statements would need to be reviewed by an independent public accounting firm. However, if the aggregate amount raised under the CF Exemption and any other prospectus exemption is over $500,000 since the issuer’s formation and the issuer has expended at least $150,000 since that time, then the annual financial statements would need to be audited.
In introducing the CF Exemption, the OSC is responding to a worldwide trend in equity crowdfunding. Given Canada's depressed venture capital market, this is potentially a significant change and puts them ahead of the SEC which, despite the JOBS Act passing in 2012, still has not adopted rules to implement an equity crowdfunding exemption in the United States.
The FFBA Exemption is an attempt to harmonize Ontario with other CSA jurisdictions and should be helpful for start-ups. While the proposed changes do not expand the categories of qualified investors from the existing founder, control person and family exemption in section 2.7 of NI 45-106, it does, among other things, provide helpful guidance on investor qualifications.
The Existing Security Prospectus Holder Exemption may provide a cost-effective method for reporting issuers listed on the TSX, and more importantly for junior issuers listed TSXV and the CSE, to do offerings to existing security holders which will be quicker and cheaper than rights offerings under the current regulatory regime. There are no additional disclosures or filing requirements (other than an offering news release) than those already required for reporting issuers.
One investor protection concern is that existing security holders who do not participate in a distribution under the Existing Security Prospectus Holder Exemption may experience significant dilution. The OSC is attempting to mitigate this
concern by limiting the maximum dilution of the outstanding securities in the same class as those subject to the offering to 100%, and requiring issuers to give existing security holders the right to subscribe on a pro rata basis.
Comments must be submitted in writing by June 18, 2014.