The initial financing for a start-up is usually provided by its founders, either through purchase of an ownership interest (equity) or through loans (debt) or combination of both. A decision to sell equity in a start-up is attractive because the start-up may be able to eliminate or reduce ongoing cost, such as interest payments, associated with a debt financing. In addition, financing a portion of the start-up’s needs with equity, which ranks behind debt financing in priority, may be a requirement to a lender making a commitment to advance a loan. The attractiveness of financing with equity will depend in part on the degree of dilution of existing ownership that new issuance will cause and the price to be paid for the new shares.
The securities market in Ontario consists of essentially two components: the primary market and the secondary market. The primary market for securities is represented by business entities which issue such securities. These entities represent all types of business organizations and include both large public companies and smaller closely held companies. The secondary market comprises transactions involving the purchase and sale of previously issued securities. The most obvious example of secondary market is a stock exchange such as the Toronto Stock Exchange.
The principal source of securities legislation in Ontario is the Securities Act and the Regulations and rules made thereafter. The Ontario Securities Commission (OSC) is charged with administering the Act. The OSC is provided with considerable authority under the Act and has broad discretion in the exercise of that authority. In its regulatory capacity, the OSC has historically issued Notices and Policy Statements, which prescribe the manner in which it intends to interpret the Act and the Regulations. Every issuance of securities must comply with the Act. A start-up which intends to trade in a security, where such a trade would be a distribution, must initially register with OSC and file with the OSC a preliminary prospectus and subsequently a final prospectus.
Since registration is a costly process, costing up to several hundred thousand dollars in accounting, legal and printing fees, it is important to find an exemption from registration. There are two main types of exemptions from the prospectus requirement: (a) the exemptions found in section 72 or in the exemption MI 45-105; and (b) exemptions that apply to the resale of securities which initially were distributed without a prospectus in reliance on one of the prospectus exemptions. Most private placements of equity securities in start-up will be made pursuant to section 72 of the Act. In addition, the prospectus exemption and corresponding registration found in paragraph 72(1)(n) and subsection 35(1)19 have been replaced by Multilateral Instrument 45-105 which governs trades to employees, senior officers, directors and consultants of a start-up.
The other two exemptions to registration are "closely held issuer" exemption and the accredited investor" exemption. Registration and prospectus exemptions are given for trades in securities of a closely-held company by either the issuer or a selling security holder provided, following the trade, the issuer remains a closely held issuer and the aggregate proceeds received by the issuer does not exceed $3 million. The "accredited investor" exemption permits issuers to raise any amount of investment at any time from any number of accredited investors who purchase the securities for their own account. Accredited investors are presumed to be capable of making an investment decision without the information in a prospectus of the assistance of a registered dealer.