Announced on March 31, 2021, the Alberta Securities Commission (ASC) and the Financial and Consumer Affairs Authority of Saskatchewan (FCAA) adopted a new Self-Certified Investor Prospectus exemption. The exemption (effective immediately) will only apply to companies in Alberta and Saskatchewan issuing securities (e.g. shares, notes, SAFEs) to investors in these provinces. The capital raising thresholds have been set at $10,000 per issuer per self-certified investor, and an investor can invest up to three times per calendar year (for a total of $30,000 in reliance on the exemption).
The exemption has been implemented on a three-year pilot basis. Full details of the exemption are set out in the Multilateral CSA Notice of Implementation Alberta and Saskatchewan Orders 45-538 Self-Certified Investor Prospectus Exemption and on the websites of the ASC and the FCAA.
This means, alongside a concurrent offering to the traditional "accredited investor" (as defined in National Instrument 45-106 - Prospectus Exemptions) typically made up of specified institutions and wealthy individuals, issuers can now distribute securities to individuals who self-certify as holding certain types of professional accreditation regardless of their financial wherewithal and without providing a prospectus.
Raising capital is a natural progression for a growing startup and there will come a day when one will run out of friends, family, and close business associates who are interested or able to invest in the company. This usually means seeking funding from accredited investors which can include angel investors, venture capitalist, and other high net worth individuals. However, the 2016 census displays only 2.8% of Canadians have an income of more than $150,000. Extrapolating from these numbers, under a million Canadians would be considered accredited investors.
The new financing tool by the ASC and FCAA comes as a response to this longstanding access to capital problem, further exacerbated by the COVID-19 pandemic. Designed to provide greater access to capital for Alberta and Saskatchewan businesses and broaden investment opportunities for Alberta and Saskatchewan investors, the ASC and FCAA intend to balance the protection of investors and access to capital.
At the same time, however, a question nonetheless arises as to whether this new group of "fallen angels" will prove to be a robust capital raising source. More importantly for startups, will these "fallen angels" be appropriate members of their early-stage cap tables? We discuss this in more length in our take below.
(3) Key Summary Points
- Investment Limitations (per calendar year) - Up to $10,000 per company with an overall $30,000 cap each year.
- Investor Qualifications (Criteria) - Prospective
investors need to satisfy any of the following:
- CFA charter
- CIM designation from the Canadian Securities Institute (CSI)
- CBV designation from the CBV Institute
- CPA designation
- CIWM designation from the CSI
- Lawyer spending at least 1/3 of his or her practice providing advice respecting financings involving public or private distributions of securities or mergers and acquisitions
- MBA with a focus on finance from a Canadian university or an accredited foreign university
- Undergrad degree in finance, or an undergrad degree in commerce or business with a major or specialization in finance or investment, and that degree is from a Canadian university or an accredited foreign university
- Passed the Canadian Securities Course (or both the Series 7 Exam from the Financial Industry Regulatory Authority in the U.S. and the New Entrants Exam from the CSI) and meets income requirements (being $75,000 net income in the last 2 years and reasonably expects at least the same in the current year (or $125,000 when combined with a spouse))
There are specific qualification rules for investors that invest through corporations, partnership, and trusts. In general, they require that a majority of the controlling parties (e.g. directors, partners, trustees) or a majority of the ownership parties (e.g. shareholders, partners, beneficiaries) fall into one of the categories noted above.
- Investor Qualifications (Paperwork) - Investors will have to complete various legal documents, such as a statutory declaration and acknowledgement. In addition, it is expected that any subscription agreement for the investor would have specific representations and warranties speaking to the exemption (and the investor's qualification).
- Company Qualifications (Criteria) - For the company, the key requirement is that the exemption must be used in tandem with the traditional accredited investor (AI) exemption. The exemption essentially says that it can only be used to allow these "fallen angels" to participate in an AI round already in the works. Consequently, the company will need to ensure it is raising funds from traditional angels (AIs) to access these "fallen angels".
- Special Purpose Vehicles (SPVs) - The exemption acknowledges the reality of SPVs in early-stage financing. At a very basic level, an SPV is nothing more than an entity (corporation or partnership in most cases) set up so that (i) investors hold equity stakes in the SPV, and (ii) the SPV is the investing party in the startup. In this way, the startup achieves investment from a broad base of investors but limits the number of people on its' cap table to one (being the SPV). Without getting into specifics, the exemption contemplates and allows for SPVs.
(4) Our Take
In our experience advising dozens (if not hundreds) of early-stage companies, specifically in the technology sector, we have seen a familiar cadence to investing, best illustrated by this table:
|Type of Investor||Rationale|
|Founders||In the early days, founders are often left with bootstrapping from their own funding sources and so they obviously become part of the cap table. Early hires (employees) can often be lumped in here as well.|
|Friends, Family, Business Associates (or the "friends, family, and fools" group)||Close family members and friends are sometimes the only source of outside capital available to early stage startups. However, the founders recognize they are inviting investment based on a personal relationship, and not (in most cases) due to the expertise of the investors. Founders also must grapple with the realities of disappointing a close family member or friend if the startup fails.|
|Angel Investors||Particularly in the pre-revenue stages of a company, traditional angels offer much-needed capital. From our experience, those first outside cheques in the $25,000-$250,000 are difficult to come by but invaluable to growth. In most cases too, the angels bring valuable connections (whether to additional investment, customer/sales leads, or to other mentors).|
|Venture Capital||For revenue-generating companies, venture capital (VC) can prove very useful to accelerate a startup. The investors are often sophisticated, have access to capital in the millions of dollars, and offer significant mentorship and connections to startups.|
With that framework in mind, our principal concerns with these "fallen angels" are summarized below:
- Capital Limitations and Busy Cap Table - Given the $10,000 limit per company, these investors are fairly limited in what they can contribute to the startup. By contrast, traditional angels (who in most cases are traditional accredited investors) have no limits on their investment. The danger of accepting a multitude of these investors is that it creates a very "busy" cap table for early-stage startups. This is typically something to avoid; future investors (VCs, private equity, etc.) will typically scrutinize a "busy" cap table. While this can be fixed through an SPV, the other concerns below still arise.
- Sophistication - Perhaps with all due respect to our own profession and other professionals within the "fallen angels" group, the intestinal fortitude to participate in early-stage startups is not correlated to whether you hold a designation. As many founders will attest to, one of the most toxic combinations you can have for an early stage investor is someone who (i) invested a small amount of money, (ii) brings no valuable skillset to the growth and scale of the startup, and (iii) believes they understand the "special sauce" to building a successful startup simply because they have been a successful lawyer, accountant, etc.
- Building the Tent - While there is always an ongoing discussion about opening capital sources for startups, we are skeptical that the "fallen angels" group was disenfranchised by previous capital raising investments. The exemption suffers in one sense from the same problems that equity crowdfunding exemptions suffered (and continue to suffer from): it turns out that the general public (even professionals adjacent to the startup world) do not possess the risk profile for investment in startups. To build the point further, our experience has been that most true angels already fit within traditional exemption categories (mostly accredited investor). For this reason, it remains to be seen, or even quantified, what groups of individuals were inappropriately left out of startup investing.
With all those concerns being said, we acknowledge what we will term the "Gamestop/Crypto/Gambling Argument". By that, we acknowledge that an individual, possessing limited funds and no knowledge of capital raising, can nonetheless take most (if not all) of their net worth and spend it on very volatile things such as "meme stocks", cryptocurrency (now also non-fungible tokens), and outright gambling. Following that argument however raises more of a policy question whether investment in private companies should be limited in any way. Supporters will argue there should be no limitations; the average Canadian should be free to allocate their wealth as they see fit. Regulators will argue that their mandate is investor protection; guard rails must be put in place to prevent outright scams and financial fraud. This tension has always existed and will continue to endure in the capital raising space.
(5) Final Thoughts
Both Alberta and Saskatchewan have been taking aggressive steps to integrate the technology sector into their provincial strategies. Most recently, Alberta Innovates issued a request for proposals (RFP) for the development of new business and technology accelerators and Innovation Saskatchewan just extended their Saskatchewan Technology Startup Incentive (STSI) for another 5 years. Saskatchewan's Growth Plan intends to triple the growth of the technology sector by 2030 and it is clear not only is there a push for more entry into the tech ecosystem, but there is also a desire to increase successful scale-ups in both provinces.
This increased access to private securities offerings, though limited, is a step in the right direction in that investor protection has expanded beyond whether one is wealthy enough to sustain a loss to whether an individual can assess a prospective investment. There is suggestion that in an optimal world, national harmonization and educational courses could form a part of the next iteration.
Regulators and stakeholders alike, will be keen to see whether the current investment limits and adding to the small subset of potential investors has gone far enough. Time will reveal whether the logistics of a large cap table and practicalities of finding individuals who qualify under the new exemption and are willing to utilize the classification will facilitate capital raising efforts as intended.
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