Securities Laws and Startups
January 15, 2018
It is a common misconception that securities laws only apply to companies whose securities are listed for trading on a stock exchange. However, even private startups must comply with securities laws in British Columbia. The purpose of this blog post is to provide startups with an overview of the securities laws applicable to them.
Overview of Securities Laws in British Columbia
Securities regulation is meant ensure the public can have confidence when they choose to invest in securities and that issuers who access the capital markets engage in common rules of fair play. The securities regulators – in BC, the British Columbia Securities Commission or BCSC – generally attempt to achieve these objectives a couple of ways:
- The prospectus provisions require every person who distributes or trades previously unissued securities to file a prospectus with the BCSC. See "Prospectus Requirement" below.
- The registration provisions require every person who is in the business of trading or selling securities to be registered with the BCSC. Fortunately, this requirement does not generally apply to startups or their officers, directors and employees as long as their activities do not constitute “trading” or “advising” in connection with securities, and they are not carrying out those activities for a business purpose.
Definition of "Security"
The Securities Act (British Columbia) uses the term “security” broadly and defines it to not only include things you would normally think of as a “security,” such as “a bond, debenture, note… share, stock, unit, unit certificate…” but also includes, among others, things like "a document, instrument, or writing commonly known as a security" and "a document evidencing an option, subscription or other interest in or to a security". It is important to keep in mind that due to this wide scope for the meaning of the term “security”, the application of securities legislation can be very broad.
A prospectus is a comprehensive disclosure document containing a full description of the business, affairs, securities and management of an issuer. The Securities Act requires that a prospectus must contain “full, true and plain disclosure of all material facts relating to the securities offered.” Unless they are ready to go public or complete an initial public offering, startups will generally find it impractical to file a prospectus in order to sell securities.
Fortunately, the BCSC recognizes that not all distributions of a security require an issuer to have to prepare and provide a prospectus. Exemptions from the prospectus requirement are available, and startups will generally rely on an exemption to access capital.
Certain of the exemptions are based on the assumption that there are certain purchasers of securities who are sophisticated enough to not require the protection of a prospectus. For example, the “accredited investor” exemption permits certain classes of persons (ex. certain institutions, wealthy individuals) to purchase under an exemption.
Other exemptions are provided based on the close relationship between the issuer and its directors and officers with the purchaser of the securities (ex. family, friends and business associations exemption, private issuer) or the nature of the transaction of which the trade or distribution is a part.
Filing Requirements and Resale Restrictions
Startups should keep in mind that certain of the prospectus exemptions require the filing of a report of exempt distribution with the BCSC within 10 days of the distribution.
Securities issued in reliance on a prospectus exemption will be subject to resale restrictions. Generally, a "seasoning period" or a "hold period" - a period of time during which the purchaser cannot sell the securities - will apply.
Becoming a Reporting Issuer
It is another common misconception that startups automatically become “reporting issuers” once they have more than 50 shareholders. Generally speaking, an issuer becomes a reporting issuer when it files a prospectus or seeks a listing of its securities on a stock exchange. Reporting issuers are subject to additional securities regulations, including the requirement to provide information about their affairs on a regular basis to the BCSC, their security holders and the public. Most startups are not reporting issuers, and therefore do not have to comply with these disclosure requirements.