securities laws considerations for private equity & venture capital funds
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When private equity or venture capital funds market and sell fund interests to investors in Canada, there are a number of provincial and territorial securities laws that may apply and which should be taken into consideration by fund sponsors. Prospectus Exemption To avoid having to file a prospectus with the Canadian securities regulators, a fund sponsor will need to distribute fund interests to Canadian investors in reliance on an available prospectus exemption. The most common exemption from the prospectus requirement is the “accredited investor” exemption. Under this exemption, so long as the fund only deals with investors who qualify as “accredited investors”, such as government entities, financial institutions, pension funds and certain high net-worth individuals, the fund will not be required to provide these investors with a prospectus. If a fund relies on this exemption to sell fund interests, it must file notice of the exempt trades with, and pay a filing fee to, the applicable Canadian securities regulators within 10 days. The amount of the filing fee will generally be a nominal amount, however, in British Columbia, Alberta and Quebec, the fee is calculated as a percentage of the investment made by the investors resident in such province and could become a significant amount depending on the size of the investment. In certain Canadian provinces, the fund also will be required to file with the applicable Canadian securities regulator any “offering memorandum” that it provides to the Canadian investors resident in such provinces. The term “offering memorandum” is broadly defined and includes private placement memoranda, certain investor presentations and any other document that describes the business of the fund that is provided to investors. In several provinces, a fund may be liable for any misrepresentation contained in an “offering memorandum” voluntarily provided to a Canadian accredited investor (subject to certain defences and limitations) and the offering memorandum is required to include a summary of the statutory rights of action for rescission or damages that are afforded to investors in such provinces. For funds based outside of Canada, typically we would prepare a Canadian wrapper or legend to supplement the fund’s private placement memorandum with the required disclosure. Dealer, Adviser and Investment Fund Manager Registration Canadian provincial and territorial securities laws also regulate those who are engaged in the business, or holding themselves out as being engaged in the business, of trading in securities or advising others as to the buying or selling of securities and those who direct the business, operations or affairs of an investment fund. While these rules are not as clear with respect to their application to private equity or venture capital funds as the prospectus exemptions, the regulators have provided guidance which suggests that in many cases, private equity and venture capital funds will not be required to satisfy the investment fund manager, adviser or dealer registration requirements.
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Canadian securities regulators have stated that venture capital and private equity investing are distinguishable from other forms of investing by the role played by venture capital or private equity management companies (“VC/PE Managers”). Regulators have described the activities of VC/PE Managers to include the following: (i) raising money on a “private placement” basis from “accredited investors” who agree to remain invested for a period of time; (ii) using the money raised to invest in securities of companies that are not publicly traded securities; (iii) becoming actively involved in the management of the portfolio company, often over several years (for example, representation on the board of directors, direct involvement in the appointment of managers and/or a say in material management decisions); (iv) seeking to realize on investments either through a public offering of the company’s securities or a sale of business, at which point, the investors’ money can be returned to them along with any profit; (v) providing expertise that investors rely on to select and manage the portfolio companies in which to invest; and (vi) receiving a management fee or “carried interest” in the profits generated from its investments in exchange for that expertise but no compensation for raising capital or trading in securities. Investment Fund Manager Registration Any person or company with a head office in Canada who directs the business, operations or affairs of an investment fund is required to be registered as an investment fund manager. This is a broad registration requirement that came into force in September 2010 and is intended to capture both public and private investment funds, including hedge funds. The key registration trigger is whether or not the fund being managed qualifies as an “investment fund”. The person directing the operations of a fund that qualifies as an “investment fund” must be registered while the manager of a fund that falls outside of the definition of “investment fund” is not required to register. An “investment fund” includes both “mutual funds” and “non-redeemable investment funds”. Of importance to note, by definition “mutual fund” securities entitle the holder to receive on demand an amount computed with reference a proportionate interest in all or part of the fund’s net assets. By definition a “non-redeemable investment fund” does not invest for the purpose of exercising control over or being actively involved in the management of any issuers in which it invests. Funds that do not permit redemption at net asset value and that engage in the activities characteristic of a private equity or venture capital fund (specifically to exercise or seek to exercise control or actively engage in management of investee companies) will likely not be considered to be investment funds and their managers should not be required to be registered as investment fund managers in Canada. Canadian securities regulators have stated that if a
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VC/PE Manager is actively involved in the management of the companies in which it invests, the investment portfolio it manages “would generally not be considered an investment fund” and, therefore, such VC/PE Manager “would not need to register as an investment fund manager”. Adviser Registration Registration as an adviser in a Canadian province or territory is required for any person or company who is engaged in the business of, or holding himself, herself or itself out as engaging in the business of, advising anyone with respect to investing in, buying or selling securities. The business of each fund must be considered on a case-by-case basis to determine whether the “business trigger” requires the fund sponsor, manager or any other person to be registered as an adviser. Regulatory guidance as to what constitutes being “in the business” includes a consideration of matters such as whether the person or company is engaging in activities similar to a registered adviser, whether the advising activities are being undertaking with repetition, regularity or continuity, whether the advising activities are remunerated or compensated and whether the person or company is directly or indirectly engaged in soliciting customers for securities advice. Canadian securities regulators have stated that VC/PE Managers are not required to register as an adviser if the advice they provide in connection with the purchase and sale of companies is incidental to the VC/PE Manager’s active management of those companies. If a fund engages in other activities in addition to those characteristic of a typical private equity or venture capital fund, analysis of whether the fund sponsor or manager is “in the business” of providing investment advisory or portfolio management services to the fund may lead to a different conclusion. Dealer Registration Registration as a dealer in a Canadian province is required for any person or company who is engaged in, or holding himself, herself or itself out as engaging in, the business of trading in securities (which includes the marketing and sales activities involved in advance of a trade in securities). Similar to the discussion above, the “business trigger” must be considered on a case-by-case basis to determine whether a fund sponsor or manager is required to register as a dealer. Canadian regulators have stated that in applying the “business trigger” to the activities of VC/PE Managers described above, “if both the raising of money from investors and the investing of that money in companies are occasional and uncompensated activities”, the fund sponsor or manager will not be required to be registered as a dealer. Particular fund sponsor or manager activities could lead to a different conclusion, especially if the fund sponsor or manager markets a number of funds and has employees whose job function includes marketing fund interests on an ongoing basis.
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Summary For a typical private equity or venture capital fund, if structured properly, the issuance of fund interests to Canadian investors can be completed without a prospectus. Depending on the facts, the fund sponsor or manager also may be able to carry out its activities without having to register as an investment fund manager, adviser or dealer.
For more information, please contact: Tina M. Antony T: 403-298-1045 E:
[email protected] Paul A. Dempsey T: 416-369-7325 E:
[email protected] Myron B. Dzulynsky T: 416-369-7370 E:
[email protected] Robert G. S. Hull T: 416-369-7313 E:
[email protected] Vince F. Imerti T: 416-369-7100 E:
[email protected] Bryce A. Kraeker T: 519-575-7545 E:
[email protected] Luc Lissoir T: 514-392-9571 E:
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