Early Stage Capital Exemptions

I. Introduction

In response to the continuously evolving landscape of businesses, investors, and market dynamics in Ontario, on May 9, 2024, the Ontario Securities Commission (the "OSC") announced several new exemptions aimed at enhancing early-stage access to capital and promoting better conditions for capital market development and innovation throughout the province's entrepreneurial ecosystem.

The new initiatives include an extension of Ontario Instrument 45-507 Self-Certified Investor Prospectus Exemption (Interim Class Order) ("OI 45-507"), as well as the introduction of the following three time-limited orders under subsection 143.11(2) of the Securities Act (Ontario) (the "Act") each of which is intended to further support early stage capital raising in Ontario:

1. A dealer registration exemption for not-for-profit angel investor groups (the "Angel Investor Exemption");
2. A dealer registration exemption for eligible early-stage businesses (the "ESB Exemption"); and
3. An exemption from the distribution reporting requirements in OI 45-507 to permit alternative streamlined reporting of distributions (the "SCIR Exemption").

(collectively, the "Early-Stage Capital Exemptions")

The notice outlining the class order and exemptions can be accessed here.

II. Background

Over the past decade, the OSC has introduced new prospectus exemptions and amended existing ones to facilitate capital raising for businesses, particularly small businesses, while protecting the interests of investors.

A concise summary of the initiatives up to date is as follows:

• February 2020: in response to a decline in new issuers and initial public offerings in Ontario, the capital markets modernization taskforce (the "Taskforce") announced their intention to review and modernize Ontario's capital markets regulatory framework in an effort to amplify growth and competitiveness in Ontario's capital markets. The Taskforce's recommendations were aimed at incubating junior issuers in the province by reducing the regulatory burden, providing new opportunities for capital-raising through the expansion of prospectus exemptions, and streamlining disclosure requirements, among others. The final report was published in January 2021;
• October 2022: the OSC published OI 45-507, an 18-month pilot program to provide Ontario investors with qualifying education or work experience access to increased investment opportunities under a prospectus exemption, which came into effect on October 25, 2022, until April 25, 2024; and
• January 2024: the OSC published a rule under the Act, OSC Rule 45-508 Extension to Ontario Instrument 45-507 Self-Certified Investor Prospectus Exemption, which came into effect on April 25, 2024, extending OI 45-507 by an additional 18-month period.

III. The OSC TestLab

The Early-Stage Capital Exemptions are being carried out as part of the OSC's TestLab, a program that was created as part of the OSC's Innovation Office to help financial technology (fintech) firms explore and test innovative products, services, and business models in a controlled environment. The OSC plans to gather data on the use of the exemptions through associated filings to evaluate the initiatives and seek input from participating businesses, investors, and other key stakeholders. The data also is expected to equip the OSC with valuable insights for future policy development.

IV. The Early-Stage Capital Exemptions

Below is a high-level summary of each of the Early-Stage Capital Exemptions.

i. The Angel Investor Exemption

Angel investors play an important role in funding early-stage businesses in Ontario as they bring together other angel investors interested in supporting Ontario's early-stage businesses. However, as these investors provide their members with investment opportunities, their activities may trigger the dealer registration requirement which states that an entity that is in the business of trading securities is required to register as a dealer or qualify for an exemption from the dealer registration requirement. To avoid triggering registration, the Angel Investor Exemption will now allow non-profit angel investor groups to be exempt from the registration requirement, provided that they meet a number of conditions as set out in the order.

The Angel Investor Exemption will allow eligible groups to:

1. identify and introduce Ontario early-stage businesses seeking capital to their members;
2. make information on Ontario early-stage businesses seeking capital available to their members;
3. hold regular meetings for Ontario early-stage businesses to present their business to their members;
4. facilitate their members' due diligence in Ontario early-stage businesses;
5. keep their members up-to-date on Ontario early-stage businesses that members have invested in; and
6. provide educational resources.

To qualify for the exemption, the angel investor group must, among other things (i) be organized and conduct its activities primarily for not-for-profit purposes; (ii) operate from and have its head office located in Ontario; and (iii) have no more than 500 members, each of whom qualifies as an accredited investor or self-certified investor. Eligible groups must also limit any compensation received in connection with an investment to a maximum of 5% of the value of the securities invested.

ii. The ESB Exemption

As a business seeks to raise capital from investors, it may be considered to be "in the business of trading" securities and accordingly required to either be registered as a dealer or rely on an exemption from registration. There is no bright-line test to make this determination, rather whether an entity is "in the business" of trading will generally be a fact-specific analysis.

The OSC recognizes that some early-stage businesses may wish to raise capital without using a dealer; therefore, two exemptions are being provided, one where the business is working with a registered dealer or an intermediary relying on an exemption from dealer registration (such as a crowdfunding portal or an angel investor group) and one where they are not. This exemptive relief aims to reduce barriers to early-stage capital up to a maximum of $3,000,000 (a business that decides to use a dealer is not subject to limits on the amount of capital that can be raised, other than limits included in the conditions to the prospectus exemption being relied on) and allow early-stage businesses to engage in permitted marketing activities so that they may reach more individuals that may be interested in investing in their business during the earliest and most critical capital raising stages.

Some of the key qualifying criteria have been highlighted below. For a full list of the qualifying criteria, reference should be made to the full text of the ESB Exemption linked herein.

Qualifying Criteria

To qualify for the ESB Exemption, an issuer must, amongst other things, be an "eligible business".

An "eligible business" is one that:

• has its head office and business operations in Ontario;
• is in the early or development stages of its business and in the process of seeking capital to start, grow or scale its business;
• has fewer than 100 employees;
• has a primary business purpose that is not investing in real estate, mortgages, other businesses, or other assets;
• has a business purpose other than to identify and evaluate assets or a business with a view to completing a merger with, amalgamation with or purchase of the securities of an issuer, or the acquisition of a business;
• not directly or indirectly engaged in the following activities:
  • holds, invests in or trades crypto assets, on the issuer's own behalf or on behalf of its clients; and
  • operates a gaming or betting business
• is not a reporting issuer, or subsidiary of a reporting issuer, in any jurisdiction of Canada or any foreign jurisdiction;
• is not registered under securities legislation in any jurisdiction of Canada or in any foreign jurisdiction; and
• is not an investment fund.

Furthermore, issuers are only permitted to distribute certain "eligible securities" of their own issue, which include: common shares, non-convertible preference shares, securities convertible into common shares or non-convertible preference shares, non-convertible debt securities linked to a fixed or floating interest rate, a unit of a limited partnership, a share in the capital of a cooperative, as defined in the Business Corporations Act (Canada) or a co-operative incorporated under the Co-Operative Corporations Act (Ontario).

Distributing Eligible Securities

With respect to distribution, qualifying issuers can choose whether to involve a registered dealer. These rules are outlined in Items 15 — 17 (distributions without a dealer) and Item 18 (distributions with a dealer) of the ESB Exemption, respectively.

Some of the unique requirements in Items 15 — 17 are noted below with respect to an issuer seeking to distribute "eligible securities" without the involvement of a registered dealer. The majority of these criteria apply in addition to those noted in section 18 with respect to distributions made with the involvement of a registered dealer.

Distributions without a Registered Dealer

If a qualifying issuer meets the various threshold criteria enumerated in the ESB Exemption, then it may distribute "eligible securities" without a dealer if it complies with Items 15 — 17 of the ESB Exemption. Amongst other things, these items dictate: (i) who the issuer's securities may be sold to and the aggregate amount of funds that can be raised from their sale, (ii) how the issuer may engage with investors, and (iii) which forms must be submitted to the OSC.

Without the involvement of a registered dealer, issuers are capped at raising a maximum aggregate amount of $3,000,000 from the sale of "eligible securities". Such sales are permitted only to Ontario residents that are either: (i) accredited investors under the prospectus exemptions set out in section 73.3 of the Securities Act (Ontario) and section 2.3 of NI 45-106 — Prospectus Exemptions; or (ii) self-certified investors under OI 45-507. Further, issuers must not provide to any person or company compensation for finding investors or any transaction-based compensation in connection with the distribution.

The ESB Exemption also states that issuers proposing to distribute securities without a registered dealer must deal fairly, honestly, and in good faith with all investors and prospective investors.

In addition to certain forms to be filed with the OSC, issuers proposing to distribute securities without a registered dealer must also deliver the following documents to the OSC:

1. for each reporting period in which the issuer distributed securities while relying on the ESB Exemption, a completed Form 32-509F2 Alternative Report of Exempt Distribution no later than the 30th day after end of the reporting period; and
2. for each reporting period in which the issuer provided an offering memorandum to investors or prospective investors, a copy of the offering memorandum or any amendment to a previously delivered offering memorandum, no later than the 30th day after the end of the reporting period.

iii. The SCIR Exemption

On October 25, 2022, the OSC adopted OI 45-507, which created a time-limited prospectus exemption allowing qualifying individuals in Ontario, who may not meet the financial thresholds or other criteria required to qualify as an accredited investor, to invest in issuers (for more information, please refer to our previous bulletin linked here). Issuers distributing securities under OI 45-507 are required to: (i) file a Form 45-106F1 Report of Exempt Distribution; (ii) file a completed confirmation of qualifying criteria under OI 45-507 and (iii) pay the applicable fee, on or before the 10th day after the closing of the distribution.

To reduce this regulatory burden, the OSC has introduced Ontario Instrument 45-509 – Report of Distributions under the Self-Certified Investor Prospectus Exemption (Interim Class Order), which provides exemptions to the above noted requirements. In order to qualify, an issuer must complete and deliver to the OSC a Form 45-509F1 Alternative Report of Exempt Distribution within 30 days of the end of each reporting period that the issuer distributed securities of its own issue in reliance on OI 45-507.

The SCIR Exemption came into force on May 9, 2024, and will remain in effect until the earlier of October 25, 2025, and the effective date of an amendment to National Instrument 45-106 Prospectus Exemptions that addresses substantially the same subject matter.

V. Conclusion

In conclusion, the introduction of the Angel Investor Exemption promises to broaden access to investment opportunities in small businesses. Similarly, the ESB Exemption streamlines the process for certain small businesses, enabling them to raise capital independently. Furthermore, the SCIR Exemption extends investment opportunities to individuals who may not meet the criteria for accredited investors. Collectively, these exemptions represent significant strides towards fostering a more inclusive and dynamic investment landscape for small businesses in Ontario. If you would like to discuss the Early-Stage Capital Exemptions or any further information, please contact any member of our Securities and Capital Markets Group.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.