When Do Start-Ups Have to Register as a Dealer in Canada – Proposed Amendments to NI 31-103

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Brian Koscak Blog | December 30, 2013

Compliance and registration triggers

This article examines proposed amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) that provides additional guidance to clarify when, and if, a start-up or early stage issuer including, a technology or mining issuer, has to register as a dealer under NI 31-103.

A start-up or early stage issuer that is raising capital for the first time, or over a period of time, that only has a business plan and is not necessarily producing a product or delivering a service, arguably has no active non-securities business and could be considered a “securities issuer” and required to be registered as a dealer absent an exemption from the registration requirements under applicable Canadian securities law.

A securities issuer is an issuer that: (a) frequently trades in securities; (b) employs or otherwise contracts individuals to perform activities on its behalf that are similar to those performed by a registrant (other than underwriting in the normal course of a distribution or trading for its own account); (c) solicits investors actively; or (d) acts as an intermediary by investing client money in securities.

The existing Companion Policy to NI 31-103 (NI 31-103CP), however, states that, generally, securities issuers with an active non-securities business do not have to register as a dealer if they: (a) do not hold themselves out as being in the business of trading in securities; (b) trade in securities infrequently; (c) are not, or do not expect to be, compensated for trading in securities (d) do not act as intermediaries; and (e) do not produce, or intend to produce, a profit from trading in securities.

NI 31-103 does not define the term “active non-securities business” but generally it is understood to mean a real, bona fide business other than the business of capital raising. The proposed guidance takes into account the enforcement cases that have dealt with “business trigger” issues where certain issuers have engaged in illegal distributions of securities with no legitimate business objectives.

Proposed clarification on “active non-securities business”

The Canadian Securities Administrators (the CSA) have proposed the following guidance to section 1.3 of NI 31-103CP:

 We consider a start-up to have an “active non-securities business”, if the entity is raising capital to start a non-securities business. We would expect the entity to have a business plan. Although the entity does not need to be producing a product or delivering a service, they must have a bona fide plan to do so, hopefully within a specified period. For example, technology companies may raise money with only a business plan for many years before they start producing a product or delivering a service, but generally the business plan will include milestones and the time anticipated to reach those milestones. In our view, to consider that an entity only has an “active business” if it is producing a product would mean many junior mineral exploration companies (even listed ones) do not have an “active business.

View:  Summary of Canadian Crowdfunding regulations (Oct 2013)

The CSA have also proposed additional commentary on the frequency of trading branch of the business trigger, where it states the following:

 We recognize that trading and soliciting may be more frequent during the start-up stage, as the issuer needs to raise capital to launch the business. If the trading and soliciting is for the purpose of advancing the business, then the frequency of the activities alone should not result in the issuer being in the business of trading in securities.

However, the capital raising must be primarily to support advancement of the business plan, not to simply sustain the issuer. During the start-up period, the use of the proceeds must support the business plan. If the capital raising and use of that capital is not advancing the business, the issuer may need to register as a dealer.

The CSA has also stated that many officers, directors or other employees of start-up issuers often actively solicit prospective investors in connection with an distribution or trade, however, it would be unlikely that the issuer or these individuals would have to be registered unless:

(a) the principal purpose of their employment is raising capital; (b) they spend the majority of their time raising capital; or (c) any of their remuneration is tied to their capital raising activities.

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