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Private Placement Memorandum Venture Capital

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					  Part Three: Relying on the “Offering Memorandum” Exemption
                to Raise Private Placement Capital
                                            (posted March 24, 2011)




Pssst…want to offer your securities
to the largest number of people
possible in Canada without filing a
prospectus? Want control and
certainty over what information
prospective investors are relying on
when purchasing securities of your
company? Want a simplified one page
subscription agreement with no investor questionnaire? Look no further then the offering memorandum
exemption in National Instrument 45-106 Prospectus and Registration Exemptions (“NI 45-106”). The
offering memorandum exemption is available in all jurisdictions across Canada except Ontario.

Yes, I know Ontario is a big market but apparently the Ontario Securities Commission does not believe
its residents are as advanced as the residents in the rest of Canada in assessing opportunities set out in an
offering memorandum. You can use an offering memorandum in Ontario but there is no offering
memorandum exemption in Ontario. You must instead rely on a registration and prospectus exemption
that is recognized in Ontario to sell securities to Ontario residents. The exclusion of Ontario is a small
hiccup but still does not take away from the usefulness of the offering memorandum exemption. After all
Ontario is not the center of the universe or Canada.

In part three of this three part series, I will discuss the offering memorandum exemption. First I will
discuss the form an offering memorandum is required to take if an issuer wants to rely on the offering
memorandum exemption. I will then cover a few of the provincial differences that seem to trip up issuers
and sometimes even their legal counsel. In closing I will discuss offering memorandum hot spots and
how to stay away from trouble when putting together an offering memorandum.

Form is Everything

The offering memorandum exemption in NI 45-106 allows an issuer to sell its securities to anyone,
regardless of their relationship, wealth or a minimum value of securities being purchased. Preparing an
offering memorandum requires a bit more input by management and its professional advisors to put
together than just a subscription agreement and investor questionnaire (which is the main reason why
issuers are reluctant to use the offering memorandum exemption). The added time and associated cost
however can be well worth the effort, particularly when an issuer is looking to raise over $100,000.

In Canada an offering memorandum is required to be prepared and delivered in the required form to
prospective investors. There are two versions of the required form: (1) is for qualifying issuers (Form 45-
106F3); and (2) the other is for non-qualifying issuers (Form 45-106F2). Qualifying issuers are issuers
listed on the TSX or TSX Venture Exchange. Non-qualifying issuers are all other issuers. The form for
qualifying issuers allows certain information that is already posted on SEDAR to be incorporated by
reference into the offering memorandum.

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The disclosure required in an offering memorandum is much less than that required in a prospectus. A
Canadian offering memorandum in the required form includes the following sections:

     Item 1: Use of Available Funds (as set out in tables in form);
     Item 2: Description of Business (no more than 2-5 pages);
     Item 3: Interests of Directors, Management, Promoters and Principal Holders (as set out in tables
        in form);
     Item 4: Capital Structure (as set out in tables in form);
     Item 5: Securities Offered (very basic description required);
     Item 6: Income Tax Consequences and RRSP Eligibility (simplified disclosure other than for
        flow-through shares or special income tax vehicle securities);
     Item 7: Compensation Paid to Sellers and Finders (basic disclosure – cannot pay finder’s fee in
        Northwest Territories, Nunavut, Saskatchewan and Yukon);
       Item 8: Risk Factors (no more than 2 pages);
       Item 9: Reporting Obligations (very basic description required);
       Item 10: Resale Restrictions (text required as set out in section);
       Item 11: Purchasers' Rights (2 day cancellation right as set out in section and statutory and
        contractual right of action disclosure as required by each province securities are offered);
       Item 12: Financial Statements (audited annual; unaudited interim);
       Item 13: Date and Certificate (certificate as of date of offering memorandum stating no
        misrepresentation in document); and
       Risk Acknowledgement Form (to be signed by all investors).

Much of the information required in an offering memorandum is set-up in tables and can be pulled from
an issuer’s business plan, corporate record book and financial statements. The disclosure sections are
meant to be short and concise with sufficient information to allow investors to make an informed
investment decision about the issuer and its business. United States and other foreign issuers often use
what is called an offering memorandum wrap which references where in a prospectus filed in their home
jurisdiction Canadian private placement investors can find the information required in a Form 45-106F2
offering memorandum.

Instructions on completing each form are included behind the basic form template provided by the
regulators. Mining development and exploration companies need to file Form 43-101 technical report as
required by subsection 4.2(1)(d) of National Instrument 43-101 Standards of Disclosure for Mineral
Projects to support any scientific or technical information describing a mineral project on a property
disclosed in an offering memorandum. Similarly, oil and gas issuers must ensure information they
include about their oil and gas activities in their offering memorandum conforms to National Instrument
51-101 Standards of Disclosure for Oil and Gas Activities.

The offering memorandum, and if applicable the Form 43-101 technical report, is required to be filed at
the same time as the first Form 45-106F1 Report of Exempt Distribution is filed (10 days after the
accepting the first subscription). The offering memorandum only needs to be filed the first time unless it
is updated. If a material change occurs in the business of the issuer after delivery of an offering
memorandum to a potential investor, the issuer must give the potential investor an update to the offering
memorandum with a newly signed certificate before the issuer accepts an agreement to purchase
securities.

Issuers who fail to prepare and file their offering memorandum in the required form can be expected to be
cease traded (see: Peace Summit Technologies (VCC) Inc. (11/05/2010); GDC Investments Inc.

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(08/31/2010); Turkanda Coal Corp. (08/26/2010); Living Forest One Limited Partnership (08/17/2010);
ACIC Marketing Limited Partnership (08/12/2010); Pioneer West Mortgage Investment Corporation
(07/20/2010); All Canadian Investment Corporation (07/13/2010); Western Liquid Funding Limited
Partnership (04/30/2010); Antrim Balanced Mortgage Fund Ltd. (04/13/2010); Kensington Realfund
Corporation (03/03/2010); Eagle Peak Resources Inc. (02/15/2010); Metal Mountain Resources Inc.
(02/16/2010); Black Sand Equity Management Ltd. (12/30/2009); Bridgeport Capital Inc. (09/14/2006);
Automoney Financial Corporation (10/22/2008); and Canadian Rockport Homes Int’l, Inc. (12/31/2008))
or find themselves and/or their management with regulatory bans and penalties (see: Gregory Clark
Carrington (02/07/2011); and China Dragon Fund Ltd, et al. (07/04/2007)). Issuers may also be required
to refund investors funds received and may face civil action in addition to regulatory action in Canada
(see: Fiorillo v. Krispy Kreme Doughnuts Inc., 2009 CanLII 29902 (ON S.C.)). Sections in the form are
not optional items. Each section of the required form must be included and all tables and required
statements must be set out exactly as in the form.

The only offering memorandum format or template issuers should be following in Canada are those set-
out in Form 45-106F2 and Form 45-106F3 of NI 45-106. Unfortunately, some issuers we have talked to
have cited a couple of Ontario based law firm articles online which state there is no required form for an
offering memorandum. When checking these articles it is obvious the authors are referring to Ontario
only. It is a correct statement that there is no required form for an offering memorandum in Ontario as
Ontario does not recognize the offering memorandum exemption. If, however, an issuer wants to rely
on the offering memorandum exemption in any other province or territory in Canada the offering
memorandum must be in the required form.

Keep in mind issuers can rely on different exemptions in different jurisdictions. For instance, an issuer
may rely on the offering memorandum in British Columbia and the accredited investor exemption in
Ontario. The British Columbia resident investor would receive the offering memorandum, one page
subscription agreement and risk acknowledgement. The Ontario resident would receive the offering
memorandum, traditional long form subscription agreement, investor questionnaire, certificate and
accredited investor verification request form. The offering memorandum in both instances should be
identical and in the required form under NI 45-106F1. The issuer would file the offering memorandum in
both provinces at the same time as filing its Form 45-106F1 Report of Exempt Distribution.

The foregoing covers 99% of all issuers relying on the offering memorandum exemption. Issuers should
be aware that British Columbia requires a different offering memorandum form be used for syndicated
mortgages (BC Form 45-901F) and real estate securities (BC Form 45-906F). Alberta also requires a
different offering memorandum form be used for real estate securities (Alberta Form 45-509F). Manitoba
also has a Made in Manitoba private placement exemption (section 91(b) of the Manitoba Securities
Regulation) for sales to related purchasers and no more than 50 sophisticated purchasers in all
jurisdictions which requires a different offering memorandum be used (MB Form 26). Issuers in these
categories should check the corresponding policy statement in each jurisdiction they intend to offer
securities before preparing one of these alternate offering memorandums.

Provincial Differences in Using the Offering Memorandum Exemption

British Columbia, New Brunswick, Nova Scotia and Newfoundland and Labrador have adopted a basic
version of the offering memorandum exemption (“Basic OM”) while Alberta, Saskatchewan, Manitoba,
Québec, Prince Edward Island, Northwest Territories, Nunavut and Yukon have adopted a slightly
enhanced version of the exemption (“Enhanced OM”). Ontario, as mentioned previously, does not
recognize the offering memorandum exemption.

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The Basic OM requirements are that (1) the investor purchases the securities offered as principal; (2) that
the issuer deliver the offering memorandum in the required form to the investor prior to the subscription
agreement being signed; and (3) that the issuer obtain a signed risk acknowledgment from the investor.

The Enhanced OM in addition to the Basic OM requirements restricts the acquisition cost of an investor
to $10,000 or less unless the investor is an “eligible investor” as defined in NI 45-106. An eligible
investor is not subject to a maximum investment cap. The eligible investor, however, must not have been
created solely for the purpose of investing under the offering memorandum. Also, if the issuer is an
investment fund, the investment fund is required be a non-redeemable investment fund, or a mutual fund
that is a reporting issuer.

In addition to the Enhanced OM requirements, Saskatchewan, Northwest Territories, Nunavut and Yukon
do not allow any commissions or finder’s fees to be paid to any person, other than to a registered dealer,
in connection with the offering memorandum exemption. This provision is taken very seriously by
Saskatchewan in particular and can result in an immediate cease trade order. (see: Sitefinders Capital 9
Corporation (02/16/2010); 20/20 Diversified Income Trust (10/27/2009); Edgeworth Mortgage
Investment Corporation (02/16/2010); Fisgard Capital Corporation (03/08/2010); and Investicare Seniors
Housing Corp. (01/27/2010)).

Surprisingly, other than the no commission or finder’s fee ban, the additional provisions of the Enhanced
OM have caused few if any regulatory actions on their own.

Hot Spots and Reoccurring Problem Areas

The Saskatchewan Securities Division publishes its review findings of offering memorandums filed in
Saskatchewan. They have identified several hot spots and reoccurring problem areas in offering
memorandums. Frankly, I found it disheartening to read that almost all offering memorandums filed in
Saskatchewan were non-compliant. A good portion of these offering memorandums must have had some
input by legal professionals, but obviously not enough input to make a real difference. Here is a quick list
of what to check before filing your offering memorandum (“OM”) as based on the Saskatchewan
Securities Divisions findings:

 Problem Areas           Remedy and Check
 Attachments to the        financial statements must be placed just before the certificate and not
 OM                         included as an attachment;
                           all information considered material should be provided in the body of the
                            OM;
                           only attach a document if it is material to understanding the issuer or the
                            proposed investment (ie., a copy of a limited partnership agreement);
                           any necessary attachments to an OM must be incorporate by reference in
                            the OM; and
                           information contained in the OM and in the attachment should be
                            reconciled and not contradict one another.




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Problem Areas          Remedy and Check
Material Agreements      provide accurate summary of all material agreements with related parties;
                         provide an accurate summary of all other material agreements;
                         disclose relationship with related party;
                         provide cost of asset to related party and cost of asset to issuer if sale of
                          asset has occurred;
                         disclose all finder’s fees and commissions paid or to be paid to related
                          parties;
                         dates of all agreements, closing dates and termination dates are required;
                         disclose material outstanding obligation under material agreements; and
                         where an agreement relates to a debenture or loan you must include
                          information about the principal amount, repayment terms, security pledged,
                          due date and interest rate.

Projections              avoid providing projections unless absolutely necessary;
                         provide underlying assumption and hypothesis to any projections or
                           financial forecasts included;
                         clearly and correctly identify any projections as audited or unaudited;
                         any audit report on projections must be clearly identified;
                         projections, information in the OM, financial statements, and audit report
                           must reconcile and not contradict one another;
                         confirm arithmetic is correct in all projections or financial forecasts based
                           on assumptions and calculation methodology disclosed;
                         limit the period covered of projections or the financial forecasts to one that
                           can be reasonably estimated (six months/one year?); and
                         all projections and financial forecasts must be compliance with parts 4A
                           and 4B of National Instrument 51-102 – Continuous Disclosure
                           Obligations and be approved by management.

                       OM with projections on business and financial assumptions that were not
                       considered reasonable under the circumstances. Canadian Rockport Homes
                       Int’l Inc.; Malone, William; and Riis, Nelson (BC)

Financial Statements    financial statements must be placed just before the certificate and not
                           included as an attachment;
                        financial statements must be prepared in compliance with National
                           Instrument 52-107 Acceptable Accounting Principles and Auditing
                           Standards and its companion policy;
                          you must include financial statements for any business acquisitions or
                           proposed business acquisitions;
                          financial statements of a general partner are required to be included along
                           with the financial statements of the limited liability partnership;
                          financial statements must be current and not stale dated at time of
                           investment;
                          Financial statements must now conform to IFRS versus Canada GAAP; and
                          Signature on any audit reports enclosed must be dated prior to the OM date.




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Problem Areas        Remedy and Check
Investors Rights/     request legal assistance to draft correct language in statutory right of action
Certificates           section to conform with each provinces requirements;
                      limited partnerships must include Item 13 certificates signed by issuer,
                       general partner and promoters; and
                      Item 13certificate must be signed by the chief executive officer, chief
                       financial officer, and any two directors of the issuer and each promoter of
                       the issuer (see subsection 2.9 of NI 45-106).

Structural Issues     a venture capital corporation (or similar issuer) formed to invest in a
                       another business must include sufficient details, including financial
                       statements and share structure, about that other business to enable investors
                       to make an informed decision; and
                      the indirect investment must be sufficiently disclosed to enable investors to
                       understand how their funds will be invested and how returns will be
                       calculated on that investment.

Securities Offered    clearly identify the material terms of the securities being offered; and
                      if the securities are redeemable provide disclosure on how the redemption
                         will be funded and the possible effect on the overall business of issuer.

Stale Dated OM        issuers must update the OM each and every time there is a material change
                         or create and deliver a new OM prior to any sales; and
                      any time an OM is updated or amended it must include a newly dated and
                         signed Item 13 certificate(s).

Use of Proceeds       if 10% or more of proceeds raised will be used to pay down debt incurred
                         in last two years issuers must disclose this intent and provide information
                         as to when this debt was incurred and for what purpose or benefit to the
                         issuer.
                        clearly identify funds from other sources required by issuer to proceed with
                         business plans;
                        provide enough detail in use of proceeds section to enable prospective
                         investors to understand how funds raised will be used;
                        identify any existing working capital deficiency and whether use or
                         proceeds will be used to remedy this deficiency or how the issuer intends to
                         remedy or manage its working capital deficiency; and
                        provide details in use of proceeds and in description of business about any
                         proposed investment in a related operation. Details should include purpose
                         and role of entity to the operations of issuer, how investment will be
                         funded, and ownership percentages and rights attached to investment (ie.,
                         subsidiary or joint venture).




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 Problem Areas           Remedy and Check
 People                   properly identify and provide all required information for all directors,
                           officers and promoters in Item 3 of the OM;
                          provide information about the business and management experience of all
                           directors and officer who will manage the business; and
                          identify all compensation (cash, share, options and warrants etc.) paid to
                           promoters in the most recently completed financial year and anticipated to
                           be paid in the upcoming financial year.

 Business Disclosure       provide sufficient detail about business, products, services, properties,
                              operations, market, marketing plans and business strategies to enable
                              prospective investors to understand your business and evaluate its
                              prospects;
                             identify all business risks in OM using full sentences and paragraphs;
                             provide a chart of subsidiary and related companies to issuer. Provide
                              sufficient disclosure of each entities role and organization to provide a clear
                              understanding of that entity and its relationship to the issuer;
                             avoid promotional words and statements that cannot be supported by an
                              independent reputable third party;
                             obtain permission in writing before including a third party's name in the
                              OM or quoting or attributing certain information contained in the OM to
                              them (trustees, transfer agents, qualified person, industry expert; tax
                              specialist, valuation report writer etc.); and
                             provide any additional disclosure outside what is requested in the required
                              form to ensure a misrepresentation does not occur by omission.
                              “Misrepresentation includes an omission to state a material fact that is
                              required to be stated or that is necessary to make a statement not misleading
                              in the light of the circumstances in which it was made.”

                         OM with fraudulent misrepresentations: Ali, Cem; Horizon FX Investments
                         Limited Partnership, Horizon FX Investments Incorporated; and HFX
                         Management Services Inc. (BC)

                          Misleading or deficient OM: Wigmore, Arthur

Voluntary pre-offering filings and reviews

Offering memorandums are not required to be pre-filed in any province or territory in Canada. In general,
the first look a securities regulator takes at an offering memorandum or its corresponding Form 43-101
technical report is when these documents are filed with an issuer’s first Form 45-106F1 Report of Exempt
Distribution after the first sale of securities. Securities regulators go through a two check process when
reviewing these documents. This first check review is a relatively quick look to make sure the offering
memorandum, and if applicable technical report, are in the required form, all sections have been
addressed, the certificates are in order and properly signed, and that the issuer has provided the regulator
with the correct filing fee. The second check review is detail oriented and deliberate. The regulators on
this go round look at the substance of the information provided by an issuer. If the offering memorandum
or technical report is found to be deficient the regulator may issue a letter requesting the deficiency be
addressed and that the investors receive an updated document. If the deficiencies are deemed significant
the securities of the issuer may be cease traded until an amended offering memorandum and or technical

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report in compliance with the rules has been filed. If the deficiencies are deemed serious or there is a
suggestion of fraud or an intentional misrepresentation the file is elevated to enforcement to handle.

Only one jurisdiction in Canada currently allows issuers to pre-file their offering memorandum to confirm
if it is in compliance with the securities rules as viewed by that regulator. Issuers may file a draft offering
memorandum with staff of the Corporate Finance Branch of the Saskatchewan Financial Services
Commission’s Securities Division. Securities Division staff will review the draft document and return
comments on how to improve the offering memorandum for compliance purposes. It is something for
issuers to seriously consider in order to avoid any potential embarrassment of having to re-file an offering
memorandum due to deficiencies.

I should also mention, the New Brunswick Securities Commission has announced that it is getting ready
to launch in 2011 its online OM Tool to assist issuers to create an offering memorandum. It will be
interesting to see if this is just a template or something more.

Conclusions

The offering memorandum exemption is a terrific way for issuers to expand their horizon as to who they
may approach to invest in their business. As an issuer you will avoid unnecessary regulatory problems if
you carefully follow the required form and related instructions that apply to you as either a non-qualifying
issuer or qualifying issuer. The key is to keep the information factual and only include statements you
can back-up or can prove are reasonable.

If you plan to go it alone in preparing your offering memorandum, you should consider conducting your
own internal due diligence review of your company prior to putting your document together. If you
engage legal counsel it is likely they will make such a review mandatory. The reason I recommend a due
diligence review is to make sure you don’t inadvertently miss something. It is why lawyers and auditors
insist on a due diligence review when drafting a major disclosure document.

I also recommend you use an offering memorandum checklist to confirm you have addressed each section
or that an item is not applicable to you. Using the wrong form or missing a required section is the
number one reason issuers get in trouble with regulators when using the offering memorandum exemption
(excluding those issuers who are involved in blatant fraud).

You may also want to consider using a lawyer to prepare your offering memorandum or at a minimum
have a lawyer review the documents you have prepared. Alternatively, if you chose to forego getting a
lawyer involved, you should seriously consider requesting a pre-filing review of your offering
memorandum with the Corporate Finance Branch of the Saskatchewan Financial Services Commission’s
Securities Division (assuming you will be offering your securities to Saskatchewan residents or reside in
Saskatchewan). It may be the best $500 you ever spent.

This ends our three part series entitled Anyone With Money is a Friend of Mine: Traps to Avoid When
Raising Private Capital. I hope you found the series useful or at a minimum informative.




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Links to the other articles in this series:

       Anyone with Money is a Friend of Mine: Introduction;

       Part One: Relying on the “Close Personal Friend” and “Close Business Associate” Exemptions to
        Raise Private Placement Capital; and

       Part Two: Relying on the “Accredited Investor” Exemption to Raise Private Placement Capital.




                                                                                  Alixe B. Cormick
                                                                                  Venture Law Corporation
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                                                                                  Vancouver, B.C.
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                                                                                  Phone: 604-659-9188
                                                                                  Fax: 604-659-9178
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