Trevor Treweeke |
Penetrating the Moat Around the Rich: How Non-Accredited Investors Can Legally Gain Access to Private Placements
Major wealth creation events in Canadian history have happened when startup companies sell stock to investors at sweetened terms.
In 2011, Shopify (TSX:SHOP) raised a Series B financing at a CDN$100M valuation. Today the Company is worth $55B.
Newmarket Gold sold units at $0.26 in 2014. The company was acquired by Kirkland Lake Gold (TSX:KL) in 2016 at $5.28 (.475:1 share consolidation). Today Kirkland shares trade at $54.
Tweed which is now known as Canopy Growth (TSX:WEED) sold shares for less than $1 per share in 2014. Those same shares traded over $65 in 2019.
In 1995, Constellation Software (TSX:CSU) raised $25M and later went public in an $80M IPO in 2006 where shares opened at $17. Today those shares trade at $1,400 or a $29B market cap.
Early investors can reap massive returns, yet regulators have largely restricted access to these financings to the wealthy, due to perceived risk in an effort to protect the “unsophisticated investor”.
Canada’s public venture market is a great way to get rich in Canada, but the sweetest opportunities are often reserved for people who are already rich.
There is a moat around wealth in Canada, and in this article, I will share a loophole to get around this exclusive problem.
The TSX-Venture Exchange is one of the world’s most active stock markets and has facilitated the raising of CDN$6.8B in financings in the past year.
In 2018, a total of 1,701 financings provided a staggering $6.8B in capital to small and micro-cap companies. Even more noteworthy, 88% of those financings were completed by private placement as opposed to IPOs (which made up a total of $70M), accounting for $4.66B or 69% of the total capital raised.
For these reasons, it’s apparent that the most common way companies listed on the TSX-Venture Exchange access capital is by private placement.
A private placement is a sale of shares or bonds to pre-selected investors and institutions rather than on the open market. Since the securities are not sold through a public offering, but rather through a private offering, they have their own set of rules.
Private placements are defined as an “exempt” market where investors are only allowed to purchase securities under an exemption from securities law which governs the public markets.
Given the limited disclosure obligations for private placements, they are restricted to most investors, unless they meet the criteria for one of the exemptions.
Of course, this can seem unfair to retail investors since there can be distinct advantages for private placement participants. “Sweeteners” are commonly added to private placements which create additional leverage as the participants receive some form of a warrant as a bonus. In an earlier article, I outlined the “Discount Market Price”, which creates another advantage for the participants as they are able to purchase their shares at a price less than what the market is trading at. With the caveat of a four-month hold escrow period, in which the investor cannot sell their shares.
So, what are these exemptions?
There are numerous capital raising exemptions for companies, such as:
Accredited Investor Exemption; Investment Dealer Exemption; Existing Security-holder Exemption; Family, Friends and Business Associates Exemption; Offering Memorandum Exemption; Rights Offering Exemption; and the Minimum Amount Investment Exemption.
Most commonly, companies rely on the Accredited Investor Exemption, and the Family, Friends and Business Associates Exemption for investor participation. Below are the legal definitions for “accredited investor” and “Family, Friends and Business Associates Exemption”
- “Family, Friends and Business Associates Exemption” means the exemption from the prospectus requirement available in all jurisdictions of Canada pursuant to section 2.5 of NI 45-106 and, without limiting the foregoing, for reference, may include a distribution of a security by an issuer to a director, executive officer, control person and founder of an issuer and certain family, close personal friends and close business associates of such persons.
- “accredited investor” has the meaning ascribed to that term in NI 45-106 and, in Ontario, section 73.3(1) of the Securities Act (Ontario), and, without limiting the foregoing, for reference, includes an individual (i) who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that, before taxes, but net of any related liabilities, exceeds CDN$1,000,000, (ii) whose net income before taxes exceeded CDN$200,000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded CDN$300,000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year, (iii) who, either alone or with a spouse, has net assets of at least CDN$5,000,000, and (iv) any person registered under the securities legislation of a jurisdiction of Canada as an adviser or dealer.
But what if you don’t meet the accredited investor criteria? What if you’re not a family member, a friend or a business associate?
Trying to meet the criteria of owning CDN$1M in financial assets or having a salary of CDN$200,000 could take years, decades or even seem impossible to achieve. Adding to the challenge of trying to attain one of these goals can seem even more unreachable after learning that private placements provide some of the best opportunities in the market.
However, there are two exemptions that are not talked about, rarely used and relatively unexplored, which may provide retail investors access to these lucrative private placement opportunities.
So, what are these two rarely used exemptions? How do they work?
The Existing Security-holder Exemption and The Investment Dealer Exemption are two underutilized exemptions that can create an opportunity for investors who failed to qualify for the previously noted exemptions. Below are the definitions for both the “Existing Security-holder Exemption” and “Investment Dealer Exemption”:
- “Existing Security Holder Exemption” means the exemption from the prospectus requirement available in all jurisdictions of Canada pursuant to the Existing Security Holder Exemption Local Instruments and, without limiting the foregoing, for reference, may include a distribution of a security by an issuer to a person who confirms in writing to the issuer that, prior to the date the offering was announced, they held the type of listed security being subscribed for and, unless the investor has obtained suitability advice from a registered investment dealer, the investor invests a maximum of CDN$15,000 per issuer under the exemption in a 12-month period.
To put it simply, when using the “Existing Security-holder Exemption” investors are allowed to participate in the private placement if they are already shareholders. But be aware, that to be deemed eligible under this exemption the investor must be a shareholder on the record date of at least one day before the news release announcing the private placement. Therefore, if you owned Company XYZ up to one day before the news release, you are eligible to participate in Company XYZ’s private placement.
- “Investment Dealer Exemption” means the exemption from the prospectus requirement available in British Columbia, Alberta, Saskatchewan, Manitoba, and New Brunswick pursuant to the Investment Dealer Exemption Local Instruments and, without limiting the foregoing, for reference, may include a distribution of a security by an issuer to a person who has obtained advice from a registered investment dealer regarding the suitability of the investment.
In layman’s terms, this exemption allows for investor participation if the investor has obtained advice regarding the suitability of the investment from an investment dealer (an investment dealer is a licensed full-service broker). It should be noted, that even if the investment dealer signs off on the suitability of the proposed investment as being NOT suitable, the investor can STILL participate.
Generally, most investors think if they’re not accredited or aren’t friends with management they can’t participate, which is not entirely true. Considering that private placements are the most commonly used tool for financing activity, it means there’s a huge number of opportunities for investors to pick and choose from.
Private placements can have quite friendly terms for new investors and in return can create some of the juiciest opportunities. By not having access as a small retail investor it could be the single largest detriment to increasing portfolio returns.
Not all private placements are a path to riches. Private placements have limited disclosure obligations and are highly risky. Therefore, an exemption must be used to purchase these types of offerings which limits the potential pool of investors a company can raise capital from. Understanding the exemptions and seeking legal advice to see if you are eligible, could be a generator of outsized returns for any micro-cap investor.
About the Author
Trevor Treweeke is a Vancouver based micro-cap investor and contributor to SmallCap Discoveries. SmallCap Discoveries is a newsletter dedicated to uncovering Canada’s best emerging growth stocks. For more information visit smallcapdiscoveries.com.
This article if for information purposes only. It is not a solicitation and no securities are being offered. Espace MicroCaps and Trevor Treweeke decline any responsibility for trading losses incurred directly or indirectly because of the information presented in this article. Individual circumstances vary, and this article is not intended to be legal or financial advice. Please consult your professional advisor before making any investment decisions. The TSX-Venture is by its very nature an exchange for extremely speculative, high risk investments, and readers are cautioned to understand the unique and specific risks of each company listed.
Commentaires sur “Penetrating the Moat Around the Rich: How Non-Accredited Investors Can Legally Gain Access to Private Placements”
Thank you for an excellent informative article on private placements.
My question is: Do US retail investors qualify for the Existing Security Holder Exemption, and if so, are minimum investment amounts required, and what would general $ requirements be?
I intend to bookmark your site.
Good question! The existing shareholder exemption is an exemption from the Canadian prospectus requirement. Therefore, the US investor will need to satisfy a US exemption (i.e. be a US accredited investor). So to specifically answer, a US investor cannot rely on this exemption.