9.3 The Exempt Market & Private Placements

While public prospectus offerings represent the most visible channel for corporate financing, preparing and filing a full prospectus is a costly, time-intensive process that can exceed hundreds of thousands of dollars in legal, auditing, and regulatory filing expenses. For early-stage ventures, growth-stage corporations, and private commercial enterprises, this regulatory overhead is often prohibitive. To facilitate efficient capital formation while maintaining investor protection, Canadian securities regulators established the exempt market.

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1. The Closed System Doctrine & NI 45-106 Architecture

Canadian securities law operates under what is known as the "Closed System" doctrine. Under this legal principle, every trade in a security that constitutes a distribution to the public is legally prohibited unless:

1. The issuer files a preliminary and final prospectus and obtains regulatory receipts; or
2. The transaction qualifies for a specific statutory exemption codified under National Instrument 45-106 (NI 45-106) Prospectus Exemptions.

The Closed System Paradigm:

                      [ Proposed Capital Raise ]
                                  |
        +-------------------------+-------------------------+
        |                                                   |
        v                                                   v
[ Prospectus Route ]                               [ Prospectus Exemption (NI 45-106) ]
  - Full, true, and plain disclosure                 - Private placement
  - Extensive review & fees                          - Targeted to qualified investors
  - Freely tradeable immediately                     - Scaled disclosure / risk forms
                                                     - Subject to resale hold periods

Transactions executed under these statutory carve-outs are called private placements or exempt market distributions. In Canada, hundreds of billions of dollars in equity, private debt, real estate partnerships, and infrastructure funds are raised annually in the exempt market. Specialized registered firms known as Exempt Market Dealers (EMDs) underwrite, distribute, and facilitate trading in exempt market products.

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2. The Accredited Investor (AI) Exemption

The Accredited Investor (AI) exemption (codified in Section 2.3 of NI 45-106) is the most heavily utilized prospectus exemption in Canadian capital markets. It allows issuers to raise unlimited amounts of capital without filing a prospectus, based on the rationale that accredited investors possess sufficient financial wealth, access to professional advice, or financial sophistication to evaluate investment risks and absorb substantial economic losses without government oversight.

Accredited Investor Individual Qualifying Tests (NI 45-106):

[ Financial Asset Test ] ---------> >\$1,000,000 in net financial assets
                                     (Cash, stocks, bonds; EXCLUDES real estate)

[ Net Income Test ] --------------> >\$200,000 individually (or >\$300,000 with spouse)
                                     in each of the 2 most recent calendar years
                                     with expectation to repeat in current year

[ Net Asset Test ] ---------------> >\$5,000,000 in total net assets
                                     (Total assets of all kinds MINUS total debt;
                                      INCLUDES real estate and private businesses)

The Three Individual Qualification Tests

An individual investor can qualify as an Accredited Investor by meeting any one of the following three tests:

1. The Financial Asset Test

• Requirement: An individual 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 $1,000,000.
• Eligible Financial Assets: Cash, bank savings, Guaranteed Investment Certificates (GICs), treasury bills, marketable stocks, corporate and government bonds, mutual funds, and exchange-traded funds.
• Excluded Assets: Real estate does NOT qualify as a financial asset. An investor's personal residence, vacation cottages, and commercial real estate cannot be counted. In addition, personal physical property (automobiles, artwork, collectibles) and non-liquid private operating business equity are excluded.
• Related Liabilities: Any debt directly incurred to purchase or carry the financial assets (such as an investment margin loan or a bank loan used to buy securities) must be deducted.

2. The Net Income Test

• Requirement: An individual whose net income before taxes exceeded $200,000 in each of the two most recent calendar years, or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of those years, and who has a reasonable expectation of exceeding that income threshold in the current calendar year.
• Important Rule: An investor cannot combine individual and spousal income across years (e.g., earning $220,000 individually in Year 1 and $310,000 jointly with a spouse in Year 2 does not qualify). The investor must satisfy either the individual test in both years or the joint spousal test in both years.

3. The Net Asset Test

• Requirement: An individual who, either alone or with a spouse, has net assets of at least $5,000,000.
• Formula: $\text{Net Assets} = \text{Total Assets of Every Kind} - \text{Total Liabilities of Every Kind}$.
• Inclusions: Unlike the financial asset test, the net asset test includes all physical assets, such as personal residences, investment real estate, vehicles, and private corporate business equity, minus all mortgages, personal lines of credit, and debts.

Institutional Accredited Investors

NI 45-106 automatically classifies major institutional entities as accredited investors, including:

• Canadian chartered banks, trust companies, and credit union centrals
• Regulated insurance companies and loan corporations
• Registered investment dealers and portfolio managers
• Regulated mutual funds and pension funds
• Federal, provincial, and municipal government bodies
• Corporations, partnerships, or trusts with net assets of at least $5,000,000

Form 45-106F9 Risk Acknowledgment Requirement

To ensure individual retail clients understand that they are forfeiting regulatory prospectus protections, individual accredited investors (qualifying under the financial asset, net income, or $5M net asset tests) must execute Form 45-106F9 Risk Acknowledgment for Individual Accredited Investors prior to purchasing securities. On this form, the investor must explicitly verify which qualifying category they satisfy and sign an acknowledgment stating:

• "I may lose all the money I invest."
• "I will not receive a prospectus containing audited disclosures."
• "I may be unable to resell the securities due to resale restrictions."

(Note: Form 45-106F9 is not required for institutional accredited investors or for individuals who qualify through financial assets of more than $5,000,000.)

Worked Example: Accredited Investor Status Evaluation

Evaluate whether each of the following four prospective investors qualifies as an Accredited Investor under NI 45-106:

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3. The Minimum Amount Investment Exemption

Under Section 2.10 of NI 45-106, a private placement distribution is exempt from prospectus requirements if the purchase involves a substantial single cash commitment:

• Threshold: The purchaser acquires securities with an aggregate acquisition cost of not less than $150,000 paid in cash at the time of the distribution.
• Crucial Statutory Restriction: Zero Eligibility for Individuals!
  • Under modern Canadian securities harmonization, the Minimum Amount exemption is strictly unavailable to individual natural persons.
  • An individual investor can no longer purchase securities under this exemption, regardless of whether they have $150,000, $500,000, or $1,000,000 in cash. Individuals must qualify under the Accredited Investor or Offering Memorandum exemptions.
  • The Minimum Amount exemption can only be utilized by non-individual entities, such as corporations, partnerships, or trusts.
• Anti-Avoidance Rule: The entity utilizing the exemption must not have been created or used solely to purchase or hold securities in reliance on the $150,000 exemption. Retail investors cannot pool $15,000 each into a newly formed numbered company to cross the $150,000 threshold.

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4. The Offering Memorandum (OM) Exemption

The Offering Memorandum (OM) exemption (codified in Section 2.9 of NI 45-106) provides an essential bridge between private companies and non-accredited retail investors. It allows issuers to raise capital from the general public without a full prospectus, provided they deliver a structured disclosure document and enforce statutory retail investment caps.

Offering Memorandum (OM) Retail Investment Limits (per 12-Month Period):

[ Non-Eligible Investor ] -----------> Maximum \$10,000 aggregate investment
  - Net income <\$75k individual
  - Net assets <\$400k

[ Eligible Investor (Standard) ] ----> Maximum \$30,000 aggregate investment
  - Net income >\$75k individual / >\$125k joint, OR
  - Net assets >\$400k

[ Eligible Investor (Advised) ] -----> Maximum \$100,000 aggregate investment
  - Meets eligible investor criteria AND
  - Receives written suitability advice from an authorized
    Portfolio Manager, Investment Dealer, or EMD

The Offering Memorandum Document & Mandatory Disclosures

The issuer must prepare and deliver an official Offering Memorandum in the form prescribed by regulation (Form 45-106F2 for corporate issuers). The OM functions as a streamlined mini-prospectus, disclosing:

• The issuer's business model, corporate history, and operating plan
• Specific use of proceeds raised from the offering
• Comprehensive material risk factors
• Executive management biographies and compensation
• Audited annual financial statements prepared under IFRS or Canadian GAAP

Investor Rights and Protective Forms

1. Two-Day Right of Action for Cancellation (Withdrawal): An investor purchasing under the OM exemption has the statutory right to cancel the agreement to purchase securities by delivering notice to the issuer within two business days after signing the agreement or receiving the OM. All funds must be refunded immediately.
2. Right of Action for Rescission or Damages: If the OM contains a misrepresentation of a material fact, the purchaser has statutory rights of rescission or damages against the issuer and its directors, mirroring prospectus protections.
3. Form 45-106F4 Risk Acknowledgment: The investor must complete and sign Form 45-106F4, confirming they have read the OM, understand that the investment is illiquid, acknowledge that they could lose all money, and verify their net income/asset eligibility bracket.

Tiered Retail Investment Limits

To prevent retail investors from over-concentrating life savings into speculative private issues, NI 45-106 imposes caps (in Alberta, New Brunswick, Nova Scotia, Ontario, Prince Edward Island, Quebec and Saskatchewan, among others) on the maximum dollar amount an individual can invest across all OM distributions in any 12-month period. Other jurisdictions apply different conditions, so check the purchaser's province:

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5. Other Key Exemptions: FFBA & Crowdfunding (NI 45-110)

The Family, Friends, and Business Associates (FFBA) Exemption

Under Section 2.5 of NI 45-106, early-stage entrepreneurs can raise seed capital from their immediate network without filing a prospectus or offering memorandum. This exemption covers trades to:

• Directors, executive officers, control persons, or founders of the issuer
• Spouses, parents, grandparents, siblings, children, and grandchildren of those insiders
• Close personal friends: Defined in regulatory guidance as individuals who have known the insider for a prolonged period, characterized by frequent personal contact, mutual trust, and shared activities outside of commercial dealings. (A casual acquaintance, former colleague, or social media follower does not qualify).
• Close business associates: Individuals who have had direct, ongoing business dealings with the insider over a substantial period, enabling them to assess the insider's commercial integrity and capabilities.

Strict Ban on Commissions: No commission, finder's fee, or referral fee may be paid to any person in connection with a trade under the Family, Friends, and Business Associates exemption.

The Harmonized Start-Up Crowdfunding Exemption (National Instrument 45-110)

Adopted across Canada to modernize venture capital formation, NI 45-110 allows start-ups and early-stage growth companies to raise capital via regulated online funding portals.

• Issuer Financing Limits: An issuer group can raise up to a maximum of $1,500,000 in total capital within any rolling 12-month period (NI 45-110, in force since 2021).
• Retail Investor Caps: To protect retail investors, individual investment limits per crowdfunding distribution are capped at:
  • $2,500 per investment for an unadvised retail purchaser; or
  • $10,000 per investment if the investor receives a written determination from a registered investment dealer or portfolio manager confirming that the investment is suitable for the client.
• Portal Obligations & Withdrawal Rights: The funding portal must be registered with securities regulators, host the standardized offering document, and provide investors with an unconditional 48-hour right of withdrawal from the time of their subscription.

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6. Resale Rules & The Four-Month Hold Period (NI 45-102)

Securities issued under prospectus exemptions cannot be resold into the public secondary market immediately. If exempt buyers could sell their shares on an exchange the next day, issuers would simply use exempt private placements to bypass prospectus disclosures, undermining public market integrity.

Under National Instrument 45-102 Resale of Securities, securities acquired under a prospectus exemption are classified as restricted securities and are subject to statutory hold periods (seasoning periods):

Resale Restrictions under NI 45-102:

[ Private Placement Issued Under Exemption ]
                     |
        +------------+------------+
        |                         |
        v                         v
[ Reporting Issuer (Public Company) ]     [ Non-Reporting Issuer (Private Company) ]
  - Issuer public for >= 4 months           - Company remains private
  - Mandatory Restricted Hold Period:        - Indefinite restricted hold
    Four Months and One Day                  - Cannot trade on public exchange
  - Certificate bears restrictive legend     - Must find another statutory exemption
  - Freely tradeable after expiry              to resell (e.g., to another AI)

Reporting Issuers (The Four-Month Hold Period)

If the issuer is already a reporting issuer in Canada (i.e., a public company listed on the TSX, TSXV, or CSE) and has been a reporting issuer for at least four months:

• The private placement securities are subject to a mandatory hold period of four months and one day from the date the securities were distributed.
• During this seasoning period, the shares cannot be traded through any public stock exchange.
• Physical stock certificates or electronic book-entry positions must carry a formal restrictive legend stating the hold expiration date.
• Once the four months and one day elapse, the legend can be removed, and the shares can be sold freely in the public secondary market, provided the seller is not a control person.

Non-Reporting Issuers (Private Companies)

If the issuing company is not a reporting issuer (i.e., a private corporation):

• The securities are locked indefinitely and can never be traded on a public exchange until the issuer files a prospectus, completes a public listing, and satisfies the subsequent seasoning period.
• An investor wishing to liquidate their holding prior to an IPO can only resell the securities privately to another purchaser who independently qualifies under a statutory exemption (such as selling to another Accredited Investor).