Lucky Number 50: Losing “Private Issuer” StatusNovember 25th, 2016
The importance of deconstructing myths
Our Partner Adam Allouba helps you understand this complex issue.
Since the adoption of Regulation 45-106 respecting Prospectus Exemptions, commercial lawyers and sophisticated businesspeople have been mindful of a magic number: 50, being the maximum number of security holders that an entity can have before losing its “private issuer” status. While private issuer status is useful, that figure has been given a virtually talismanic importance that is largely unwarranted. The consequences of ceasing to be a private issuer are meaningful, but not debilitating. This article will debunk some of the common misperceptions that the author has encountered in his securities law practice.
Before busting any myths, it is important to note that the threshold of 50 security holders has some important caveats. First, the issuer’s employees and former employees are excluded from the count. Second, its holders of non-convertible debt securities (such as bonds or non-convertible debentures) are also omitted. Conversely, the number of security holders cannot be reduced through corporate entities created or used solely to buy or hold securities of the issuer. For example, if 10 people incorporate a company solely to pool their shares of the issuer, they still count as 10 separate shareholders for purposes of calculating the number of security holders.
The first myth – and the most pernicious – is that losing its private issuer status causes an entity to become a “reporting issuer” (commonly called a public company), thereby making it subject to the myriad continuous disclosure obligations and other requirements and restrictions applicable to such entities. In fact, the circumstances under which an entity becomes a reporting issuer are set out in each province’s securities legislation and include, for example, filing a final prospectus or completing certain transactions with existing reporting issuers. Reaching the 50 security holder threshold is insufficient, in itself, to create a reporting issuer.
A second myth is that a non-private issuer can issue securities only to accredited investors. In fact, “private issuer” and “accredited investor” are only two prospectus exemptions among many set out in NI 45 106 and elsewhere. Other exemptions that issuers commonly use include those for close personal friends, certain family members, close business associates, corporate entities investing at least $150,000 in cash, and employees or consultants of the issuer or its affiliates. Granted, there are some minor complications; for example, an issuer using the accredited investor exemption to issue securities to an individual must generally obtain a signed risk acknowledgement form that must be kept on file for eight years. In addition, a private issuer may issue securities to its current security holders, whereas no such exemption exists for non-private issuers (1). Finally, certain exemptions – including the accredited investor exemption – require the issuer to file a report of exempt distribution with the applicable securities commission, along with a fee that varies from province to province.
A third myth is that a non-private issuer must send an information circular to its shareholders in order to hold a meeting. In fact, no such requirement exists under Regulation 51 102 respecting Continuous Disclosure Obligations. Some corporate statutes, such as the Canada Business Corporations Act (the CBCA), do require entities incorporated under them to send an information circular when they have more than 50 security holders (in the case of the CBCA, employees and former employees are included in the count). So while reaching the threshold can trigger such an obligation, that is a question of corporate law and each issuer should review the statute under which it is constituted to determine the circumstances (if any) under which that act requires the use of an information circular.
While there are myths about non-private issuers that need debunking, there are also relatively obscure facts that must be brought to light. In particular, when an entity exceeds the 50-security holder threshold, it and its security holders lose access to the most commonly-used exemption from the take-over and issuer bid rules. Generally speaking, a take-over bid is any acquisition of an issuer’s voting securities following which the acquirer will hold 20% or more of the issuer’s voting rights, while an issuer bid is any redemption by an issuer of its own securities. In both cases, unless an exemption is available the acquirer or issuer must comply with a lengthy and complex procedure that involves sending a circular to each security holder of the issuer, thereby making the offer to purchase or redeem securities to each of them. While Regulation 62-104 respecting Take-Over Bids and Issuer Bids does not provide an exemption specifically for private issuers, it does generally exempt most issuers with 50 or fewer security holders (not including employees and former employees). As a result, once that threshold is exceeded any such transaction must either qualify for another exemption or comply with the requirements of the take-over or issuer bid regime, as applicable.
While it is important to know what restrictions the law imposes on your business, it is no less crucial to set aside misperceptions that may dissuade you from pursuing your objectives. Fear of the 50 security holder threshold should not prevent you from implementing your business plans.
For comprehensive and practical advice on securities laws matters, contact our securities partner, Adam Allouba, at email@example.com or 514-397-6918.
- There is another exemption under which issuers listed on certain stock exchanges may issue securities to their existing security holders.