Heads up Startups - New CSA regulations may affect your ability to raise capital

By Ross Finlay

Imagine a new restaurant is opening in town.  You go there to try it out and at the reception desk they ask to see your net worth statement to make sure you can afford to eat there.  What would be your reaction?  How long do you think that restaurant will stay in business?

This is similar to what the Canadian Securities Administrators (CSA) is requiring early stage companies looking for angel investment to do effective May 5 this year.  From then on, entrepreneurs will have the new obligation to verify a prospective investor’s ability to invest using the minimum net worth criteria of the accredited investor exemption. 

The changes being made by the CSA appear to indicate that the issuer must collect personal information from the prospective investor to independently verify that the prospective angel investor meets the qualification criteria. Exactly what that “personal information” consists of is left unclear. 

Specifically, the language states that:

“When distributing securities under these exemptions [being the accredited investor exemption], the seller will have to obtain information from the purchaser in order to determine whether the purchaser has the requisite income, assets or relationship to meet the terms of the exemption.

It will not be sufficient for the seller to accept standard representations in a subscription agreement or an initial beside a category on Form 45-106F9 Form for Individual Accredited Investors unless the seller has taken reasonable steps to verify the representations made by the purchaser.”

Also, the entrepreneur will need to obtain and retain for at least 8 years personal financial information of the prospective investor.  As well, during that time the issuer must comply with applicable federal and/or provincial privacy laws pertaining to the collection and retention of such personal information.

This has the potential to put a big chill on angel investing in Canada.  This will inhibit an entrepreneur’s ability to raise the capital they need to create successful companies.  This rule change doesn’t impose any hardship on angel investors, as the reality is that they don’t have to invest in anything.

In issuing this new rule one would think there is an angel compliance issue with the accredited investor status.  How big is that issue?  Is it worth risking the chill on angel investing by implementing a verification process that could be costly, complex, time‐consuming, and/or a violation of investor privacy?

Entrepreneurs and the organizations that support entrepreneurship in Canada need to mount an effort to have this change either reversed or modified to create a solution acceptable to issuers and investors that doesn’t impede early stage company development.