Venture capital

How BC law treats it

In British Columbia, a company that issues shares to investors is making a distribution of securities. Under the Securities Act, RSBC 1996, c 418, s. 61, a distribution needs a prospectus unless an exemption applies. Startups almost always rely on exemptions in National Instrument 45-106 Prospectus Exemptions, most often the accredited investor exemption (s. 2.3). The issuer does not register with the BC Securities Commission. It files a report of exempt distribution (Form 45-106F1) for exemptions that require one, generally within 10 days after the distribution. The company's side of the deal runs through the Business Corporations Act, SBC 2002, c 57 (BCBCA). Investors usually take a new class or series of preferred shares, so the company must create that class and set its special rights and restrictions in the articles, often by special resolution and an alteration to the notice of articles. Typical preferred share rights include a liquidation preference, conversion into common shares, anti-dilution protection and protective provisions (veto rights over key decisions). Venture funds themselves raise money from their own investors under prospectus exemptions. A fund manager may need registration with the BC Securities Commission as an adviser, exempt market dealer or investment fund manager depending on what it does, but there is no general rule that every VC fund registers. Separately, the Small Business Venture Capital Act, RSBC 1996, c 429 supports BC tax credit programs for investments in registered venture capital corporations and eligible business corporations. A typical round moves from a non-binding term sheet to definitive documents: a subscription or share purchase agreement, amended articles, and an investors' or shareholders agreement covering board seats, information rights, rights of first refusal, drag-along and tag-along rights.

What it means for your business

Venture capital can fund growth that a bank will not, but it changes who controls the company. Preferred share rights, board seats and veto rights can limit a founder's freedom to sell, borrow or hire. A liquidation preference can mean investors are paid first on an exit, leaving little for common shareholders in a modest sale. Missing a prospectus exemption or a report of exempt distribution can give investors rescission rights and attract regulatory attention. Clean corporate records and a sensible cap table make due diligence faster and cheaper. Example: A Vancouver software company issues Series A preferred shares to two accredited investor funds, relying on NI 45-106 s. 2.3. It amends its articles to create the new class, signs an investors' rights agreement giving the lead fund a board seat, and files Form 45-106F1 with the BC Securities Commission within 10 days.

Risks and common mistakes

Assuming the startup must register with the BC Securities Commission or file a prospectus, instead of relying on a prospectus exemption. Issuing preferred shares before the articles have been altered to create the class and its special rights and restrictions. Treating the term sheet as non-binding in every respect, when confidentiality and exclusivity clauses are usually binding. Ignoring how a participating liquidation preference reduces the founders' payout in a sale. Failing to file the report of exempt distribution on time or to confirm each investor actually qualifies for the exemption claimed.