This resource has been prepared for educational purposes only. This information is current as of the date of writing and does not constitute legal, investment or other professional advice, which should be obtained prior to relying on anything herein.
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In Ontario, securities laws protect investors by requiring companies to file a prospectus—a detailed document outlining an investment’s risks and benefits—when offering securities to the public. However, certain investors meet financial or professional criteria that qualify them as accredited investors. These individuals and entities are permitted to invest in private markets without the need for the protections of a prospectus. This is known as the Accredited Investor Exemption, which plays a significant role in Ontario’s capital markets. In this post, we’ll dive into the accredited investor exemption, the qualifications for accredited investors, and what this means for both investors and issuers.
1. What is the Accredited Investor Exemption?
The Accredited Investor Exemption, as outlined in National Instrument 45-106, allows companies to issue securities to accredited investors without filing a prospectus. This exemption is based on the premise that accredited investors are financially sophisticated and capable of understanding the risks involved in private investments.
Private companies can use this exemption to raise capital more quickly and cost-effectively than through public offerings, making it an essential tool for startups, venture capital, private equity, and other sectors looking to attract substantial investments from a smaller pool of qualified investors.
2. Why the Accredited Investor Exemption Exists
The Accredited Investor Exemption is designed to:
A. Streamline Capital Raising
The exemption allows companies to raise funds without the high costs and regulatory hurdles associated with a full prospectus, supporting the growth of small and mid-sized companies.
B. Recognize Investor Sophistication
Accredited investors are considered to have the financial acumen and resources to assess risks and invest responsibly without needing the protections afforded to retail investors in public markets.
C. Promote Innovation and Economic Growth
By making it easier for private companies to raise funds, the exemption helps drive innovation, job creation, and economic development in Ontario and across Canada.
3. Who Qualifies as an Accredited Investor in Ontario?
To qualify as an accredited investor, individuals and entities must meet specific financial thresholds, which indicate that they can bear the risks associated with private investments. Here are the main categories:
A. Individuals Based on Income
An individual qualifies as an accredited investor if they have a net income of $200,000 or more in each of the past two years (or $300,000 when combined with a spouse) and expect to maintain this income level going forward.
B. Individuals Based on Financial Assets
An individual qualifies if they hold financial assets (such as cash, stocks, bonds, or mutual funds) exceeding $1 million, excluding the value of their primary residence.
C. Individuals Based on Net Worth
An individual can also qualify based on net worth, which must be at least $5 million in total assets, including real estate holdings.
D. Entities as Accredited Investors
• Corporations, partnerships, trusts, and other entities can qualify if they have net assets exceeding $5 million.
• Certain financial institutions, such as banks, credit unions, and insurance companies, automatically qualify as accredited investors.
• Family trusts and other types of trust arrangements may qualify if all beneficiaries meet accredited investor criteria.
E. Professional Advisors
Individuals licensed to provide investment advice, such as portfolio managers and securities dealers, are also accredited based on their professional credentials and industry experience.
4. Benefits of the Accredited Investor Exemption for Issuers
For companies looking to raise capital, the accredited investor exemption offers several advantages:
A. Reduced Costs and Complexity
Unlike a public offering, which requires a prospectus and a lengthy approval process, the accredited investor exemption allows companies to raise funds with minimal regulatory requirements, reducing costs and accelerating the timeline.
B. Access to High-Capacity Investors
Accredited investors often have the financial means to make substantial investments, allowing companies to meet capital-raising targets without needing a large number of investors.
C. Flexibility and Control
The accredited investor exemption provides companies with greater flexibility to raise capital on their own terms, setting the conditions, duration, and structure of their private offering.
5. Benefits and Risks for Accredited Investors
For accredited investors, the exemption opens up a wide range of opportunities beyond traditional public markets, but it also carries unique risks. Here’s a look at the benefits and risks:
Benefits
A. Access to Private Market Opportunities
Accredited investors can participate in private investments, including venture capital, private equity, real estate development projects, and hedge funds, which are often restricted to public investors.
B. Potential for High Returns
Private market investments can deliver higher returns than public markets, particularly when investing in early-stage companies with high growth potential. Accredited investors can access promising startups and exclusive investment opportunities.
C. Portfolio Diversification
The ability to invest in private markets allows accredited investors to diversify their portfolios across asset classes beyond traditional stocks and bonds, potentially reducing overall portfolio risk.
Risks
A. Higher Risk of Loss
Private investments, especially in early-stage companies, are inherently riskier than publicly traded securities. Accredited investors face a higher risk of loss, including the possibility of losing their entire investment.
B. Illiquidity
Many private investments are illiquid, meaning they cannot be easily sold or exchanged. Accredited investors should be prepared to hold their investments for an extended period, often five years or more, until a liquidity event occurs, such as a buyout or IPO.
C. Limited Disclosure
Unlike public companies, private issuers are not required to disclose detailed financial and operational information. Accredited investors must perform due diligence and may have limited information on which to base their investment decisions.
6. Exemptions and Compliance Requirements for Companies Using the Accredited Investor Exemption
While the accredited investor exemption simplifies the capital-raising process, companies must still meet certain compliance requirements:
A. Offering Documents:
Companies generally provide an offering memorandum or similar disclosure document to inform accredited investors about the investment’s risks, terms, and potential returns. Although not as detailed as a prospectus, this document includes key information that investors need to make informed decisions.
B. Verification of Accredited Investor Status
Companies must verify each investor’s eligibility as an accredited investor. This can be done through self-certification or by requesting documentation such as income statements, tax returns, or financial asset records.
C. Resale Restrictions
Securities sold under the accredited investor exemption are subject to resale restrictions, meaning investors cannot easily sell them on secondary markets. These restrictions are in place to protect the issuer from unqualified investors who may not fully understand the risks.
D. Reporting Obligations
Companies may be required to file a report of exempt distribution with the OSC to disclose details about the offering, including the total funds raised and the number of accredited investors.
7. The Role of Accredited Investors in Ontario’s Capital Market
The Accredited Investor Exemption plays an essential role in Ontario’s financial ecosystem by providing capital for high-growth businesses while offering sophisticated investors access to exclusive opportunities. This exemption fuels innovation, job creation, and economic growth, enabling startups and expanding businesses to thrive.
For investors, however, the accredited investor exemption carries responsibilities. Accredited investors must be prepared to take on higher risk, perform thorough due diligence, and work with financial professionals to evaluate the suitability of private investments in their portfolios.
8. Conclusion: Is the Accredited Investor Exemption Right for You?
For companies, the Accredited Investor Exemption offers a practical and efficient way to raise capital while avoiding the costs and complexities of a public offering. This exemption is particularly valuable for early-stage companies, real estate ventures, and private equity funds that rely on private funding.
For investors, qualifying as an accredited investor provides access to high-potential private investments, but it also requires careful consideration of the risks involved. Accredited investors should be prepared for illiquidity, higher risks, and less transparency compared to public market investments. As always, consulting with financial and legal professionals can help both issuers and investors make the most of the Accredited Investor Exemption.
In Ontario’s fast-evolving investment landscape, the accredited investor exemption continues to serve as a vital bridge between private companies and high-capacity investors, driving growth, innovation, and diverse investment opportunities.