While nattering with one of our clients I was discussing the merits of employing an offering memorandum over a term sheet. The client asked, “What’s an ‘offering memorandum’?” to which I moronically responded “Anything more than a term sheet!” (See an earlier discussion with a client about Term Sheets here: [•].)
Some Background – How Canadians raise money for investment – A brief History!
In Canada the issuer (the party asking for the money) only has two ways of raising capital: publicly or privately. When we raise money publicly, a prospectus is employed; when we raise money privately, a term sheet or offering memorandum is often used. In both cases, the purpose of the document is for the issuer to inform a prospective investor about its history and credentials, what’s being offered, and on what terms. These documents simply tell a story.
If a prospective investor elects to buy what is being described in the offering documents, they will complete and deliver to the issuer (or its agent) a “subscription agreement” whereunder they will subscribe or buy the investment being offered. The subscription agreement is a contract between the prospective investor and the issuer. Once the subscription agreement is accepted by the issuer, the issuer is obligated to sell and the prospective subscriber is obligated to purchase the securities described in the offering documents.
Where only a term sheet is used, the subscription agreement and the term sheet will typically be bound together in one document.
How we tell our story – Part I: The Prospectus Requirement
If you elect to raise money from the public, then you have to use a “prospectus”. A prospectus (“forward look” – from the latin verb prospicere, from pro- ‘forward’ + specere ‘to look’) is a highly detailed document that is prepared by an issuer together with its lawyers and auditors under complicated rules that govern our public capital markets. A prospectus tells the story of the issuer and why buying the securities of the issuer is a good investment. The document is first filed with the regulatory authorities who will actually review the preliminary drafts to ensure that the document complies with what is required by the legislation. The regulators do not assess the worthiness of the investment; they simply assess whether the document provides the disclosure required by law. This document is generally the only document an issuer can use to solicit the public. There are severe financial and criminal penalties if an issuer fails to use a prospectus to solicit the public or uses it improperly.
For a new issuer a prospectus can be hundreds of pages and cost in excess of a million dollars taking into account such things as legal, auditing and printing expenses. It is very very expensive to raise money under a prospectus. The advantage though is that anyone can purchase securities that are qualified for distribution under a prospectus.
How we tell our stories – Part II – The Term Sheet and Offering Memorandum Option
Instead of raising money from the public, an issuer may raise money privately in the “exempt market”. This is in fact the most common route issuers take for their capital raising activities. Raising money from the private capital market is also governed by extensive legislation. What makes it easier is that a prospectus is not required! Therefore the cost saving is tremendous. The drawback is that an issuer is only permitted to solicit certain groups of investors who the regulators believe do not need the disclosures and regulatory imprimatur provided by a prospectus.
The “exempt market” describes a section of Canada’s capital markets where securities can be sold without the protections associated with a prospectus. Examples of activity in the exempt market include:
- Canadian and foreign companies, both public and private, selling securities to institutional investors and qualified investors
- Canadian and foreign hedge funds and pooled funds selling securities to institutional investors and qualified investors
These prospectus exemptions can help a company raise money without the time and expense of preparing a prospectus.
Investors who buy securities through prospectus exemptions generally do not have the benefit of ongoing information about the security that they are buying or the company selling it. As well, they often do not have the ability to easily resell the security. There is a presumption that given the wealth or expertise of the investor or the quality of the security for which is being subscribed the extensive protections provided by the prospectus requirements are not necessary.
The most common document used by issuers in the exempt market is a “term sheet”. A term sheet is an abbreviated soliciting document that carries significantly less regulatory burden than an offering memorandum. A term sheet is a bare-bones, skeletal overview of a securities offering where only the terms of purchase and sale and a summary description of the offering are provided. By regulation, a term sheet can have no more than three lines of text to describe the business of the issuer!
The Non-Prescribed Offering Memorandum
Three lines are hardly enough for every issuer. As a result, the “offering memorandum” was born!
So, what is an offering memorandum? Glibly as we said above an offering memorandum is anything more than a Term Sheet. S.1(1) of the Securities Act (Ontario) (the “OSA”) (and repeated at OSC Rule 14-501) defines an offering memorandum as “a document purporting to describe the business and affairs of an issuer that has been prepared primarily for delivery to and review by a prospective purchaser so as to assist the prospective purchaser to make an investment decision for a security being sold in a distribution to which [the prospectus requirements] of the Securities Act would apply but for the availability of one or more of the exemptions contained in Ontario securities law but does not include a document setting out current information about an issuer for the benefit of a prospective purchaser familiar with the issuer through prior investment or business contacts.”
Offering memorandums (“memoranda” is often used as the plural form, but “memorandums” is now common usage) come in two forms: prescribed and not prescribed. “Prescribed” simply means the offering memorandum is in a form prescribed by law. An offering memorandum that is not in a prescribed format is anything else: a summary of an offering beyond a term sheet, a powerpoint presentation,an “executive overview”, a confidential information memorandum (often called a “CIM”), an “information packet” and/or any pile of paper compiled and put in front of a prospective purchaser for the purpose of soliciting their interest in purchasing securities.
Abusive practice quickly emerged as many offering memorandums were littered with misstatements, misrepresentations, material omission, fabrication and out-and-out falsehoods and deceptions! The regulators quickly stepped in with relatively novel solutions.
Emergence of the Contractual Rights of Action and Rescission
Instead of mandating the contents of offering memorandums, the regulators put the onus on issuers to insure the information they put before investors was accurate by giving them the right to sue an issuer or cancel their subscription in the issuer’s security if a misrepresentation was found in the offering documents.
Under the law of the Provinces and Territories wherever an offering memorandum is used the issuer MUST (except in very limited circumstances) provide to potential purchasers various contractual rights of action and rescission for any misrepresentation. The actual granting of the right will often be found in the subscription agreement (the agreement by which one purchases the relevant securities).
The requirement to provide these contractual rights of action and rescission (and to mandate their disclosure in offering documents) was an enormous advance for investor protection. Briefly, what these rights provide is the right to (i) sue an issuer or (ii) rescind the contract if a misrepresentation had been made in the offering document WITHOUT having to demonstrate reliance on the misrepresentation!
In the 1980s, this was groundbreaking. Having to demonstrate reliance on the misrepresentation was a cost consuming uncertain exercise that discouraged many abused investors from seeking redress. By removing the requirement to demonstrate reliance for a damages award, investors were newly armed against unscrupulous promoters and issuers. The enactment of contractual rights was aimed directly at the increased prevalence of poor, incomplete, inaccurate, false, misleading and downright false information that would sometimes be circulated to investors in the exempt market. Mining, oil & gas, scientific research and tax-orientated offerings are some industry examples where disclosure problems were sometimes encountered. These contractual rights provided investors serious remedial rights that they hadn’t had before. And the regulators took it a step further: they required that there be a full description of the grant of the contractual rights in any offering document promoted by issuers or their agents.
An offering memorandum is supposed to provide “prospectus like disclosure”. The standard for disclosure in a prospectus is “full, true and plain disclosure of all material facts relating to the securities issued or proposed” (s.56(1) OSA). This often results in many prospectuses being hundreds of pages long and nearly indecipherable. For offering memorandums, the rule of thumb when the document is not required to be in a prescribed form, is to provide that information an ordinary subscriber of exempt market security would expect upon which a reasonable decision can be made. At the heart of disclosure, it must not contain (i) a misrepresentation or (ii) an omission that would be tantamount to a misrepresentation.
The Evolution of the Prescribed Offering Memorandum
As the use of offering memorandums grew in popularity, the regulators, first in British Columbia and Alberta, began to impose content requirements for what they expected to see in offering memorandums. With the development of prescribed forms of offering memorandums they created further exemptions from the prospectus requirement where their form of offering memorandum was employed. Soon Saskatchewan and Manitoba followed suit, amending their respective securities laws to incorporate similar form requirements where issuers wanted to raise money under their respective “OM exemptions” to the prospectus requirements. Now, throughout the Western provinces anyone can purchase exempt market securities if an offering memorandum in the required form is prepared and delivered to the prospective investor.
A “National” OM Exemption
Ontario was slow to follow suit. It was only after the adoption of National Instrument 45-106 that in April 2016 Ontario formally adopted the offering memorandum exemption set out under 2.9 of the Instrument (the “OM Exemption”). As implied by its title, the “National Instrument” is adopted by all of the Provinces and Territories. The National Instrument program is an undertaking by our provincial and territorial securities administrators to facilitate the offering of securities across Canada under one common regulatory umbrella. Under our Canadian constitution the purchase and sale of “securities” is a matter that is governed by provincial law – the National Instruments are designed to coordinate the differing Provincial legislative regimes to facilitate the sale of securities across the Country. Befitting our regional differences, Ontario, together with a handful of other provinces, imported its own quirks into the national instrument.
A “National” OM Exemption
The OM Exemption under the National Instrument effectively democratised the exempt market. Prior to it, the exempt market was essentially reserved for high net worth persons, their families, friends and business associates. If you were not wealthy or connected, you were excluded.
The OM exemption created two new classes: eligible investors and non-eligible investors.
An “eligible investor” (for the sake of brevity) is an individual who makes $75,000 (or together with a spouse makes $125,000) in each of the last two calendar years and expects to make the same in the current year or who has $400,000 of net assets.
A “non-eligible” investor is a person who does not meet this minimum requirement.
An eligible investor can invest up to $30,000 in any one calendar year and, if a securities dealer has determined it is suitable for the eligible investor, the eligible investor may invest up to $100,000 in any calendar year.
A non-eligible investor who is an individual person may only invest up to $10,000 in any calendar year.
The OM Exemption requires a precise form of offering document be employed. The regulation requires that audited statements be provided by the issuer and mandates a continuous disclosure regime. And, as with any other offering documents other than a Term Sheet, there must be the provision of the required contractual rights of action together with a description thereof in the offering memorandum itself. Investors also have the right to cancel their subscription under the OM Exemption by simply giving notice within two days of signing the agreement to purchase the offered securities.
So, in summary, there are several differences among a Term Sheet, an offering memorandum and an offering memorandum used under the OM Exemption. The table below summarizes the major differences.
|Term Sheet||Offering Memorandum outside the OM Exemption||Offering Memorandum inside the OM Exemption|
|Contractual Right of Action|
|Contractual Right of Rescission|
|Two Day Cooling Off|
|Available to Eligible Investors|
|Available to Ineligible Investors|
|Audited Financial Statements|
|Continuous Disclosure Obligations|
Investor Investment Limits (cap based upon what type of investor you
ineligible investors: 10,000 / year
eligible investors: 30,000 –
accredited investors: No investment cap
Family, Friends and Associates of the Issuer: No investment Cap
The Exempt Market Dealer
People that sell securities in the exempt market typically need to be registered with the regulatory authorities. An “Exempt Market Dealer” (“EMD”) is a firm that has been licensed to distribute investment securities that haven’t been qualified by a prospectus, but are exempt from the prospectus requirement based on the rules and regulations of each province where the EMD is registered to carry on business.
Fundscraper Capital Inc.
Fundscraper is an Exempt Market Dealer registered to sell securities in the Provinces of Ontario, our Principal Jurisdiction, British Columbia, Alberta, Quebec and Prince Edward Island.
Fundscraper has employed the rules of the exempt market to facilitate investment in the private real estate market. Our offerings are unique to Canada – Fundscraper is the only online investment platform today where anybody can learn about, become qualified to invest in and actually subscribe for in a secure and transparent environment private real estate investment opportunities that have been vetted for consideration.
Fundscraper brings all of this together under one umbrella in The Fundscraper Property Trust to be introduced in September 2020.