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Exempt market investing: Understanding the basics

Investing successfully requires being informed and taking the time to research and review investment opportunities before jumping in. Analyzing financial reports and disclosure documentation for a publicly traded company or issuer are critical tools in helping you understand if the investment is right for you. Examples of documents available from all publicly traded companies include: prospectuses, annual financial statements and management discussion and analysis. These documents include detailed information for investors considering making an investment in an issuer’s business. When investing in the exempt market you may not have access to these types of documents.

 

Outside of the public markets, private and public companies can also use the exempt market to raise money from investors. Acquiring securities in the exempt market is different from acquiring securities through a public offering. Companies that raise money through the exempt market do so under exemptions from the requirement under securities law to file a prospectus when issuing securities. The exempt market is an important source of funding for Alberta companies and entrepreneurs, it also offers unique investment opportunities for investors who meet the exempt market requirements.

Why do exempt markets exist?

Access to investment capital is vitally important for Alberta companies, but preparing a prospectus for investors and having it reviewed by securities regulators can be a costly and time-consuming process particularly for early-stage companies. Where there are alternative ways of protecting investors, the exempt market allows companies to forego the prospectus requirement and allows them to raise capital quicker and more cost-effectively. The trade-off for companies is that they must meet stricter guidelines as to who can invest. In most provinces and territories, exemptions are available to an issuer for distributing securities:

  • To an investor that is a financial institution or an individual whose net financial assets or net income allows them to qualify as an accredited investor
  • In Alberta and Saskatchewan, to a person or company that certifies they are a self-certified investor
  • To an investor who is not an individual and who purchases, as principal, at least $150,000 of the securities being offered
  • To employees or existing security holders
  • To the general public where a specified offering memorandum or other offering document is provided to investors outlining the company’s management, business and associated risks and often subject to investment limits, which will typically vary depending on the level of disclosure e.g., financial statements, required in the offering document.
  • To directors, executive officers, control persons and close personal friends, family members or business associates of the company’s directors, executive officers and control persons

Do you qualify to purchase exempt market securities and are they suitable for you?

In determining whether you qualify to invest in the exempt market, the company issuing securities is responsible for ensuring that its investors qualify for the applicable exemptions being relied on. If the company has not provided you with an offering memorandum, or you are not an accredited investor, a member of the company’s management team, an employee, or a close personal friend, family member or business associate of the company’s directors and officers, chances are the issuer can not legally sell its securities to you without a prospectus.

If you qualify, ensure that you take the time to understand why the investment is being offered to you and do not feel pressured to invest. Some issuers may pay agents commissions to find more investors for exempt offerings. It is also essential to understand how and if you will receive information about the investment. Depending on the exemption used, you may be entitled to an offering memorandum containing information on the business and the investment. If an offering memorandum isn’t required, the issuer may choose to provide very little information. You also need to be aware that exempt securities in private companies are hard to transfer and you may not be able to sell your securities for a very long time, if at all.

If the issuer selling securities in the exempt market is a reporting issuer (public company) you can look at the continuous disclosure information they are legally required to publicly disclose, both before investing and after, to monitor your investment. By law, they must publish financial information quarterly and news releases whenever there are material changes in their affairs. You can usually get access to this information from the issuer’s website, your financial adviser if you have one, and internet sources, including www.sedar.com. If the issuer is not a reporting issuer, then the company likely has no obligation to provide you with the same level of reporting and may not be required to provide any ongoing information.

Risks of investing in exempt markets

For those who qualify, investing in exempt markets may meet your desired investment goals, but these opportunities pose significant risks, including:

Lack of information: Even with an offering memorandum, companies offering exempt market securities are not required to provide the same amount of information as a public company. You may not have sufficient information to make an informed investment decision.

Investment loss: Many early-stage companies raise money in the exempt market. If you are investing in an early-stage company or business that is not yet profitable there is a high risk that you could lose a significant amount, if not all of your investment.

Liquidity risk: There is the possibility that you may not be able to resell exempt market securities when you need or want to. Since exempt securities are usually not publicly traded, you might not be able to find a buyer for your investment.  Even if you can find a potential buyer, there are significant resale restrictions that may make it impossible to sell to them.

Risk of investment fraud: Fraudulent individuals or firms may insist that they do not need to be registered to sell exempt market investments. However, a firm in the business of trading in securities for issuers that rely on an exemption from the prospectus requirement must be registered as a securities dealer e.g., an exempt market dealer, unless there is an available exemption. An individual who is selling securities on behalf of an exempt market dealer firm must be registered as a “dealing representative.”  If you are buying exempt market securities from a financial intermediary, please be sure to check their registration status at www.checkfirst.ca as well as exemption orders on the Alberta Securities Commission’s website.

Knowledge is power

The exempt market may offer worthwhile investments for investors, but like any security, it should be researched before you chose to get involved and can introduce additional risks. If you have been offered an exempt market security, remember to check if you qualify for purchasing the security and the registration of the individual or firm offering it to you. Once you can verify these details, ensure you understand how information will be provided to you and if your comfortable with the fundamentals of the business and the underlying risks associated with this type of security.