Spotlight On: The Impact of Having 50 Shareholders

For many companies, bringing on new shareholders is an exciting occasion. Once a corporation accumulates a certain amount of stakeholders, however, new rules and requirements will apply.

All companies are subject to different prospectus exemptions and reporting obligations under Canadian securities laws upon accumulating 50 securityholders (including holders of shares, warrants, options, convertible notes, and other securities, but generally not including current or former employees of the issuer or its affiliates).

In addition, federally incorporated companies (including privately held companies) with more than 50 holders of voting shares must solicit proxies and prepare information circulars for each shareholder meeting.

Here’s what to consider if your company is approaching this threshold, and how your obligations change once you cross it.

Counting to 50

This threshold is calculated in different ways depending on the area of law involved.

For purposes of securities laws

Exempt trade reporting

Here is how to calculate whether you have crossed the key 50-securityholder threshold for the purposes of exempt trade reporting under securities laws (discussed in more detail below):

• (a) First, add up all of the different persons (including individuals, companies, and other entities) which beneficially own any securities of the company. Include shareholders as well as optionholders, warrantholders, convertible debt holders, and holders of any other outstanding securities.
• (b) If any non-individual securityholder (such as a company, partnership, or trust) was created or used solely to purchase or hold securities of your company, count each beneficial owner of that securityholder as an additional beneficial owner of your company.
• (c) Then, subtract employees and former employees of the company and its affiliates from the number above.

Regarding (b) above, many subscription documents include a representation that the subscriber, if not an individual, was not created or used solely to purchase or hold securities of the issuer. Consider reviewing your investment documentation, and the other information you know about your investors, to help confirm whether you may need to add any beneficial owners to your total under (b).

The sum of the above steps is your number of beneficial owners of securities for purposes of exempt trade reporting.

Issuer bids

Another area of securities law that is concerned with an issuer’s securityholder count is the rules around issuer bids.

An issuer bid is an offer by a company to acquire or redeem any of its outstanding securities, a solicitation or acceptance of an offer to sell securities, or any combination of the foregoing.

An issuer bid does not include an acquisition or redemption (or an offer in relation thereto) (i) where no valuable consideration is offered or paid by the issuer; (ii) where the securities are non-convertible debt securities; or (iii) which is a step in an amalgamation, merger, reorganization, or arrangement which requires securityholder approval.

Issuer bids can be used for purposes such as redistributing cash to securityholders, or reducing an issuer’s outstanding share count. An issuer bid is subject to a number of technical requirements under securities laws set out primarily in Part 2 of National Instrument 62-104 – Take-Over Bids and Issuer Bids (“NI 62-104”), and Multilateral Instrument 61-101 – Protection of Minority Shareholders in Special Transactions (“MI 61-101”). These may include, among other things:

• a requirement that an issuer bid circular (in the prescribed form and as approved by the board) be prepared and mailed to all security holders of, and holders of securities convertible into, the class of securities subject to the bid; and
• a formal valuation of the securities that are subject to the bid, particularly if there is no published or liquid market for such class of securities (which could be the case if the company is privately held).

An exemption from Part 2 of NI 62-104 may be available for an issuer bid where an issuer is not a reporting issuer, there is no published market for the securities that are the subject of the bid, and the number of security holders of that class of securities at the commencement of the bid is not more than 50, exclusive of: (i) holders employed by the issuer or its affiliate, and (ii) holders who were formerly employed by the issuer or its affiliate and who were securityholders at that time and have continued to be securityholders of the issuer.

Although the above is similar to the counting method for exempt trade reporting, NI 62-104 specifically requires that to be exempted, a former employee must have been a securityholder during their employment.

For purposes of federal corporate law

The key threshold for a federal corporation, incorporated under the Canada Business Corporations Act (the “CBCA”), is 50 shareholders entitled to vote at a meeting, with two or more joint holders being counted as one shareholder. There is no exemption for current or former employees.

Approach the threshold with caution

Keep in mind that the 50-securityholder or 50-shareholder threshold can be crossed even if your company has not issued securities to 50 different investors. Investors may transfer securities to third parties, or securities may be transferred to multiple beneficiaries where an individual passes away, for example, spreading the existing shares among additional beneficial owners. There could also be claims from third parties that they are entitled to securities that were not properly documented at the time.

As such, companies approaching these key thresholds should be especially alert to any circumstances which could result in additional beneficial owners of their shares. You may, for example, consider starting to file Form 45-106F1 reports and taking other compliance steps in advance of crossing the threshold to be on the safe side. More on those below.

Early-Stage Capital Raising: The Private Issuer Exemption

Frequently, a business raises its first dollars from its founders and their friends, family, and business associates. Securities laws require that a company issue a prospectus whenever it issues securities from its treasury, but exemptions to the prospectus requirement may be available.

One such exemption is the “private issuer” exemption, which provides that a prospectus is not required for a company which qualifies as a “private issuer” by meeting the following criteria:

• its securities (other than non-convertible debt securities) are subject to restrictions on transfer (contained either in its constating documents or in security holders’ agreements),
• its securities are beneficially owned by not more than 50 persons, not including employees and former employees of the issuer or its affiliates (provided that each person is counted as one beneficial owner unless the person is created or used solely to purchase or hold securities of the issuer, in which case each beneficial owner or each beneficiary of the person, as the case may be, must be counted as a separate beneficial owner), and
• it has distributed its securities only to a select list of persons, including:
  • directors, officers, control persons, and founders of the issuer, and certain specific members of their families;
  • employees of the issuer;
  • existing securityholders of the issuer;
  • “accredited investors”; and
  • “close personal friends” and “close business associates” (each term carries specific requirements) of directors, executive officers, control persons, and founders.

Certain other requirements apply to rely on the private issuer exemption, including that no finder’s fee can be paid to a director, officer, founder, or control person of an issuer in connection with a distribution under the exemption.

The Consequences of Crossing the 50 Securityholder Threshold

Different Prospectus Exemptions

Once an issuer’s securities are held by more than 50 beneficial owners, the issuer will no longer qualify as a “private issuer” and so it will not be able to rely on the “private issuer” prospectus exemption. Other prospectus exemptions may be available instead. These include the “accredited investor” exemption, the “friends, family, and business associates” exemption, and the “director, officer, employee, and consultant” exemption, both found in in National Instrument 45-106 – Prospectus Exemptions (“NI 45-106”).

However, the category of “existing securityholders of the issuer” ceases to be available after the 50-securityholder threshold is crossed, because it is not included under any prospectus exemption other than the private issuer exemption. This means that after your company crosses the threshold, it will no longer be enough for a potential investor to already hold securities of the company in order to make a further investment into the business. The investor will need to qualify under a different exemption – for example, as an accredited investor – in order to purchase additional securities of the company.

Exempt Trade Reporting: Filing Form 45-106F1

Certain of the prospectus exemptions that remain available after crossing the threshold, including the “accredited investor” exemption and the “friends, family and business associates” exemption, require the issuer to make a filing within 10 days after any distribution of securities (including shares, warrants, options, convertible debentures, and other securities) pursuant to the exemption.

These filings, sometimes known as “exempt trade reports”, are in a prescribed form, typically Form 45-106F1 (where the issuer relies on an exemption in NI 45-106) or Form 72-501F (where the issuer relies on an exemption in OSC Rule 72-503 – Distributions Outside Canada). Within 10 days of the distribution of securities, a Form 45-106F1 or Form 72-501F must be filed on SEDAR+ and/or with certain securities commissions, depending on various factors, including where the company and the investors participating in the financing are located. A filing fee typically applies, which varies by jurisdiction.

The 10-day deadline to file exempt trade reports is strict. In Ontario, for example, a late Form 45-106F1 is currently subject to late fees of $100 per business day, up to a maximum of $5,000 for all reports required to be filed by the company in the calendar year.

A single Form 45-106F1 can capture all distributions of securities made within the 10 consecutive days before it is filed. In light of that fact, and in order to generally streamline their filing obligations, issuers may consider closing on various subscriptions for securities all at once, or within a few days’ time, and then submitting a single Form 45-106F1 report for all of the distributions.

The form requirement for an exempt trade report is made up of several parts, including an overview of information about the issuer, the amounts raised and exemptions relied upon, and certain materials used in the offering of securities. It also includes several schedules: one which sets out the names, addresses, and certain other personal information about each investor; and another which sets out the addresses and certain other information about the directors and officers, and any promoters, of the issuer. An issuer will need to collect certain information about its investors, usually in the subscription agreement, in order to have the information required to complete the report.

Issuer Bid Considerations

A privately held company with more than 50 security holders may no longer rely on the non-reporting issuer exemption from the substantial issuer bid requirements in Part 2 of NI 62-104. Accordingly, in order to repurchase any of its outstanding securities, a company may need to take steps such as preparing and distributing an issuer bid circular, and obtaining a formal valuation, unless another exemption is available.

CBCA Companies – Requirement for Proxies and Information Circulars

Federal companies which are formed or continued under the CBCA, including privately held companies, have an additional set of obligations upon acquiring more than 50 holders of voting shares: in connection with each shareholder meeting (including annual general meetings and any special shareholder meetings), the corporation must “solicit proxies” from its shareholders. Soliciting proxies involves sending a form of proxy to shareholders (more on that below).

The CBCA goes on to provide that if a company solicits proxies, it must also prepare a management proxy circular in prescribed form, either as an appendix to or in a separate document accompanying the notice of the meeting.

Therefore, proxy solicitation involves the preparation and mailing of both an information circular and form of proxy (each in prescribed form) together with other meeting materials, to both shareholders and certain other recipients. Non-compliance with this requirement carries potential penalties for both the corporation and its directors and officers.

Form of Proxy

The proxy must be a form that complies with the requirements set out in section 9.4 of National Instrument 51-102 – Continuous Disclosure Obligations (“NI 51-102”). That provision, subject to certain exceptions, requires that a form of proxy must contain certain statements to the shareholder, and must provide certain options for a shareholder when it comes to voting their shares.

Information Circular

The information circular must be in the form provided for in Form 51-102F5 of NI 51-102, subject to certain exceptions, and must also set out a variety of additional information, including:

• the percentage of votes required for the approval of any matter that is to be submitted to a vote of shareholders at the meeting, other than the election of directors;
• a statement of the right of a shareholder to dissent under section 190 of the CBCA with respect to any matter to be acted on at the meeting, and a brief summary of the procedure to be followed to exercise that right;
• a statement, signed by a director or an officer of the corporation, that the contents and the sending of the circular have been approved by the directors; and
• a statement indicating the final date by which the corporation must receive a shareholder proposal for the purpose of paragraph 137(5)(a) of the CBCA.

Recipients of Meeting Materials

Information to be sent to each shareholder entitled to receive notice of the meeting

A CBCA corporation with more than 50 shareholders must send the following materials to its shareholders not less than 21 days and not more than 60 days before each shareholder meeting:

• the notice of meeting;
• the circular; and
• the form of proxy.

Information to be sent to each director and the auditor of the corporation

Concurrently with sending the meeting materials to its shareholders, a CBCA corporation must send a copy of the following materials to each director and the auditor of the corporation (if applicable):

• the notice of meeting; and
• the circular.

Information to be sent to the Director of Corporations Canada

Concurrently with sending the meeting materials to its shareholders, a CBCA corporation must send a copy of the following materials to the Director of Corporations Canada:

• the notice of meeting;
• the circular;
• the form of proxy; and
• a statement signed by a director or an officer of the corporation to the effect that a copy of the circular has been sent to each director, to each shareholder whose proxy has been solicited, and to the auditor of the corporation.

Key Take-Aways

Crossing the 50-securityholder or 50-shareholder threshold can give rise to significant considerations for a company, especially if it is federally incorporated.

• Keep a sharp eye on your cap table and, if yours is a federal corporation formed under the CBCA, the holders of your voting shares.
• Have a plan for preparing to file exempt trade reports and prepare circulars (if applicable) ahead of actually crossing the threshold.
• Allow plenty of time. Exempt trade filings and information circulars are subject to strict deadlines and potential late fees. They often require a variety of information which may involve follow-up requests to your shareholders or management. Circulars must be approved by the board.
• Ensure your subscription documentation collects all the information you’ll need for your exempt trade reports, check that each subscription agreement has been completed properly and consistently, and obtain any further information you require about your investor before you close on the investment. Ultimately, it is the issuer’s obligation to ensure it may properly rely on any prospectus exemption.
• If you expect to accumulate a lot of shareholders, consider forming your company (or continuing it, if already formed) under provincial law, rather than the CBCA. While a continuance requires shareholder approval, jurisdictions such as Ontario do not carry the obligation to prepare an information circular. Consult your tax advisor before undertaking an incorporation or continuance.
• If you are required to prepare an information circular, view it as an opportunity to thoughtfully review your company’s business and exercise good governance in the preparation and approval process. A circular is also a chance to speak directly to your shareholders – make the most of it!