Venture capital investment in Canada: market and regulatory overview

A Q&A guide to venture capital law in Canada.

The Q&A gives a high level overview of the venture capital market; tax incentives; fund structures; fund formation and regulation; investor protection; founder and employee incentivisation and exits.

To compare answers across multiple jurisdictions, visit the Venture Capital Country Q&A tool.

This Q&A is part of the global guide to venture capital. For a full list of jurisdictional Q&As visit www.practicallaw.com/venturecapital-guide.

Contents

Market overview

1. What are the main characteristics of the venture capital market in your jurisdiction?

Venture capital and private equity

Venture capital is a subset of the private equity market and is characterised by private or publicly sponsored pools of capital taking a minority equity position in early stage or growth companies in exchange for significant influence over the management and direction of the company. Venture capital funds (VCFs) typically invest in early stage or growth companies before sufficient predictable cash flows have been generated to attract mainstream institutional financing.

Sources of funding

Typically, early stage companies obtain funding from sources in a number of financing rounds. Many early stage companies source seed or start-up capital from founders and their friends and families. The next round of funding typically comes from angel investors, followed by venture capital or venture debt.

Government grants and tax credits are also available to certain early stage companies.

In January 2013, the federal government announced its Venture Capital Action Plan. Since its inception, the Venture Capital Action Plan has made up to CAN$350 million available to establish private sector-led fund of funds and up to CAN$50 million available to invest in established high-performing VCFs. In addition to federal government funding, various provincial governments have allocated funds to both direct and indirect financing in the venture capital space, including:

  • British Columbia.

  • Ontario.

  • Alberta.

  • Québec.

  • Nova Scotia.

The following also support both direct and indirect funding in the venture capital sector:

  • Banks.

  • Insurance companies.

  • Family offices.

  • Corporate strategics.

  • High-net worth individuals

Types of company

VCFs have a strong presence in the information technology, clean technology and life-sciences sectors and, to a lesser degree, in traditional sectors such as industrial or energy, manufacturing and consumer-related areas.

Market trends

Venture capital investment continued to grow in the first half of 2015, which was the strongest first half since 2002. The total amount invested in Canadian companies was approximately CAN$1.19 billion in 300 deals, with 33% more dollars invested than in the first six months of 2014. The strong investment level was driven by deals valued at CAN$20 million or higher, with eleven transactions in that range compared to only five in the first half of 2014. The average deal size of CAN$4 million in Canada was still significantly lower than in:

  • The US (CAN$17 million).

  • The UK (CAN$13.7 million).

  • Israel (CAN$10 million).

Government funds continued to support venture capital, providing a record 17% of all capital invested in the first half of the year. Investors outside of North America accounted for an 11-year high 9% of total dollars invested.

As in 2014, the information technology sector received the largest share of venture capital investment in the first half of 2015, with approximately CAN$650 million or 55% of the total funds invested. Investment in information technology increased by 20% over the first half of 2014, with software and internet companies receiving the most capital. The other top sectors were:

  • Life sciences (approximately CAN$243 million or 20% share).

  • Clean technology (approximately CAN$159 million or 13% share).

Traditional sectors including industrial or energy, manufacturing and consumer-related areas represented the remaining 12% of first-half investment.

Provincially, Ontario led deal-making activity in the first half of 2015, with approximately CAN$641 million (54% of total investment), representing the highest share for the province in 14 years. Seven of the top eight venture capital deals involved Ontario-based companies. Québec companies raised approximately CAN$294 million, which was nearly double the amount raised in the first half of 2014. British Columbia had the third largest share of total venture capital invested, receiving approximately CAN$179 million in the first six months of the year.

Canadian VCFs raised approximately CAN$878 million in the first half of 2015. This represented a 21% increase over the same period in 2014 and was the best fundraising period since the first half of 2012. Eleven Canadian funds held closings during the first six months of the year.

Private equity and venture capital market participants remain optimistic about deal activity. In a July 2015 survey of its members, the Canadian Venture Capital and Private Equity Association (CVCA) found that 82% of respondents believe that current economic conditions favour the private capital industry and 66% believe that a lower Canadian dollar improves the business outlook. When asked about potential exit opportunities, 60% of respondents expected IPO and mergers and acquisition activity to remain the same for the rest of 2015.

 
2. Are there any recent or proposed regulatory changes affecting the venture capital industry?

The federal labour-sponsored venture capital corporation (LSVCC) tax credit, which provides a 15% tax credit to individuals for the acquisition of shares of federally registered or prescribed provincially registered LSVCCs on investments up to CAN$5,000, is being phased out in 2015. This tax credit was first introduced in the 1980s to encourage investment by retail investors in small and medium-sized businesses. In 2015, the LSVCC tax credit will be reduced to 10%, followed by 5% in 2016, and will be eliminated for taxation years after 2016. The impact of these changes will be most acutely felt in Québec where labour-sponsored funds, such as the Fonds de solidarité (FSTQ) and CSN Fondaction, have been large beneficiaries of this tax incentive and important players in the Québec market.

 

Tax incentive schemes

3. What tax incentive or other schemes exist to encourage investment in venture capital companies? At whom are the schemes directed? What conditions must be met?

Canadian-controlled private corporations (CCPCs) are entitled to a number of tax-related benefits (most of which are aimed at small businesses), including:

  • A lower rate of tax deduction on operating income up to a threshold of CAN$500,000.

  • Enhanced investment tax credits for qualified expenditures on scientific research and experimental development.

  • Deferral of an employee's taxable benefit arising from the exercise of share options.

  • Shareholder entitlement to a capital gains exemption on a disposition of qualified small business corporation shares.

The federal government and certain provincial governments also provide tax credits to individuals that are resident in Canada or in specific provinces and who invest in certain labour-sponsored venture capital corporations (LSVCCs). The LSVCC tax credit is being eliminated for taxation years after 2016 (see Question 2).

These various schemes are directed primarily at small businesses or smaller individual investors that are Canadian taxpayers.

A CCPC is a Canadian corporation that is not a public corporation (that is, a corporation that is listed on a stock exchange in Canada or elsewhere) and that is not controlled, directly or indirectly, by one or more non-residents of Canada or public corporations.

LSVCCs are subject to restrictions on the companies that they can invest in and are in general more tightly regulated than other forms of private equity funds. LSVCCs are typically only active in the domestic venture capital market.

 

Funding sources

4. From what sources do venture capital funds typically receive funding?

Individuals and family offices, government and fund of funds were the top sources of capital for venture capital fundraising in the first half of 2015. Other sources include:

  • Banks.

  • Insurance companies.

  • Certain corporate investors.

One of the largest sources of investment in venture capital funds (VCFs) is the Business Development Bank of Canada, a development bank owned by the federal government.

 

Fund structuring

5. Can the structure of the venture capital fund affect how investments are made?

Venture capital funds (VCFs) are generally structured in the form of limited partnerships. Separate limited partnerships can be used in order to accommodate the needs of different investors. For example, it is a common practice for resident investors to invest through one limited partnership while non-resident investors invest through a parallel limited partnership. This parallel fund structure allows the fund manager to more efficiently manage fiscal compliance and reporting requirements related to the Canadian fund and the parallel fund.

 
6. Do venture capital funds typically invest with other funds?

Venture capital funds (VCFs) often invest with other private equity funds and even in other VCFs. Those funds can be domestic, from the US or elsewhere. Also, funds of funds invest in direct funds that in turn invest in early stage or growth companies. Fund of funds were among the top sources of venture capital fundraising in the first half of 2015 (see Question 1).

 
7. What legal structure(s) are most commonly used as vehicles for venture capital funds?

Venture capital funds (VCFs) are generally structured in the form of limited partnerships formed under the laws of one of the provinces of Canada (see Question 5). Although other investment vehicles such as trusts can be used, the potential risks inherent in the nature of investments in early stage or growth companies can make these vehicles more difficult to market to prospective investors.

In a limited partnership, a limited partner's liability is limited to the amount the limited partner contributes or agrees to contribute to the capital of the limited partnership so long as it is not actively involved in the conduct of business of the limited partnership. The general partner, who is typically set up as either a newly incorporated corporation that is a wholly-owned subsidiary of the manager of the VCF or an affiliated limited partnership, is subject to unlimited liability. Parallel investment vehicles (including one or more additional limited partnerships) are also commonly established to facilitate co-investments by non-Canadian investors or to permit investments in assets that the main fund is not able to acquire or hold directly (see Question 5).

 

Investment objectives

8. What are the most common investment objectives of venture capital funds?

Venture capital funds (VCFs) generally invest in early stage or growth companies with a view to receiving a return on capital, although different types of funds can also have other objectives. For example, government-backed or sponsored funds typically also have mandates to create employment or to stimulate investment in certain sectors of the economy or geographic regions. Corporate-backed or sponsored funds often seek out strategic investments or partnerships with early stage or growth companies with complementary or synergistic businesses.

 

Fund regulation and licensing

9. Do a venture capital fund's promoter, manager and principals require licences?

A venture capital fund's (VCF) manager may be required to register in each province or territory in Canada where they conduct business. Under securities laws, in the absence of an exemption for the registration requirement, firms must register if they:

  • Are in the business of trading or advising.

  • Hold themselves out as being the business of trading or advising in securities.

  • Act as an underwriter or acting as an investment fund manager.

Individuals must register if they:

  • Trade, underwrite or advise in securities on behalf of a registered dealer or adviser.

  • Act as the ultimate designated person or chief compliance officer of a registered firm.

Depending on the nature of the activities carried out by the firm or individual, registration in more than one category may be required.

As long as a VCF's manager is not trading or advising in securities for a business purpose, there is generally no requirement for the manager to register under securities laws. For example, a manager of a VCF does not have to register as a portfolio manager if the advice being provided by the manager in connection with the selection of the portfolio companies that the VCF invests in is incidental to the manager's active and ongoing management of these companies on behalf of the VCF. Similarly, if the capital-raising activities and the subsequent investment of such capital undertaken by the manager on behalf of a VCF are infrequent and uncompensated activities incidental to the manger’s primary role, the manager does not have to register as a dealer. If the manager is actively involved and participates in the management and control of the business and affairs of the portfolio companies that the VCF invests in, the VCF would not be considered an investment fund for the purposes of securities laws and accordingly the manager does not have to register as an investment fund manager.

 
10. Are venture capital funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions?

The equivalent of a US investment company is generally referred to as an investment fund, which can be organised as either:

  • A limited partnership, through which investors can invest as limited partners.

  • A trust, which issues units of beneficial interest to investors.

  • A corporation, which issues shares to investors.

As with any issuer of securities, venture capital funds (VCFs) must comply with applicable securities laws.

Generally, marketing or advertising the sale of securities (in particular, the limited partner interests, units or shares of a VCF) is prohibited unless those securities are qualified for distribution by a prospectus. There are exemptions from prospectus and registration requirements under securities laws including certain sales to:

  • Friends, family and business associates.

  • Accredited investors.

  • Non-individual investors of minimum amount investments of at least CAN$150,000.

 
11. How is the relationship between investor and fund governed? What protections do investors in the fund typically seek?

If the venture capital fund (VCF) is structured as a limited partnership, the relationship between the investor and the fund is governed by the terms of a limited partnership agreement among the general partners and the limited partners of the limited partnership and a subscription agreement under which an investor would subscribe for an interest in the limited partnership as a limited partner.

The limited partnership agreement can contain the following protections for investors:

  • Investment restrictions, including:

    • concentration limits;

    • geographic requirements;

    • diversification;

    • limits on borrowing by the limited partnership;

    • related party transactions; and

    • the availability and access to co-investment opportunities.

  • Capital commitment and call obligations over the term of the fund, including consequences in the event of a default by any limited partner with respect to meeting such obligations.

  • Financial and other reporting requirements to investors.

  • Priorities for returns of capital or the payment of distributions and clawback provisions with respect to any expenses or other carry obligations paid to the general partner or fund manager.

  • Governance provisions, including the requirement for a management or other advisory committee to oversee the day-to-day business of the fund.

  • Key person clauses with respect to the retention of key employees of the fund manager.

  • Other investor remedies including early termination of the term of the investment or commitment period or the term of the limited partnership and provisions allowing for removal of the general partner or fund manager under certain circumstances.

 

Interests in investee companies

12. What form of interest do venture capital funds take in an investee company?

Some common forms of equity interests that venture capital funds (VCFs) can take in an investee company include:

  • Common shares.

  • Preferred shares, including convertible preferred shares.

  • Share purchase warrants.

  • Units comprised of common shares and share purchase warrants.

  • Bridge investments, most often convertible debentures.

  • Other developing structures, such as simple agreements for future equity (SAFE).

VCFs can also make debt financing available to investee companies, for example, through subordinated, convertible or mezzanine debt that can be either secured or unsecured.

Although the least prevalent, issuing straight common shares is cost effective and establishes a simple capital structure for investee companies. Convertible preferred shares, the most popular instrument, enable investors to participate in upside gains and limit downside exposure with respect to their investment. Many preferred shares also have conversion rights that are triggered by automatic conversion events including:

  • Consolidation, amalgamation, merger, arrangement or other form of business combination of the investee company with another entity.

  • A sale, lease or exchange of all or substantially all of the assets of the investee company.

  • Certain changes of control.

  • An IPO of the investee company.

Preferred shares can also be given preference vis-à-vis other shareholders of the investee company to dividends or distribution of the assets of the investee company on liquidation. From the perspective of an investee company, a preferred shareholder's preference with respect to dividends or distribution of the assets on liquidation justifies a higher issue price for preferred shares as compared to straight common shares. Preferred shares can often also carry certain advantageous anti-dilution protection and other investor rights.

A more recent innovation (originally made popular by Y-Combinator in the US) is a SAFE that is a cash investment in a company where the investor receives shares at a later date in connection with a specific event. It affords the same flexibility as convertible debt but is considered to be equity. Generally, a SAFE investment is given the same rights, privileges, preferences and obligations as standard preferred shares but have different liquidation preferences, conversion prices and dividend rates.

Warrants allow the holder to purchase common or preferred shares of the issuer in the future at a specified price, such as a premium or discount to the current market price of the shares at the time of issue. Warrants are also frequently attached to debentures or preferred shares as a "sweetener" to allow investors to capture the capital appreciation of the underlying shares over time.

An advantage of secured debt is that it gives investors first priority as creditors of the investee company and can sometimes be secured against some or all of the assets of the investee company. Convertible debt also enables investors to participate in upside gains through a conversion to common or preferred shares.

 

Valuing and investigating investee companies

13. How do venture capital funds value an investee company?

Venture capital funds (VCFs) value investee companies based on:

  • Their business model.

  • Financial and operational results.

  • Future financial and operational projections.

  • The strength of the management team.

  • Intellectual property.

  • Present and future capital requirements.

  • Potential exit strategies.

VCFs generally also prepare their own financial models based on various economic scenarios in assessing an investment.

 
14. What investigations do venture capital funds carry out on potential investee companies?

Venture capital funds (VCFs) carry out extensive business (including financial and operational) and legal due diligence investigations. Such investigations include reviewing the company's:

  • Business plan.

  • Budgets.

  • Financial information.

  • Material contracts.

  • Corporate books and records.

  • Searches of the public records of the investee company and its property and assets.

Frequently, the scope of the review is tailored to the specific circumstances of the proposed investment and the requirements of the VCF.

 

Legal documentation

15. What are the principal legal documents used in a venture capital transaction?

The principal legal documents commonly used in venture capital transactions include:

  • A subscription or investment agreement between the venture capital fund (VCF) and the investee company.

  • If the investment is in the form of an equity interest in the investee company (for example, common shares or preferred shares), the share provisions setting the rights attached to the class or series of shares being subscribed for by the VCF. These provisions are set out in the investee company's articles.

  • A shareholders' agreement among the investee company, the VCF and the other shareholders in the investee company setting out their respective rights and obligations in respect of the shares and the management and control of the investee company.

Demand or piggy-back registration or prospectus qualification rights agreements can also be negotiated, particularly where the investee company contemplates an exit by way of an IPO, along with board nomination rights agreements, to the extent that such matters are not addressed in the subscription or investment agreement.

 

Protection of the fund as investor

Contractual protections

16. What form of contractual protection does an investor receive on its investment in a company?

Venture capital funds (VCFs) typically negotiate and receive the following contractual protections in respect of their investments in investee companies:

  • Indemnities from the investee company and in certain cases, their founders or principals, for breaches of any representations and warranties in the investment or subscription agreement.

  • Restrictions on the use of proceeds of the VCF's investment.

  • Board or board committee nomination or representation or veto rights, or alternatively, board observer rights.

  • Information rights.

  • Pre-emptive rights on subsequent share issuances and financing rounds.

  • Liquidity rights.

  • Demand or piggy-back registration or prospectus qualification rights in respect of any prospective IPO.

  • Rights of first refusal, drag-along or tag-along rights in connection with exit transactions involving a sale of the investee company or a sale of all or substantially all of the assets of the investee company.

  • Forced exit or redemption provisions.

 

Forms of equity interest

17. What form of equity interest does a fund commonly take (for example, preferred or ordinary shares)?
 

Preferred shares

18. What rights does a fund have in its capacity as a holder of preferred shares?

Preferred shares typically rank higher than common shares on liquidation but do not typically carry voting rights and instead are often granted special economic rights. Dividends on preferred shares are declared from a company's earnings that remain after debt obligations, senior preferred share dividends and other obligations have been satisfied and corporate solvency tests are met. Failure to pay dividends would not provide the holder with remedies typically negotiated under a debt instrument in an event of default.

Common features of preferred shares include:

  • Dividend preference.

  • Liquidation preference on the occurrence of a liquidity event (such as a sale of the shares of the investee company or a sale of all or substantially all of the assets of the investee company or the IPO of the investee company in connection with an exit transaction, or in connection with the wind-up and liquidation of the assets of the investee company on dissolution) for holders to receive their initial investment or a multiple of it, together with any accrued, but unpaid dividends. It is now relatively uncommon for preferred shares to participate alongside common shares in the remaining proceeds of the investee company on liquidation.

  • Negotiated fixed dividend amount.

  • Cumulative dividend rights such that if the dividend is not paid, it accumulates from year to year.

  • Fixed liquidation value.

  • Protective provisions that prevent the issuance of new preferred shares with a senior claim. Individual series of preferred shares can have a senior, pari passu or junior relationship with other series issued by the investee company.

  • Preferred shares typically do not have a maturity date.

  • The investee company may have the option to pay dividends by delivering additional preferred shares having a liquidation preference value equal to the dividend payment owed.

  • The holder of preferred shares could be granted special voting rights to approve extraordinary events or the right to elect nominees to the board.

Common features of convertible preferred shares also include the following:

  • Conversion rights with respect to the conversion of the preferred shares into common shares (see Question 12).

  • Anti-dilution or "price protection" rights, which adjust the ratio or price at which the preferred shares can be converted to common shares after the occurrence of a triggering event. Triggering events can include:

    • subsequent financing rounds at a lower price than the conversion price set out in the preferred share provisions;

    • a subdivision or consolidation of the common shares;

    • a stock split;

    • a capital reorganisation;

    • reclassification or change of the common shares;

    • a consolidation, amalgamation, merger, arrangement or other form of business combination of the investee company with another entity; or

    • a sale, lease or exchange of all or substantially all of the assets of the investee company.

    Anti-dilution rights can be either "full ratchet" where the conversion price adjusts if the new price at which the investee company sells shares is lower than the prior issue price, regardless of how many shares the investee company sells at that lower price, or based on a "weighted average" formula where the conversion price adjusts based on the ratio of share issuance proceeds (where shares are issued at a lower price per share) to the investee company's total share capital immediately prior to when the investee company issued shares at that lower price.

  • Redemption features.

 

Management control

19. What rights are commonly used to give a fund a level of management control over the activities of an investee company?

Governance rights commonly used to give a venture capital fund (VCF) a level of management control over the activities of investee companies include:

  • Board or board committee nomination and representation rights in the investee company or its subsidiaries, or alternatively, board observer rights in the absence of such nomination and representation rights, or both.

  • Quorum requirements for board meetings to ensure that business cannot be conducted at any board meetings without the participation of some or all of the VCF's director nominees.

  • Veto or super-majority approval rights at the board or shareholder level with respect to certain corporate actions or fundamental transactions.

  • Second or casting vote rights in the event of an equality of director or shareholder votes with respect to matters requiring board or shareholder approval, as applicable.

  • Information and other reporting rights and covenants in favour of the VCF.

 

Share transfer restrictions

20. What restrictions on the transfer of shares by shareholders are commonly contained in the investment documentation?

A shareholders' agreement often prohibits any transfer of shares unless specifically permitted under the terms of the agreement. A type of transfer that is sometimes expressly permitted is a transfer of shares to an affiliate of the transferring shareholder.

Restrictions on the transfer of shares are also frequently included in the articles of private companies. In many cases, the transfer of shares by shareholders requires the approval of the board of directors of the company.

Under securities laws, shares issued under a prospectus exemption cannot be resold or transferred unless qualified by a prospectus or unless a further appropriate prospectus exemption is available. There are a number of exemptions from the prospectus requirements in each province or territory of Canada (see Question 10).

 
21. What protections do the investors, as minority shareholders, have in relation to an exit by way of sale of the company?

Protections that investors, as minority shareholders, can have in relation to an exit by way of a sale of the investee company include:

  • Put options by which investors can opt to sell all of their shares in the investee company to certain other shareholder or to all other shareholders.

  • Tag-along rights in the context of third party sales permitting such sales only if the third party commits itself to purchase the shares of all shareholders that elect to exercise their tag-along rights.

  • Drag-along rights that enable a specified majority of the shareholders to enter into an agreement with respect to the sale of their respective shares of the investee company and to compel the other shareholders to sell their shares on the same terms. A modified drag-along provision can also be used to address the possibility of a third party acquisition by a sale of all or substantially all of the assets of the investee company, as opposed to a sale of all of the issued and outstanding shares of the investee company.

 

Pre-emption rights

22. Do investors typically require pre-emption rights in relation to any further issues of shares by an investee company?

Pre-emptive rights in relation to further share issuances are typically required by venture capital investors in the context of their investment as a means of maintaining their equity ownership percentage in the investee company to avoid dilution. These rights typically entitle the venture capital fund (VCF) to receive notice of subsequent offerings or financing rounds and to subscribe for a portion of that offering or financing round that is equal to its existing percentage ownership in the investee company under the same or better terms offered to the other investors.

Typical exemptions from these pre-emptive rights being triggered include:

  • Shares issued on the exercise of stock options.

  • Other equity-based incentive awards granted to employees, directors, officers and consultants of the investee company, or in connection with stock splits or stock dividends.

 

Consents

23. What consents are required to approve the investment documentation?

Investment by an investor in a VCF

The necessary approvals required at the investor level in respect of the documentation relating to its investment or subscription for securities of a venture capital fund (VCF), whether in the form of limited partner interests in a limited partnership, units of a trust or shares of a corporation, varies depending on the nature of the investor and size of its investment. Most institutional investors have an internal investment committee or board approval requirements based on established authorisation limits and as required to comply with applicable corporate legislation.

Investment by a VCF in an investee company

Any issuance of securities by an investee company must comply with the corporate legislation governing the investee company. The board of the investee company must conclude that the transaction is in the best interests of the investee. Directors of the investee company that have an interest in any proposed transaction may have to declare that interest and abstain from voting.

If the investee company has granted investors in prior financing rounds pre-emptive rights in connection with their investment, the prior consent or approval of these investors may be required.

If a proposed transaction contemplates a new class of shares that has not been previously approved by the shareholders of the investee company, then the articles of the investee company must be amended. The creation of a new class of shares is a fundamental change that generally requires a special resolution of shareholders (typically approval by the holders of at least 66.67% of the shares). Depending on the governing statute and other constating documents, a special resolution by class vote may also be required.

 

Costs

24. Who covers the costs of the venture capital funds?

Reimbursement by investee companies of the fees and expenses incurred by venture capital funds (VCFs) in connection with their investment are negotiated between the VCFs and investee companies.

 

Founder and employee incentivisation

25. In what ways are founders and employees incentivised? What are the resulting tax considerations?

Incentives

Founders typically subscribe for a block of common shares for consideration equal to the fair market value of the shares on the founding of the corporation. However, this consideration is generally nominal since the value of the common shares is minimal at the start-up stage of the corporation.

Employees are generally incentivised through the grant of share options under the corporation's stock option plan. Stock options generally vest over time and will be exercisable for shares of the corporation. The investment or shareholders' agreement generally limits the size of the option pool, with any increases requiring investor approval. The exercise price must be in line with the market price of the corporation's shares (with the exception of the shares of Canadian-controlled private corporations (CCPCs)) as of the date of grant to avoid tax being payable by the employee as of the grant. The option plan generally includes provisions dealing with treatment of the options on an exit event.

Tax

On the sale or other disposition of the common shares of the investee company, the founder is generally subject to capital gains tax except where there is a deferral. Shares of another Canadian corporation issued as consideration for these shares are generally subject to a tax deferral, although shares of foreign corporations are not. Stock options are considered a taxable employment benefit and accordingly, employees who exercise stock options are subject to tax on the resulting benefit, with the corporation being required to withhold a portion of the benefit. Employees of CCPCs may be entitled to a deferral of the taxable benefit arising from an exercise of stock options.

 
26. What protections do the investors typically seek to ensure the long-term commitment of the founders to the venture?

Protections that venture capital investors typically seek to ensure the long-term commitment of the founders to the investee company include non-competition and non-solicitation agreements that restrict founders from:

  • Carrying on or being engaged in a competing business for a certain period of time after leaving employment with the investee company.

  • Hiring or soliciting for employment any employee of the investee company or its affiliates.

Other devices include:

  • Vesting provisions associated with stock option awards.

  • The grant of other equity-based incentive awards.

  • Risk and performance-based compensation arrangements.

  • Share escrow regimes.

Investors also impose rights (similar to "restricted stock" in the US) that allow them or the company to buy back the shares of a founder at lower than fair value if the founder leaves the investee company prematurely.

 

Exit strategies

27. What forms of exit are typically used to realise a venture capital fund's investment in an unsuccessful company? What are the relative advantages and disadvantages of each?

Exit strategies that can be used to realise a venture capital fund's (VCF) investment in an unsuccessful investee company include:

  • Put options (see Question 21).

  • Auction process: running an auction process for a sale of the shares of the unsuccessful investee company or some or all of the assets of the unsuccessful investee company to seek the best price available and to ensure that the VCF receives some return on its investment.

  • Corporate restructuring or reorganisation of the unsuccessful investee company: corporate restructurings are generally governed by either the federal Companies' Creditors Arrangement Act or the proposal provisions of the federal Bankruptcy & Insolvency Act. Sometimes, corporate statutes can be used to effect fundamental changes in the corporate structure through a court approved plan of arrangement. If the VCF holds any debt in the investee company, they are given priority as creditors. If the debt is secured, the VCFs can elect to enforce its security in respect of the assets of the investee company. In addition, if a sale of some or all of the assets is approved, preferred shares typically have priority over common shares during the division of the assets on liquidation.

 
28. What forms of exit are typically used to realise a venture capital fund's investment in a successful company? What are the relative advantages and disadvantages of each?

Many successful early stage companies have a choice between an IPO, a sale of the company to a strategic buyer or receiving additional private equity or institutional funding:

  • IPO: Using an IPO as an exit strategy creates liquidity for the venture capital fund (VCF) and typically results in a higher return on investment. It is easier for the VCF to dispose of its shares once the investee company is listed on a stock exchange. Disadvantages include:

    • dilution of shares;

    • hold or lock-up periods following the completion of the IPO;

    • the expense required to complete the IPO; and

    • the disclosure requirements under applicable securities laws.

  • Sale to a strategic buyer: a sale of the company to a strategic buyer, whether a publicly-held corporation or a private corporation, can be used to achieve a full or partial exit and are typically less resource intensive than an IPO. There are also generally fewer regulatory requirements when entering into a strategic sale transaction. However, depending on the circumstances of the buyer the transaction may be subject to competition or other regulatory review.

  • Private equity or institutional funding: recapitalisation of the investee company by way of private equity or institutional funding can also be used as a full or partial exit strategy.

 
29. How can this exit strategy be built into the investment?

An exit strategy can be built into a particular investment using:

  • Demand or piggy-back registration or prospectus qualification rights in respect of the securities held by the venture capital fund (VCF) on or following the IPO of the investee company.

  • Put options (see Question 21).

  • Tag-along or drag-along rights in the context of a sale of the shares of the investee company or all or substantially all of the assets of the investee company (see Question 21).

 

Online resources

Canadian Securities Administrators

W www.securities-administrators.ca

Description. Website of the Canadian Securities Administrators (CSA).

Alberta Securities Commission (ASC) (Canada)

W www.albertasecurities.com

Description. Website of the Alberta Securities Commission.

British Columbia Securities Commission (BCSC)

W www.bcsc.bc.ca

Description. Website of the British Columbia Securities Commission.

The Manitoba Securities Commission

W www.mbsecurities.ca

Description. Website of The Manitoba Securities Commission.

Financial and Consumer Services Commission

W www.fcnb.ca

Description. Website of the Financial and Consumer Services Commission.

Superintendent of Securities, Service Newfoundland & Labrador

W www.servicenl.gov.nl.ca/securities/index.html

Description. Website of the Office of the Superintendent of Securities, Service Newfoundland & Labrador.

Superintendent of Securities, Northwest Territories

W www.justice.gov.nt.ca/SecuritiesRegistry

Description. Website of the Office of the Superintendent of Securities, Northwest Territories.

Nova Scotia Securities Commission

W nssc.novascotia.ca

Description. Website of the Nova Scotia Securities Commission.

Nunavut Securities Office

W nunavutlegalregistries.ca/sr_index_en.shtml

Description. Website of the Nunavut Securities Office.

The Ontario Securities Commission (OSC)

W www.osc.gov.on.ca

Description. Website of the Ontario Securities Commission.

Office of the Superintendent Securities - Prince Edward Island

W www.gov.pe.ca/securities

Description. Website of The Office of the Superintendent Securities, Consumer, Corporate and Insurance Services Division, Office of the Attorney General, Prince Edward Island.

Autorité des Marchés Financiers (AMF) (Canada)

W www.lautorite.qc.ca/en/index.html

Description. Website of the Autorité des marchés financiers.

Financial and Consumer Affairs Authority of Saskatchewan

W www.fcaa.gov.sk.ca

Description. Website of the Financial and Consumer Affairs Authority of Saskatchewan.

Office of the Yukon Superintendent of Securities

W www.community.gov.yk.ca/corp/securities_about.html

Description. Website of the Office of the Yukon Superintendent of Securities.



Contributor profiles

Robert Lehodey Q.C., Partner

Osler, Hoskin & Harcourt LLP

T +1 403 260 7001
F +1 403 680 4444
E rlehodey@osler.com
W www.osler.com

Professional qualifications. Alberta, Barrister and Solicitor, 1983

Areas of practice. Corporate finance; securities; corporate governance; mergers and acquisitions; private equity; venture capital.

Non-professional qualifications. BSc in Chemical Engineering, University of Alberta, 1979; LLB, Dalhousie University, 1982

Recent transactions

  • Advising Special Committee of the Board of Directors of Legacy Oil and Gas Inc. in connection with an activist shareholder initiative and CAN$1.5 billion acquisition of Legacy by Crescent Point Energy Corp.
  • Advising Veresen Inc. in the formation of a new entity, Veresen Midstream Limited Partnership, equally owned by Veresen and affiliates of Kohlberg Kravis Roberts & Co. L.P., which acquired certain midstream assets from Encana Corporation and the Cutbank Ridge Partnership.
  • Represented the consortium of purchasers of the Arizona Coyotes National Hockey League franchise in connection with all Canadian legal matters, including overall ownership governance structure and cross border tax structuring.

Languages. English

Professional associations/memberships. Canadian Bar Association; Law Society of Alberta

Publications

  • "Shareholder Activism: The New Takeover?" Osler Seminar, 21 November 2012.
  • Decision in Deer Creek Assesses Sales Process in Context of Dissent and Valuation Litigation, Osler Update, 19 June 2009.

Shahir Guindi, Montréal Managing Partner

Osler, Hoskin & Harcourt LLP

T +1 514 904 8126
E sguindi@osler.com
W www.osler.com

Professional qualifications. Québec, 1990; New York, attorney, 1990

Non-professional qualifications. LLB, McGill University; BCL, McGill University

Areas of practice. Corporate finance and securities; emerging companies; investment funds and asset management; life sciences; mergers and acquisitions; private equity; retail; technology; US cross-border legal services; venture capital.

Recent transactions

  • Advising PasswordBox Inc. in connection with its sale to Intel.
  • Advising DAVIDsTEA in its Initial Public Offering and Listing on the NASDAQ.
  • Advising UBS Securities in connection with the proposed initial public offering of Klox Technologies Inc.
  • Advising DataWind Inc., in connection with its CAN$30 million initial public offering and listing on the Toronto Stock Exchange.
  • Advising MEGA Brands in connection with its proposed US$460 million acquisition by Mattel.
  • Advising HarbourVest Partners in connection with the formation of a Canadian fund of funds pursuant to Canada''s Venture Capital Action Plan.
  • Advising Lumira Capital, in the formation of two funds in an aggregate amount of CAN$142.5 million.

Languages. English, French, Arabic

Professional associations/memberships. New York State Bar Association; Association du Barreau du Québec; Canadian Bar Association

Publications

  • CEO Vision PDG, Seminar on "Exit Strategies", Mont-Tremblant (2014 to 2015)
  • CEO Vision PDG, Seminar on "Capital de croissance", Mont-Tremblant (2014 to 2015)
  • The Role of State Financial Institutions in the Development of Social Entrepreneurship, Rise Egypt Launch, Harvard Medical School, June 2014.

François Auger, Partner

Osler, Hoskin & Harcourt LLP

T +1 514 904 8118
E fauger@osler.com
W www.osler.com

Professional qualifications. Québec, 1992; Paris, lawyer, 2012

Areas of practice. Plan Nord; taxation.

Non-professional qualifications. LLB, Université de Montréal; B. Comm, École des Hautes Études Commerciales, Université de Montréal

Recent transactions

  • Advising Teralys Capital in the formation of the CAN$1.3 billion managed fund of funds.
  • Advising AXA Private Equity, CBC Pension Fund and Caisse de dépôt in the establishment of two Novacap Funds, namely Novacap Technologies III and Novacap Industries III, in an aggregate amount of CAN$600 million.
  • Advising Caisse de dépôt et placement, Tandem Capital, Rho Capital, Inovia Capital, Real Ventures, Garage Technology, Ventures West, Vimac Ventures, Entrepia Ventures, Desjardins Venture Capital, Société Innovatech du Grand Montréal and Investissement Québec in several private equity and venture capital investments.

Languages. English, French

Professional associations/memberships.

  • Association du Barreau du Québec.
  • Canadian Bar Association.
  • Barreau de Paris.
  • Canadian Institute of Chartered Accountants.
  • Ordre des comptables professionnels agréés du Québec.
  • Canadian Tax Foundation.
  • International Fiscal Association.
  • Association de planification fiscale et financière (APFF).
  • Society of Trust and Estate Practitioners (STEP).

Heidi Wong, Associate

Osler, Hoskin & Harcourt LLP

T +1 403 260 7076
E hwong@osler.com
W www.osler.com

Professional qualifications. Alberta, Barrister and Solicitor, 2006

Areas of practice. Corporate finance and securities; mergers and acquisitions; corporate governance.

Non-professional qualifications. B.Comm (Hons.), University of British Columbia; LLB, Osgoode Hall Law School.

Recent transactions

  • Advising Canada Pension Plan Investment Board in its investment through a private placement of subscription receipts as a cornerstone investor of TORC Oil & Gas.
  • Advising Microsoft Corporation, as Canadian counsel on its EUR5.4 billion acquisition of Nokia Corporation's devices and services business, and in its acquisitions of InCycle Software, Opalis Software Inc., BigPark Inc. and 90 Degree Software Inc. and its acquisition of the assets of Dundas Software.
  • Advising Hill-Rom Canada Respiratory Ltd., on its acquisition of Chestmaster Inc.

    Advising Crest Energy International in WesternZagros' CAN$200 million rights offering, private placement backstop agreement and loan facility

Professional associations/memberships. Canadian Bar Association; Calgary Bar Association


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