Private Equity and Subscriptions

Private equity is an investment in a company which does not take place through the public markets. At its simplest, an investor pays money to the corporation in exchange for shares of the corporation. This article focuses on securities (which include shares) which are issued privately pursuant to Ontario's exempt market regime.

Exemptions from Securities Laws

Securities laws govern the issuing of securities. In general terms, securities must be issued in accordance with the a prospectus regime, unless the issuer qualifies for a prospectus exemption. The prospectus regime requires the issuer to file a prospectus - a detailed disclosure document - with securities regulators and provide it to prospective investors. The issuer is then subject to ongoing reporting requirements. As the prospectus regime is burdensome and costly, most private issuers take advantage of exemptions to the prospectus regime where available.

The most commonly relied upon exemption from the prospectus regime is the private issuer exemption which permits an issuer to issue shares to up to 50 persons (excluding employees and former employees), who fall within certain categories (such as directors and officers and their family members and close personal friends, employees and accredited investors). Other exemptions include the accredited investor exemption; friends, family and business associates exemption; employee, executive officer, director or consultant exemption; and offering memorandum exemption.

Class of Shares

There are wide variety of ways that a private equity investment can be structured. Often the investor will subscribe for common shares or preferred shares. Common shares have the right to vote, to a share in the profits and to share on the assets of a corporation on liquidation or windup. Preferred shares are a general description for shares with certain preferred rights, such as the right to a fixed dividend and right to a priority return of capital. They may also provide their shareholders with other rights such as the right to vote, the right to convert the preferred shares into common shares and the right to retract the shares (i.e. require the corporation to repurchase the shares at a certain price). The rights which attach to preferred shares are one of the elements that are negotiated between the parties.

Steps to a Private Equity Transaction

From a legal perspective, the following are the main steps to a private equity investment:

1. The parties sign preliminary agreements, often a term sheet and non-disclosure agreement.
2. The investor conducts due diligence.
3. The parties negotiate the final agreements, which generally include a subscription agreement and shareholder agreement.
4. The parties execute the closing documents and the corporation's minute book is updated.

The term sheet is typically a short document which confirms the key business terms of the transaction - the shares to be issued, the purchase price and any conditions to the closing of the transaction, including required due diligence. The term sheet will also set out the definitive agreements that need to be entered into, including the subscription and shareholder agreements, and will set out key provisions.

The two main agreements that are executed are the subscription agreement and shareholder agreement. See Shareholder Agreemeents for a discussion of shareholder agreements.

Subscription Agreements

A subscription agreement is an agreement to subscribe for (or purchase) shares of a corporation. The following are the main elements of a subscription agreement:

• Description of shares to be purchased and payment terms.
• Representations and warranties of the parties. These are the most important and cover a wide variety of topics. The issuers representations and warranties typically provide assurance that the issuer is authorized to issue the shares and that it is complying with applicable law. The subscriber's representations and warranties are typically more extensive. In addition to legal compliance, they provide confirmation as to the documentation provided to the subscriber (or lack thereof), that the subscriber qualifies for the prospectus exemption relied upon and that the subscriber is not relying on any advice or statement of the Company.
• Depending on the prospectus exemption relied upon, the subscription agreement may also require the subscriber to confirm that they understand they will be subject to resale restriction on the shares they are purchasing.