Dec 18

A Rough Guide to Starting a Business Legal Expenses

We frequently take calls from entrepreneurs wondering about the legal expenses they should expect to incur in starting a business.  Sometimes the business has been operated as a sole proprietor and the entrepreneur recognizes it is time to incorporate a business and other times the entrepreneur is starting a business fresh.  The calls typically follow the same general path: first we are asked about the necessary steps (i.e. incorporation, banking, financing, shareholder agreements, etc…) and second we are asked how much taking those steps to start the business will cost.  While every business is unique and the start-up costs vary somewhat from business to business, in this post, we provide some rough guidance regarding what to expect when it comes to business start-up legal expenses.

Incorporation

You should budget $1,200 to $1,500 for incorporating your new business.  Legal fees are roughly $900, more or less depending upon complexity of the share structure.  Disbursements – i.e. expenses incurred by your lawyer in connection with the incorporation – , including name reservation, incorporation filing fee, name reservation report (if applicable) and minute book binder total $500 more or less.  Savings can be had by choosing the following:

  • incorporating federally and you will save $100 because the government filing fee is less;
  • incorporating using a numbered company (i.e. 1234567 Canada Inc.) and you will save the $56 NUANS name search report fee; and
  • tell us you don’t want a fancy minute book binder and you will save approximately $125.

In addition to the saving opportunities listed above, you can avoid the incorporation legal fees altogether by preparing and filing the incorporation yourself, but in our experience often the share structure isn’t set up correctly for the business start-up and articles of amendment need to be filed, which cost approximately the same as hiring us to do the incorporation in the first instance.

The incorporation fees quoted above include the initial set-up of the corporation, including resolutions, share issuances and registrars.

Financing Agreements

The type of financing agreements a start-up will need will of course depend upon how the business will be financed.  Financing options generally include shareholder loans, equity or debt investment from angel investors and bank debt.    Providing an estimate of the cost of legal fees for financing agreements is not easy because of the diverse range of financing options.   In addition to the cost of preparing the financing agreement for the start-up there are typically also legal expenses associated with the financing transaction itself.  For example, an equity financing by angel investors (be they accredited investors or friends and family) will involve a subscription agreement, corporate authorizing resolutions and other transaction documents.  Moreover, the terms of the financing may be extensively negotiated with the investors or a broker-dealer representing the investors, which will further increase legal costs.   By way of rough guidance, budget $3,000  to $7,500 for an equity round of financing or a bank debt financing.  If the start-up is financed by shareholder loans, the cost will be much less i.e. $500 to $2,500, depending upon various factors including whether or not the shareholder will take security over the assets of the business.

Shareholder Agreement

If the business we incorporate for you is a professional corporation or a single owner-operator business, you will not need a shareholders agreement.  However, if there are multiple arms-length shareholders, we strongly recommend a shareholders agreement.  Since shareholders’ agreements are long and tend to be reviewed and revised extensively to suit the business shareholders’ preferences, lawyers typically charge anywhere from $1,500 to $5,000 to prepare a shareholders agreement.

Next Steps 

If you are starting a new business, we would be pleased to give you a more precise idea of how much to budget for legal fees.    We don’t charge for this valuable service and, best of all, if we give you a quote and you go forward with us, you can rest assured that, barring rare extraordinary situations, your ultimate bill will be the amount we quoted.  No unpleasant surprises.

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Oct 20

Investors: Get Legal Advice and Representation Before You Invest

Recently we were consulted by a doctor (here, we’ll call him the “Investor”) that had made a large investment (i.e. >$500k) into a property development project.   The client was concerned that nearly 3 years had past since he wrote the large cheque and the property remained undeveloped.   He wanted to know his options for confirming the developer was diligently working on the project and, if not, how he could get his his money back.

My first question to the Investor was “Did you have a lawyer represent you on the investment?”  I asked this question for two reasons: 1) the structure of the investment was more likely to be in his favour if he had legal representation and 2) if he was represented by a business lawyer or attorney and still wasn’t protected correctly he may have a recourse to the lawyer’s insurance policy if the investment was bad.  Secondly, I asked the Investor to show me all the “paper” that was given to him and/or signed as part of his investment.  In the case of an equity investment, I want to see the term sheet, subscription agreement, share certificates, articles of incorporation of the company in which in the investment was made and any other documents that were exchanged as part of the investment.  In the case of a loan investment, I want to see the term sheet (if any), the loan agreement and/or promissory note, the general security agreement, mortgage, etc…  In either case, for the company in which the investment was made I want to review all available financial statements, bank statements, property title documents, ppsa reports, etc…    The contents of these documents determine an investor rights and remedies.

In the case of our doctor client, a lawyer did prepare the transaction documents, which included a shareholders agreement, subscription agreement and share certificates.  This same lawyer  incorporated a company for the doctor to use for his investment.  Did this lawyer represent the doctor on the investment?  The doctor-investor may have thought so, but the typical protections were absent from the documents we examined.  Specifically, the shareholders agreement did not require the investor shareholder’s approval of any corporate action nor did it give our investor a way out.    Moreover, the investment itself was structured as an equity investment rather than debt and, accordingly, the investor did not have any security over the property to be developed.

We have yet to determine if our doctor client will lose his investment, but this case highlights the importance of getting good legal advice and legal representation before investing.

 

 

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Jul 18

Crowdfunding in Canada

Crowdfunding is a high profile means of raising seed capital for start-ups.   Services such as kickstarter and indiegogo are frequently looked to by Canadian companies as potential funding vehicles.   Unfortunately, raising money by crowdfunding services such as these is not a viable option for most Canadian start-up businesses.   The reason being that the investment model of crowdfunding, sometimes referred to as “equity crowdfunding” – where funders provide money in exchange for equity or debt in the start-up company – violates Canadian securities laws.  On the other hand, the rewards model of crowdfunding, where funders provide seed money in exchange for a non-financial benefit, such as a pre-order of a new product or service like a watch or a phone app., do not generally violate Canadian securities laws.   In a nut shell, crowdfunding is only an option if your start-up business model lends itself to the rewards model of crowdfunding.

Canadian companies raising capital by issuing equity or debt to investors – regardless of whether the funding round is seed financing, angel investment or second round financing – must continue to comply with the capital raising prospectus exemptions available in their jurisdiction and the jurisdictions of their investors.   The most frequently relied upon exemptions being: accredited investor exemption, family, friends and business associates exemption, private issuer exemption and offering memorandum exemption.  These exemptions are available only if the company seeking the investment and the investor fit squarely within the capital raising exemption criteria.

There is reason to be optimistic that some form of equity crowdfunding will eventually be permitted in Ontario.    The Ontario Securities Commission (OSC) is reviewing the rules regulating equity and debt financing in Ontario and this review includes the consideration of the adoption of a prospectus exemption to permit crowdfunding.   Essentially, Ontario is following the Jumpstart Our Business Startups Act (the JOBS Act)  recently enacted by the U.S. Congress in April 2012, which will allow non-accredited or non-sophisticated investors to buy small equity stakes in companies without going through the costly process of preparing and filing a prospectus.   (The JOBS Act is currently waiting on more detailed rulemaking by the SEC).   However, such optimism should be tempered because even if the OSC does eventually adopt an equity crowdfunding prospectus exemption, unless other provinces in Canada adopt a similar exemption, it will only help companies in Ontario raise seed financing from investors in Ontario.

For more information, give us a call or send us an email.

Phone: 613 869 5440
Email: koby@lawyercorporation.ca

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May 13

Why is an Offering Memorandum rarely used to raise money in Ontario?

An “offering memorandum” (“OM”) is a disclosure document intended to provide investors with the ability to make an informed investment decision.

A client recently approached us wanting to use an offering memorandum to raise money in Ontario.  Our advice was to suggest the company use a term sheet, which is a bare bones description of the financing and use of proceeds, and a subscription agreement and not to use an offering memorandum.  Here’s why:

First, all Canadian provinces except Ontario have an “offering memorandum” prospectus exemption.   In Ontario, a company can provide its potential investors with an offering memorandum, but there is no offering memorandum exemption.  Even if the company prepares and provides investors with an offering memorandum, the client would need to rely on  prospectus exemption to offer and sell its securities – typically, the “accredited investor” exemption.

Generally, for individual investors to qualify as an accredited investor, the individual must be:

  • an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1 000 000,
  • an individual whose net income before taxes exceeded $200 000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300 000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year, Unofficial consolidation for financial years beginning on or after January 1, 2011,
  • an individual who, either alone or with a spouse, has net assets of at least $5 000 000.

Second, although the level of disclosure in an OM is less than that required in a prospectus offering, preparing an OM is onerous.  The format and contents of the offering are set out in Form 45-106F3.  As the April 26, 2012, Canadian Securities Administrators’ guidance demonstrates, the expectations are high for an issuer’s disclosure included in an offering memorandum.  See Form 45-106F3 and also see Multilateral CSA Staff Notice 45-309 Guidance for Preparing and Filing an Offering Memorandum under National Instrument 45-106 Prospectus and Registration Exemptions; and CSA Staff Notice 45-308 Guidance for Preparing and Filing Reports of Exempt Distribution under National Instrument 45-106 Prospectus and Registration Exemptions.

Third, under the offering memorandum exemption, subscribers in Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island and Saskatchewan have statutory rights of action that must be described in the offering memorandum distributed to them. Subscribers in Alberta, British Columbia, and Québec will be entitled to contractual rights of action for damages or rescission similar to the statutory rights provided to purchasers in Ontario.  These rights are in addition to, and do not derogate from, any other right or remedy that purchasers may have at law.

Section 5.2 of Ontario Securities Commission Rule 45-501 – Ontario Prospectus and Registration Exemptions provides such investors who purchase securities offered by an OM with a statutory right of action against the issuer of securities for rescission or damages in the event that the offering memorandum and any amendment to it contains a “misrepresentation”. The term misrepresentation” is defined to mean an untrue statement of a material fact or an omission to state a material fact that is required to be stated or that is necessary to make any statement not misleading in the light of the circumstances in which it was made. These remedies, or notice with respect to these remedies, must be exercised or delivered, as the case may be, by the purchaser within the time limits prescribed by applicable securities laws.  If the purchaser elects to exercise the right of rescission, he must do so not more than 180 days after the date of the transaction; or, in the case of any action other than an action for rescission, the earlier of: (i) 180 days after the plaintiff first had knowledge of the facts giving rise to the cause of action, or (ii) three years after the date of the transaction that gave rise to the cause of action.

 

The bottom line for clients is that preparing an offering memorandum is costly and increases their liability exposure and they will still need to rely on another prospectus exemption if they wish to accept investment from Ontario residents.  

 

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