The Accredited Investor Exemption under NI 45-106

Nick Wright, BA JD MBA LLM (Tax)
Wright Business Law

The accredited investor exemption is the cornerstone of Canada’s exempt market. Every year, Canadian issuers raise billions of dollars from accredited investors without filing a prospectus, making the exemption one of the most important capital raising tools available to private companies, investment funds, real estate issuers, mortgage investment corporations (MICs), and private real estate investment trusts (REITs).

For many businesses, the accredited investor exemption provides a practical alternative to the time and expense associated with preparing and obtaining a receipt for a prospectus. It allows issuers to access capital from investors who meet prescribed financial or institutional criteria and are generally considered capable of assessing investment risks without the protections afforded by a prospectus.

The exemption, however, is frequently misunderstood. Some issuers assume that a signed subscription agreement is sufficient to establish compliance. Others mistakenly believe that the exemption eliminates dealer registration requirements or permits unrestricted capital raising without regulatory oversight. Neither assumption is correct.

This article explains how the accredited investor exemption operates under National Instrument 45-106 Prospectus Exemptions (“NI 45-106”), who qualifies as an accredited investor, and how issuers typically rely on the exemption when conducting Canadian private placements.

What Is the Accredited Investor Exemption?

Canadian securities legislation generally prohibits an issuer from distributing securities unless a prospectus has been filed and receipted by the applicable securities regulator or a prospectus exemption is available.

The accredited investor exemption, found in section 2.3 of NI 45-106, is one of the principal exemptions from the prospectus requirement. It permits an issuer to distribute securities without a prospectus where the purchaser qualifies as an accredited investor within the meaning of NI 45-106 and the issuer satisfies the other applicable requirements of securities legislation. The definition of “accredited investor” is set out in section 1.1 of NI 45-106 and includes a broad range of individuals, corporations, institutional investors, investment funds and other qualifying entities.

The exemption is available to a wide range of issuers, including:

• private corporations;
• start-up and growth companies;
• investment funds;
• mortgage investment corporations;
• real estate investment trusts;
• limited partnerships;
• family office investment vehicles; and
• reporting issuers conducting exempt financings.

Likewise, the exemption can be used to distribute virtually any type of security, including common shares, preferred shares, limited partnership interests, trust units, debt securities, convertible securities and warrants.

Although the exemption eliminates the requirement to prepare a prospectus, it does not eliminate the application of securities legislation more generally. Issuers must still comply with applicable filing requirements, resale restrictions, anti-fraud provisions and, where applicable, dealer registration requirements.

The exemption is therefore best understood as a prospectus exemption rather than a general exemption from securities regulation.

Why Does the Accredited Investor Exemption Exist?

Canadian securities regulation is founded on investor protection. A prospectus is intended to provide prospective investors with comprehensive disclosure regarding an issuer’s business, financial condition, management, risks and securities being offered.

Preparing a prospectus is often costly and time-consuming. For many private issuers seeking to raise capital from sophisticated investors, the burden of preparing a prospectus would make smaller financings commercially impractical.

The accredited investor exemption reflects the policy judgment that certain investors require less regulatory protection than members of the general public. These investors generally possess one or more of the following characteristics:

• substantial financial resources;
• investment experience;
• access to professional legal, accounting or investment advice;
• institutional investment expertise; or
• sufficient bargaining power to obtain additional information directly from the issuer.

The exemption therefore facilitates capital formation by allowing issuers to raise funds efficiently while limiting the exemption to investors who satisfy prescribed financial or institutional criteria.

For investment funds, private equity funds, venture capital funds and real estate investment vehicles, the accredited investor exemption frequently serves as the primary method of distributing securities in Canada.

Who Qualifies as an Accredited Investor?

The definition of “accredited investor” in NI 45-106 is extensive and includes numerous categories of purchasers. Rather than memorizing each category, issuers should understand that accredited investors generally fall into four broad groups: qualifying individuals, institutional investors, qualifying entities, and certain investment funds and managed accounts.

Individuals

Many private placements rely on individual accredited investors. An individual may qualify under several different financial tests.

The first is the financial assets test. An individual qualifies if they alone, or together with their spouse, beneficially own financial assets having an aggregate realizable value exceeding $1 million before taxes, net of any related liabilities. Financial assets generally include cash and securities, but do not include personal residences, recreational property or other non-financial assets.

The second is the income test. An individual qualifies if they earned net income before taxes exceeding $200,000 in each of the two most recent calendar years, or combined income with a spouse exceeding $300,000 in each of those years, and reasonably expect to reach the same income level during the current year.

A third category applies to individuals who, either alone or together with a spouse, have net assets of at least $5 million. Unlike the financial assets test, this category considers overall net assets rather than only financial assets.

Importantly, these tests are distinct. Financial assets, net assets and income each have different meanings under NI 45-106, and issuers should avoid treating them as interchangeable.

Institutional Investors

Many institutional purchasers automatically qualify as accredited investors.

These include, among others, registered advisers, registered dealers, certain governments, pension funds, trust companies, financial institutions, and other regulated market participants identified in the definition. These entities are generally considered sufficiently sophisticated to evaluate investment opportunities without the protections associated with a prospectus.

Institutional investors frequently participate in financings involving private equity funds, infrastructure funds, commercial real estate projects and exempt market offerings.

Corporations, Trusts and Other Entities

Corporations and other non-individual entities may also qualify.

For example, a corporation that has net assets of at least $5 million, as shown on its most recently prepared financial statements, generally satisfies one category of accredited investor. Likewise, certain trusts, partnerships and entities whose owners are themselves accredited investors may also qualify under the definition.

This is particularly important for family investment corporations, holding companies, special purpose vehicles and institutional investment structures that regularly participate in private placements.

Investment Funds and Managed Accounts

The definition also encompasses various investment funds and fully managed accounts.

Certain investment funds qualify because of the manner in which they distribute their own securities, while others qualify because they are advised by registered advisers. Fully managed accounts managed by appropriately registered advisers or trust companies may also qualify as accredited investors under specified categories of the definition.

These categories recognize that professional investment managers possess the expertise necessary to evaluate investment opportunities on behalf of their clients.

How Issuers Use the Accredited Investor Exemption

In practice, reliance on the accredited investor exemption is relatively straightforward, provided the issuer approaches the process carefully.

A typical private placement begins by identifying prospective purchasers who are expected to qualify as accredited investors. The issuer or its exempt market dealer then determines the category under which each purchaser qualifies and obtains information necessary to establish a reasonable basis for relying on the exemption.

If the purchaser qualifies, the parties negotiate and execute the subscription documentation, the securities are issued, and the issuer completes any required post-closing regulatory filings, including the report of exempt distribution where applicable.

Many financings involve purchasers qualifying under different accredited investor categories. One investor may qualify based on financial assets, another because it is a corporation with more than $5 million in net assets, and another because it is a registered portfolio manager or investment fund. Provided each purchaser independently satisfies an available category, the issuer may rely on the exemption for each distribution.

The accredited investor exemption is also frequently used alongside other prospectus exemptions. For example, an issuer may sell securities to accredited investors under section 2.3 of NI 45-106 while simultaneously relying on the family, friends and business associates exemption or the offering memorandum exemption for other purchasers participating in the same financing. Each purchaser, however, must independently satisfy the requirements of the exemption relied upon for that distribution.

While the exemption offers considerable flexibility, issuers should remember that qualification is only the first step. Proper verification, record-keeping and compliance procedures remain essential to demonstrating that the exemption was validly available if the financing is later reviewed by securities regulators.

Verifying Accredited Investor Status

One of the most important aspects of relying on the accredited investor exemption is verifying that each purchaser actually qualifies. The person relying on the exemption is responsible for determining whether the conditions of the exemption have been satisfied.

This is an area where issuers often make mistakes. A common misconception is that obtaining a signed subscription agreement in which the purchaser checks a box or represents that they are an accredited investor is sufficient. Although purchaser representations remain an important part of the subscription process, they should not be the issuer’s only evidence that the exemption was available.

The Companion Policy to NI 45-106 makes it clear that sellers should take reasonable steps to verify a purchaser’s status. What constitutes reasonable steps will depend on the particular facts, including the nature of the purchaser, the accredited investor category being relied upon, the issuer’s knowledge of the purchaser, and the circumstances of the offering.

For example, where an individual qualifies based on income or financial assets, the issuer should understand which qualification category applies and ask questions sufficient to establish that the purchaser meets the applicable threshold. If the purchaser’s responses raise concerns or appear inconsistent, additional inquiries may be appropriate. In some circumstances, independent documentation may be warranted to support the purchaser’s representations.

The verification process should also be documented. Depending on the circumstances, issuers may retain subscription agreements, accredited investor certificates, correspondence with purchasers, meeting notes, due diligence records, or other documentation demonstrating the basis on which the issuer concluded that the exemption was available.

The objective is to ensure that the issuer can demonstrate, if questioned by securities regulators, that it exercised reasonable care before relying on the exemption.

Dealer Registration Considerations

The accredited investor exemption removes the requirement to file a prospectus. It does not eliminate dealer registration requirements. This distinction is frequently misunderstood.

National Instrument 45-106 addresses prospectus exemptions. Registration requirements are governed primarily by National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations. As the Companion Policy explains, a person may still be required to register as a dealer, adviser or investment fund manager, notwithstanding the availability of a prospectus exemption.

Whether registration is required depends upon the nature of the activities being conducted rather than the exemption relied upon. For example, a person that is in the business of trading securities may require dealer registration even if every purchaser qualifies as an accredited investor.

Similarly, investment fund managers and portfolio managers should separately consider their registration obligations under applicable securities legislation.

Accordingly, issuers should avoid assuming that reliance on the accredited investor exemption resolves all regulatory issues associated with a financing. Prospectus compliance and registration compliance are separate analyses.

Do You Need a Private Placement Memorandum?

Unlike the offering memorandum exemption, the accredited investor exemption does not require an issuer to prepare or deliver a prescribed disclosure document.

Nevertheless, many issuers voluntarily prepare a private placement memorandum (“PPM”), particularly where they are raising larger amounts of capital or offering securities to institutional investors.

A well-prepared PPM can serve several purposes. It explains the issuer’s business, investment objectives, management team, material risks and use of proceeds, while providing investors with information necessary to evaluate the investment opportunity. It also promotes consistency of disclosure by ensuring that all prospective investors receive substantially the same information.

For investment funds, real estate funds and other professionally managed offerings, a comprehensive PPM is often expected by sophisticated investors, even where no legal requirement exists to provide one.

Issuers should appreciate, however, that voluntarily preparing a PPM does not eliminate liability for inaccurate or misleading disclosure. Any offering document should be prepared with the same care and diligence applied to other material disclosure documents.

Common Compliance Issues

Although the accredited investor exemption is widely used, compliance issues frequently arise during private placements.

One common mistake is confusing the various financial qualification tests. Financial assets, net assets and income are distinct concepts under NI 45-106, and an individual may satisfy one test without meeting another.

Another frequent issue is relying exclusively on standardized subscription agreement representations without conducting an appropriate verification process. As discussed above, securities regulators expect issuers to take reasonable steps to establish that purchasers satisfy the exemption being relied upon.

Some issuers also overlook the relationship between prospectus exemptions and registration requirements. Completing a financing exclusively with accredited investors does not necessarily eliminate the need to consider dealer registration or other regulatory obligations.

Finally, inadequate record-keeping can create unnecessary regulatory risk. Even where purchasers clearly qualify as accredited investors, an issuer may encounter difficulty demonstrating compliance if it has failed to retain appropriate documentation supporting its reliance on the exemption.

Careful planning before the offering begins is generally far more effective than attempting to reconstruct compliance records after a financing has closed.

Frequently Asked Questions

Do I need an offering memorandum to rely on the accredited investor exemption?

No. The exemption does not require an offering memorandum or any other prescribed disclosure document. Many issuers nevertheless prepare a private placement memorandum to facilitate investor due diligence and promote consistent disclosure.

Can an issuer rely on more than one prospectus exemption?

Yes. A single financing may involve multiple prospectus exemptions. For example, some purchasers may qualify as accredited investors while others invest under the offering memorandum exemption or another available exemption. Each purchaser must independently satisfy the requirements of the exemption relied upon.

Can an issuer advertise an offering made under the accredited investor exemption?

The accredited investor exemption does not prohibit advertising. However, issuers should ensure that any marketing activities comply with applicable securities laws, accurately describe the intended investor category and do not contain misleading statements. The Companion Policy contemplates solicitation of accredited investors provided that the solicitation clearly identifies the intended class of investors.

What happens if a purchaser does not qualify?

If no prospectus exemption is available for a particular purchaser, the issuer generally cannot distribute securities to that purchaser without filing a prospectus or relying on another exemption. Issuers should therefore confirm purchaser eligibility before accepting subscriptions.

Does the accredited investor exemption remove resale restrictions?

No. Securities acquired under the exemption may remain subject to applicable resale restrictions under Canadian securities legislation. Issuers and purchasers should consider those restrictions before completing the transaction.

Conclusion

The accredited investor exemption is the foundation of most Canadian private placements. It provides issuers with an efficient means of raising capital without preparing a prospectus while recognizing that certain investors possess the financial resources or institutional sophistication to evaluate investment opportunities independently.

Successful reliance on the exemption, however, requires more than confirming that a purchaser falls within one of the accredited investor categories. Issuers should understand the applicable qualification criteria, take reasonable steps to verify purchaser status, maintain appropriate records, and separately consider any registration obligations that may arise under Canadian securities legislation.

For private companies, investment funds, REITs, MICs and other exempt market participants, careful implementation of the accredited investor exemption remains an essential component of a compliant and efficient private placement.

Book a Consultation

If you are structuring a private placement or assessing the availability of the accredited investor exemption under NI 45-106, contact us to schedule an initial consultation with Nick Wright.