So you've got yourself a business but you will still need money, or financing, to run your business. There are two ways to obtain that money: through borrowing (debt-financing) or through equity (non-debt financing). In this article, I will explain these concepts and set out what you should consider to determine what form of financing is most suited to your business needs.
Equity Financing: Equity refers to a right of ownership in your business. That right is generally directly proportional to the amount of money or property contributed into the business. Equity usually also reflects a person's ability to control the business and profit from its success.
Equity Financing is therefore a contribution of capital in exchange for a right of ownership in your business and your financier becomes an investor in your business.
Sources of Equity Financing: Yourself, of course. Your friends and family. Third Parties. Banks and Institutions. Government. You should know, however, that securities law in Canada prohibits you from making public offerings of securities (including shares in a company) unless you comply with applicable registration and prospectus requirements.
A Note on Securities Legislation
The Private-Company Exemption: If you do not propose to offer your securities to the public (interestingly enough, the legislation does not define public.) and your company's articles contain the relevant private-company restrictions (restrictions on share transfers, limit the number of shareholders etc.), you are generally exempt from registration and prospectus requirements. These private company restrictions appear in the articles on most small businesses.
So, if you incorporate a company and issue shares only to yourself or a a limited number of shareholders with whom you are personally acquainted and that are in the business with you then, arguably, you are not offering shares to the "public".
Private Placements: In the event that your business requires a large sum of money and you wish to raise this by offering securities but without having to go through the registration (as an issuer) or preparing a prospectus, you may wish to consider a private placement of your securities.
Securities legislation acknowledges that a detailed disclosure document (such as a prospectus) would be redundant in circumstances where the prospective purchasers were all sophisticated investors or in which the offer to buy securities was made to a limited number of people (usually no more than 50) and an actual sale to no more than 25 took place. In such circumstances, companies can avail of certain exemptions which exempt them from registration and prospectus requirements. You instead provide your investors with a document known as an Offering Memorandum. An offering memorandum is not a public document and need only be presented to potential investors. This is a significant advantage where privacy is a concern.
Lastly, raising capital by way of a private placement allows you to maintain the tax benefits associated with private-company status.
I will talk about Debt Financing in my blog next week! Stay tuned.
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