Securities law when you sell the shares of a private company

A share sale looks like a contract between a seller and a buyer. Securities legislation sees a trade in securities as well, and a trade that would be a distribution needs a prospectus unless an exemption applies. Whether that matters to you depends on who is selling, who is buying and what the shares were issued under. This guide sets out the questions, using the Securities Act (Ontario) and the national instruments as the Ontario Securities Commission publishes them. It does not describe any other province’s statute; check the rules where you are.

Why a share sale raises a securities question

Section 53(1) of the Securities Act (Ontario) says no person or company shall trade in a security, on their own account or for another, if the trade would be a distribution of the security, unless a preliminary prospectus and a prospectus have been filed and receipts issued. The Act’s definition of distribution is not limited to a company issuing new shares. Among other things, it covers a trade in previously issued securities of an issuer from the holdings of any control person, a term the Act defines. Ask your lawyer early whether the sale you are planning falls inside the definition.

Where the private issuer exemption fits

National Instrument 45-106 sets out the prospectus exemptions. Section 2.4 covers a private issuer, which it defines as an issuer that is not a reporting issuer or an investment fund, whose securities, other than non-convertible debt securities, are subject to restrictions on transfer contained in its constating documents or security holders’ agreements and are beneficially owned by not more than a stated number of persons, not counting employees and former employees of the issuer or its affiliates, and which has distributed its securities only to persons in the categories listed in s.2.4(2) (the definition also allows for a completed transaction). Under s.2.4(2), the prospectus requirement does not apply to a distribution of a security of a private issuer to a person who purchases as principal and falls within the listed categories. Section 2.4(3) says that, except for a distribution to an accredited investor, no commission or finder’s fee may be paid to any director, officer, founder or control person of the issuer in connection with that distribution. Section 2.4(5) says subsection (2) does not apply in Ontario; there, s.73.4(2) of the Securities Act provides a similar exemption. Ask whether your company meets the definition and whether your buyer fits a listed category.

The buyer’s resale and what travels with the shares

National Instrument 45-102 deals with resales. Section 2.5(1) says that, unless the conditions in subsection (2) are met, a trade specified as subject to that section is a distribution. Separately, the first trade of securities issued by a private company or private issuer, made after the issuer has ceased to be one, is a distribution unless the listed conditions are satisfied, and those include that the issuer is a reporting issuer and has been for the four months before the trade. The instrument also defines a control distribution by reference to a list of provisions in its appendix. If the buyer plans to resell, ask whether the shares will carry a legend. Our entry on the legend on restricted securities explains it.

Reports of exempt distribution

Section 6.1(1) of National Instrument 45-106 requires issuers that distribute their own securities, and certain underwriters, to file a completed report if they make the distribution under one or more of the exemptions the subsection lists, subject to s.6.1(2) and s.6.2. Section 6.1(2) says the report must be filed in the jurisdiction where the distribution takes place no later than 10 days after the distribution. The Canadian Securities Administrators say the report is Form 45-106F1, filed through SEDAR+. The obligation is written for the issuer distributing its own securities, so it is a different question from a shareholder selling shares they already hold. If the deal also includes new shares issued by the company, ask your lawyer whether a report is required and who files it.

Transfer restrictions are a separate layer

A private company’s own documents can also restrict a sale. Under s.173(1) of the Canada Business Corporations Act, subject to ss.176 and 177, the articles of a corporation may by special resolution be amended to add, change or remove restrictions on the issue, transfer or ownership of shares. National Instrument 45-106 also refers to restrictions contained in security holders’ agreements, so ask whether you have one. These restrictions come from corporate documents, not from the securities regulators, and a sale has to satisfy both. They also matter for the private issuer definition above, which refers to restrictions contained in constating documents or security holders’ agreements. Ask your lawyer to read the articles and any shareholder agreement alongside the securities questions, because the answers feed each other: National Instrument 45-102 treats a first trade after an issuer ceases to be a private issuer differently, so a sale that changes the company’s status needs checking before closing. For a wider walk-through of the sale itself, see our guide on how to sell the shares of a privately held company.

• Is the company a private issuer under s.2.4 of National Instrument 45-106, and is it a reporting issuer anywhere?
• Is the sale a trade from a control person’s holdings, which the Securities Act (Ontario) treats as a distribution?
• Does the buyer fit a category in an exemption you can rely on, and who confirms that in the agreement?
• What do the articles, by-laws and any shareholder agreement say about transfers and approvals?
• Will the shares carry a legend, and what is the buyer allowed to do with them afterwards?