Ontario based investors who want to pool their resources into a private equity or venture capital fund need to follow some rules before proceeding. This post will describe some basic rules such PE/VC funds must follow to avoid compliance headaches.
Generally, the Ontario government want to protect the average retail investor from fraud and investments they don’t understand. And so, there are various rules about which investments can be offered to investors.
But, to foster business formation and innovation, the government also wants to encourage capital investment. So, there are a special set of rules for investors into private equity and venture capital funds.
Basically, a fund that (i) does not permit redemption on demand at net asset value, and (ii) invests for the purpose of exercising control over and actively managing the issuers in which it invests (other than another investment fund) may be considered ca private equity or venture capital fund.
The Canadian securities regulators have provided guidance which indicates that funds that generally engage in private equity or venture capital (“PE/VC”) investing will not be considered to be investment funds and that the managers of PE/VC funds will not be required to register as investment fund managers. In this regard, the Canadian securities regulators have identified certain characteristics typical of PE/VC investment:
- PE/VC funds typically raise money under one of the prospectus exemptions in National Instrument 45-106 (Prospectus and Registration Exemptions), including for trades to “accredited investors”;
- investors in PE/VC funds typically agree that their money will remain invested for a period of time;
- PE/VC funds typically use the money raised from investors to invest in the securities of portfolio companies that are not publicly traded;
- PE/VC funds usually become actively involved in the management of their portfolio companies, often over several years, and in this respect examples of active management of a portfolio company include circumstances when a PE/VC fund has: (i) representation on the board of directors, (ii) direct involvement in the appointment of managers, and/or (iii) a say in material management decisions;
- a PE/VC fund looks to realise on its investment either through a public offering or a sale of business, at which point the investors’ money will generally be returned to them, along with any profit;
- investors rely on the expertise of the PE/VC fund and its manager to select and manage the portfolio companies it invests in; and
- a PE/VC fund manager typically receives a management fee and carried interest in the profits generated from its investments and does not receive compensation for raising capital or trading in securities.
Venture capital and private equity investment funds offer a unique opportunity for innovation and growth in Ontario’s economic landscape. Understanding the intricate rules that govern these funds is crucial for investors and fund managers alike to avoid compliance issues and capitalize on their investments effectively.