Top considerations for investing in a Canadian business

Canada is home to a strong and rapidly growing, start-up scene with notable hot spots in Vancouver, Toronto, Kitchener-Waterloo and Ottawa. Over the past few years, Canada has cultivated a thriving start-up culture with incubators, tax incentives and special visas. It is a major contender for technology talent globally. While there are some differences, there is great similarity between investing in the US and Canadian businesses. This article provides a brief overview for US investors considering an investment in a Canadian business.

The transaction

Like in the US, a transaction would ‎typically start with a Term Sheet and then move to the other main documents which include: amended articles (in the US, charter), ‎subscription agreement or share purchase agreement  and shareholder agreements, either the Canadian-style single agreement or the US style three agreements.

Documents

The Canadian Venture Capital Association has form documents such as the share purchase agreement, articles, term sheet and shareholder agreements, which are modeled after the National Venture Capital Association (“NVCA”) documents, modified where necessary to conform to Canadian law.

These documents capture all the applicable protections including rights of first refusal, drag along rights, voting rights and information rights. Notwithstanding these similarities, the documents are still subject to the Canadian legislative landscape and case law which would impact any interpretation of the commercial agreements.

Diligence

Similar diligence is conducted in Canada as in the US. Counsel would typically conduct a minute book review, conduct a standard suite of searches (including liens and IP) ‎and a review of any material contracts.

Terminology

Different terminology is used in Canada versus in the US. For example, stock and stockholder, as used in the US, would be share and shareholder, respectively in Canada. Other key differences are set out in the conversion chart below:

Corporate law

The corporate law regime with respect to principles like fiduciary duties is similar to what’s in place in the US and more specifically, Delaware. However, there are differences and Canadian corporate counsel should be consulted at the appropriate time.

Structuring the investment vehicle

Typically, investors from the US don’t need, or want, to setup a separate investment ‎vehicle to invest in Canadian businesses.  However, if the US investor is an LLC, it might consider putting a US holding company in place to reduce withholding tax on ‎dividends. Tax considerations are an important component of the analysis, and a tax advisor should be consulted at the appropriate time.

Director residency requirements

There are additional considerations if a board seat is secured as part of the investment. In some ‎Canadian jurisdictions, a certain number of ‎’resident’ Canadian directors is required. For federally ‎incorporated corporations and corporations formed in Saskatchewan, Manitoba, and ‎Newfoundland and Labrador, at least 25% of the directors must be resident Canadians (or 1 ‎director, if the board has fewer than four members). Some provinces have no resident Canadian ‎director requirements, such as British Columbia, Nova Scotia, Prince Edward Island, New ‎Brunswick, Quebec, Alberta, and most recently, Ontario.‎

Regulatory implications & government approvals

Investments by non-Canadians to establish a new Canadian business or acquire control over an existing Canadian business are either notifiable or reviewable under the Investment Canada Act (“ICA”), which is Canada’s foreign investment regime. Apart from the national security regime, the ICA does not apply unless the investment involves an “acquisition of control” of  a Canadian business by a non-Canadian. Of key importance is that the threshold to constitute an “acquisition of control” is high and will not be reached in most cases of investment. However, whether an investment is reviewable turns on many factors and corporate counsel should be consulted at the appropriate time.

Government assistance programs*

The Canadian Federal Government offers tax incentives such as the Scientific Research and Experimental Development Tax Incentive Program (“SRED”) that provide support in the form of tax credits and/or refunds to corporations, partnerships or individuals who conduct scientific research or experimental development in Canada. The corporation is required to be a Canadian-controlled private corporation or else it loses access to any applicable SRED credits.

Pre-closing reorganizations

It is possible (even, common) for a corporation to undergo a “reorganization” prior to a major investment to take advantage of certain other tax planning opportunities that are available in Canada for founders and owners of closely-held businesses.

Canada has made significant progress to establish itself as a major player in the technology and start-up landscape and is home to a thriving start-up culture. US investors considering an investment in a Canadian business should take comfort in the fact that both marketplaces, as it pertains to investments, are relatively similar and easily navigated with the assistance of Canadian counsel.

*This is more relevant to an acquisition.

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