Ten Key Considerations for Growth Equity Investments in Canada: Part 3 | Stikeman Elliott LLP
As growth equity investment strategies gain prominence in global private equity fundraising and institutional capital allocation, we have seen an increase in this type of investment in Canadian companies, particularly by U.S. and other non-Canadian private equity and growth equity funds interested in mid-stage companies in software, technology and other high growth industries.
Non-Canadian investors interested in making these types of investments should be aware of some unique features of the applicable legal regimes and market practices in Canada. Topics considered in the previous posts in the series include:
- First post: primary vs. secondary transactions; key Canadian taxation issues.
- Second post: foreign investment and merger review; corporate structures and transaction documentation).
In the final installment in this three-part series, we look at the last four of our ten key considerations:
- Shareholder approval considerations
- Employment considerations
- Corporate transparency
- Working with existing investors
7. Shareholder Approval Considerations
Where the negotiated terms of a growth equity investment require changes to a company’s shareholders’ agreement and other fundamental organizational documents, it is often preferable to have all of the company’s existing investors sign-on to the amendments. When that is not feasible, it may be possible to rely on mechanisms in the company’s existing documents to amend them without unanimity or certain statutory mechanisms that can be used to effect transactions via approval from two-thirds of a company’s shareholders voting at a meeting.
8. Employment Considerations
There are certain distinctive aspects of the employment regime in Canada that foreign investors should be aware of when assessing opportunities and structuring transactions.
Restrictive covenants, such as non-compete and/or non-solicitation obligations, can be important tools for protecting the interests of the company’s business. However, introducing new, enforceable, restrictive obligations into an employment relationship in Canada can be difficult. Due diligence of existing restrictive obligations in respect of key employees is therefore important to assess the nature of any risk that potential departures could pose. Where growth equity investments involve secondary transactions, if key employees are participating as selling securityholders, an investor can also use this as an opportunity to introduce restrictive covenants outside the employment relationship.
There is no concept of “at will” employment in Canada and accordingly, in terminating the employment of an employee without cause, an employer must provide notice of termination or pay in lieu of notice to the employee in accordance with applicable provincial employment standards legislation and, in the case of non-unionized employees, at common law (which can be quite significant, particularly for employees with seniority). However, written employment contracts may circumscribe the applicable notice or pay in lieu of notice so long as the notice is not less than that which is required by minimum employment standards legislation. If any sort of post-closing restructuring of the business is contemplated, investors should pay close attention to the severance liabilities that may be triggered.
9. Corporate Transparency
The Canadian federal government and various provincial governments have been pursuing corporate transparency objectives in recent years. Federally incorporated corporations are now required to maintain registers of individuals with significant control. These registers are private, but available to law enforcement, tax and other governmental and quasi-governmental authorities. With the exception of Alberta, all of the other provinces have adopted, or are in the process of adopting, similar regimes. Québec’s regime – one of those that is not yet in force – is closer to European models than the others and will apply to any corporation, partnership or trust operating a commercial enterprise in that province (regardless of its jurisdiction of formation). It will also give the public online access to reported ultimate beneficial owner information.
The Canadian federal government had also announced its intention to launch a public registry of individuals with significant control by the end of 2023 and, in the meantime, has introduced amendments to the existing regime that will, when in force, require corporations to file information regarding their individuals with significant control with Corporations Canada annually and in connection with certain changes (although such information will not be accessible to the public, at least at the outset).
Investors in Canadian companies should be aware that, if their investments exceed certain thresholds (generally 25%), they (or, if they are not individuals themselves, their own significant investors or controlling individuals) may be subject to having their identities and certain additional personal information disclosed in filings that while initially private may in future be made public (depending on the governing jurisdiction).
10. Working With Existing Investors
Our final consideration, while not unique to Canada, is highly important. Balancing the interests of founders and other existing investors with those of new investors who may have different time horizons or other expectations can be one of the challenges for a company seeking growth equity financing. Given the possibility for such varying expectations to derail negotiations, both founders and growth equity investors can benefit from being forthright about their expectations, particularly in respect of post-closing control and governance matters, from the outset.
Furthermore, taking on new investors often involves granting new investor rights and potentially limiting the rights granted to outside investors on prior rounds. As such, it is important for these companies to involve their key existing investors in the growth equity fundraising process and to manage their expectations. Companies should also consider the possibility of such competing interests when conducting earlier stage financing rounds or when issuing shares to employees, and include mechanisms that will help to simplify future fundraising.