Despite a recent cooling in the overall investment climate, the number of active U.S. venture investors in Canada has more than doubled over the past five years. This migration north coincides with a climb in overall venture investment activity in Canada, increasingly challenging pricing on U.S.-based deals and a lower Canadian dollar, which depreciated extensively over the same period. According to PitchBook, more than one-third of all venture-backed deals in Canada in 2015 involved foreign capital, and the number of deals that U.S. firms have participated in have more than tripled over the past five years from 44 in 2010 to 143 in 2015.
With significant talent in large entrepreneurial hubs, such as Vancouver and Toronto, and lucrative exits from several reputable Canadian startups (e.g., Shopify’s debut on the NYSE and ProNAi Therapeutics’ public offering), U.S. venture firms are beginning to respond to the value and opportunities that exist in Canada.
Canadian corporate law will seem relatively familiar to active U.S. investors, though there are several key distinctions that U.S. investors should consider prior to making an investment north of the border. Below is a high level summary of some of the most important differences between U.S. and Canadian corporate laws for venture investors:
- Director Residency Requirements. In Canada, business entities may be formed under Canadian federal law or the laws of any of the provincial jurisdictions. Several corporate statutes, including the federal statute as well as those in Ontario, Alberta, and Saskatchewan require that 25% of a corporation’s directors be Canadian residents (not merely Canadian citizens). If there are fewer than four directors, at least one must be Canadian. This residency requirement also applies to holding and taking action at board meetings. For a meeting of the directors to be properly constituted to conduct business, 25% of the directors present must be Canadian. Where corporate action is taken by the board without meeting the director residency requirement, the action must be ratified in writing by the absent Canadian director(s) to be effective. Director residency requirements can pose unique challenges to an investor’s right to appoint it’s designees to a company’s board. Investors looking to mitigate the impact of the residency requirement may demand preferential rights regarding the appointment of non-resident Canadian directors. Alternatively, director residency requirements may be avoided completely by incorporating (or re-incorporating, as the case may be) in a province whose business corporation statute does not have a director residency requirement. These provinces include British Columbia, New Brunswick, Quebec, Yukon and Nova Scotia.
- Shareholder Consents. Actions requiring shareholder approval under Canadian corporate statutes, such as amending a company’s articles of incorporation, must either be approved at a duly constituted shareholder meeting or by the unanimous written consent of the shareholders. While this requirement does not apply to matters requiring shareholder consent as a function of contractual approval rights, it can be significantly more burdensome than corporate statutes in the United States and may pose challenges to a company’s ability to move swiftly on transactions and matters of corporate governance. For companies with a large number of shareholders, it may be extremely difficult to track down each and every shareholder and obtain unanimous approval. As such, many Canadian companies find it easier to hold special shareholder meetings to obtain the requisite shareholder approval. Unfortunately, shareholder meetings often pose similar problems of uncertainty and delay in ensuring sufficient shareholder attendance and participation. To mitigate these issues, Canadian companies often include provisions in their bylaws allowing them to call shareholder meetings on short notice, while others seek to have shareholders enter into voting trusts where certain lead investors are given powers of attorney over a shareholder group’s shares.
- Classes vs. Series of Shares and Class Voting Rights. Much like corporate law in Delaware and other U.S. states, Canadian corporate statutes generally allow companies to authorize different classes of shares in their articles of incorporation and issue multiple series of shares within each class of preferred stock. However, many Canadian corporate statutes prohibit companies from granting different rights, such as rights to receive dividends or liquidation preferences, to series of shares within the same class. Due to this limitation, startups incorporated in Canada typically issue preferred shares in new classes (e.g., Class A Common, Class B Common, Class A-1 Preferred, Class B-1 Preferred, etc.) rather than series (Series A Preferred, Series B Preferred, Series C Preferred, etc.) to provide varying rights to investors in different rounds of financing. In addition to statutorily mandating equality among investors in the same class, corporate statutes in Canada also provide for statutory class voting rights with regard to certain significant corporate actions including certain amendments to the articles of incorporation or selling substantially all assets. In practice, this means that approval by the holder of an otherwise non-voting class of shares may be required to take these actions. Although some of these statutory class voting rights may be waived explicitly in a company’s articles of incorporation, others are non-waivable. Consequently, separate voting agreements may be necessary to ensure investors’ negotiated voting rights are not pre-empted by statute.
- Unlimited Authorized Capital. Unlike in the United States, corporate statutes in Canada allow for unlimited authorized capital and do not require companies to state the share capital – i.e., the number of shares of capital stock – they are authorized to issue in their articles of incorporation. This allows a Canadian company to issue as many shares of capital stock as it wants without having to amend its articles of incorporation, thereby significantly increasing the investors’ risk of dilution without their consent. While sophisticated investors in U.S. companies often negotiate protections against future securities issuances in certain situations, the specter of limited authorized capital serves as an ultimate cap on a company’s ability to issue any securities without the investors’ consent.In light of this company favorable statute, many investors in Canadian companies negotiate for protective provisions giving them greater control over when and how additional shares are issued. Such protective provisions are typically found in a company’s articles of incorporation or investor rights agreement, and often require shareholder approval prior to issuing additional shares. Investors in Canadian companies may also ask a company to forgo its right to unlimited authorized capital and, instead, fix a specific number of authorized shares in its articles of incorporation. Most investors prefer protective provisions, however, given the practical difficulties associated with amending a company’s articles of incorporation under Canadian law, as discussed in Section 2 above.
- Unanimous Shareholder Agreements. Unanimous shareholder agreements are unique instruments under Canadian corporate law in that they are considered to be one of the company’s organizational documents, on the same level as its articles of incorporation and bylaws. These unanimous contractual agreements are binding on subsequent purchasers of a company’s shares, and may be used to place limits on the directors’ authority to manage the company or transfer such authority to shareholders. For example, though a unanimous shareholders agreement, shareholders may limit the directors’ discretion to, among other things: issue shares; appoint officers; make, amend or repeal bylaws; or borrow money, give guarantees and grant security interests in company property. In this way, a unanimous shareholder agreement can effectively transfer management of the company to its shareholders. Wielding the directors’ authority, however, layers upon shareholders the duties and liabilities of directors under corporate statutes. Unanimous shareholder agreements also typically address all of the corporate governance, voting and shareholder rights that are commonly addressed in U.S. voting agreements, investor rights agreements and registration rights agreements.
With U.S. deal values on the rise, there are great investment opportunities in Canada for savvy investors. However, before signing a term sheet, there are several considerations unique to corporate law in Canada to consider.