The information in this blog is for general informational purposes only and does not constitute legal advice. Consult a qualified attorney for advice on your specific situation. We make no guarantees about the accuracy or completeness of the information provided. Reliance on any information in this blog is at your own risk.
Early-stage founders often fixate on valuation, dilution, and interest rates. Yet the legal architecture behind equity and debt financing can be just as consequential as the price of money itself. Each route triggers distinct regulatory filings, investor rights, tax outcomes, and default consequences. Choosing poorly—or blending instruments without clear documentation—can hamstring future rounds and expose directors to personal liability.
Below is a practical, Ontario-focused guide to the legal dimensions that should shape how, and when, a start-up raises capital through equity, debt, or a hybrid instrument like a convertible note or SAFE.
Regulatory Frameworks: NI 45-106 vs. PPSA
Equity (Shares, SAFEs, Convertible Notes)
Most Ontario start-ups rely on National Instrument 45-106 prospectus exemptions—usually the Accredited Investor or Private Issuer exemption—to issue shares or convertible securities. Each distribution requires:
- A signed subscription (or SAFE/note) agreement with risk acknowledgements.
– - Filing Form 45-106F1 and paying OSC fees within 10 days of closing (once you cease being a “private issuer”).
– - Legending certificates for a four-month resale hold period.
Debt (Promissory Notes, Venture Term Loans)
Straight loans do not count as securities if they are commercial in nature and lack an equity kicker. Instead, they fall under Ontario contract law and the Personal Property Security Act (PPSA):
- Lenders register a PPSA financing statement to perfect security over assets.
– - No OSC filings, but failure to perfect can leave lenders unsecured in insolvency.
– - Interest-rate disclosure must comply with the Interest Act and Criminal Code rate caps (60 % effective annual).
Practical implication: Equity raises demand securities-law precision; debt demands lien perfection and interest-rate compliance.
Control and Governance Rights
Equity
Preferred-share investors often negotiate:
- Board seats or observer rights.
– - Vetoes over issuing more shares, incurring debt, or selling assets.
– - Information covenants (monthly KPIs, audited financials).
Founders dilute ownership and decision-making but retain flexibility on cash flows because dividends are usually discretionary.
Debt
Lenders, particularly venture-debt funds or bank lines, impose:
- Negative covenants (no new borrowings, no dividends, limits on capital expenditures).
– - Financial covenants (minimum cash balance, revenue multiples).
– - Default triggers leading to accelerated repayment or asset seizure.
Debt leaves cap-table control intact but constrains operational discretion.
Tax Treatment
Equity
Investment inflows are not taxable. On exit:
- Investors aim for capital gains, potentially sheltered by the Lifetime Capital Gains Exemption if the company remains a CCPC.
– - Dividends are taxed at shareholder rates; the corporation receives no deduction.
– - Founders issuing shares to employees must price options at fair market value to avoid immediate taxable benefits.
Debt
Interest payments are tax-deductible for the corporation, lowering effective borrowing costs. Investors receive interest income taxed at higher ordinary-income rates. Loan fees and warrant coverage may be deductible or depreciable depending on structure.
Insolvency and Risk Allocation
Equity
If the company fails, shareholders rank last in liquidation. Preferred holders may recover something via liquidation preferences, but common shares are typically wiped out. Directors generally avoid personal liability unless they breached duties or left statutory payments (HST, source deductions) unpaid.
Debt
Secured lenders can enforce on collateral under PPSA or Bankruptcy and Insolvency Act remedies. Founders who signed personal guarantees (common with banks) face personal exposure. Directors may also bear liability if they authorised dividend payments that rendered the company insolvent.
Speed and Cost of Closing
| Item | Equity | Debt |
| Legal Docs | Subscription, shareholders’ agreement, security terms for convertibles | Loan agreement, security agreement, PPSA filings |
| Due Diligence | Cap table, IP chain-of-title, financials | Asset appraisals, lien searches, financial covenants |
| Typical Timeline | 4–8 weeks (longer if multiple investors) | 2–6 weeks (banks may push longer) |
| Cost Drivers | Negotiating investor rights; OSC filings | Security registrations; legal opinions on collateral |
Convertible notes and SAFEs shorten equity timelines by postponing valuation, but they still require exemption filings and, if secured, PPSA work.
Future-Financing Impact
- Equity-Heavy Balance Sheet: Easier to attract follow-on VC money; harder to obtain bank debt because assets are unencumbered but burn rate may be high.
– - Debt-Heavy Balance Sheet: Preserves cap table but deters new equity if covenants inhibit dilution or if a liquidation preference stack is absent.
– - Convertible Instruments: Bridge rounds convert into next priced equity round; but stacking too many notes can confuse cap-table math and extend valuation uncertainty.
Key Contractual Clauses to Negotiate
For Equity
- Liquidation Preference: 1× non-participating is market for seed rounds; multiple or participating can chill future investors.
– - Anti-Dilution: Weighted-average vs. full ratchet.
– - Drag-Along/Tag-Along: Smooth exits vs. minority protection.
For Debt
- Security Package: Specific intellectual-property security vs. blanket lien.
– - Covenant Reset: Permits raising more equity without lender consent.
– - Warrant Coverage: Grants lender an option to buy equity at a set price; negotiate size and exercise period.
Hybrid Choices: SAFEs and Convertible Notes
These bridge instruments combine debt-like priority (notes) or contract-based rights (SAFEs) with equity upside:
- Convertible Note: Debt until conversion; interest accrues; must observe Criminal Code rates; secured or unsecured.
– - SAFE: Not debt; no interest; conversion triggered by next equity round. In Canada, SAFEs are securities and need NI 45-106 filings.
Both defer valuation, accelerate cash, and are popular in pre-seed/seed deals. But too many outstanding convertibles can overhang future rounds if discount or valuation-cap terms vary widely.
How AMAR-VR LAW Can Support
Financing strategy is part legal engineering, part capital science. Our team helps Ontario start-ups:
- Assess optimal capital mix based on runway, burn, and exit horizon.
– - Draft and negotiate shareholder agreements, SAFE and note templates, loan and security agreements.
– - Secure compliant exemptions under NI 45-106 and file Form 45-106F1 on time.
– - Perfect security interests under the PPSA, including cross-border assets.
– - Model cap-table and liquidation waterfalls to visualise dilution and debt seniority before closing.
We deliver deal-ready documents and risk assessments that let founders fund growth while avoiding future legal roadblocks.
Conclusion
Equity and debt each offer potent advantages—and distinct legal obligations—for Ontario start-ups. Equity trades control for permanent capital and can unlock tax-advantaged exits; debt preserves ownership but introduces covenants, security interests, and repayment risk. Hybrid instruments split the difference but require careful exemption compliance and cap-table management.
Evaluate investor profile, cash-flow visibility, covenants, and future-financing roadmap before picking a path. Then paper the deal with precision to keep regulators satisfied and options open.
Contact us today for a consultation if you’re deciding between equity, debt, or a hybrid raise—or need to audit existing instruments. We’ll tailor a financing structure that fuels your vision while safeguarding legal and financial flexibility.
Frequently Asked Questions (FAQs)
- How do Ontario securities laws differ when raising capital through equity versus debt?
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Equity issuances require compliance with National Instrument 45-106, including subscription agreements, risk acknowledgements, Form 45-106F1 filings, and resale restrictions. Debt instruments like promissory notes fall outside securities law but require lien perfection under the Personal Property Security Act (PPSA), enforceable security agreements, and strict compliance with interest-rate caps.
– - What control and governance trade-offs exist between equity and debt financing?
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Equity investors often negotiate board representation, veto rights, and extensive information covenants, diluting founder control but preserving operational flexibility on cash usage. Debt lenders preserve founder ownership but impose restrictive financial and operating covenants that constrain corporate decision-making, particularly in secured lending structures.
– - How do taxation outcomes differ for equity and debt investors?
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Equity returns are primarily capital gains, potentially sheltered under the Lifetime Capital Gains Exemption if CCPC status is preserved. Dividends are taxable to shareholders. Debt interest is deductible by the company but taxed to lenders as ordinary income, generally at higher marginal rates.
– - What insolvency risks attach to each financing type?
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Equity investors rank last in liquidation and typically lose their full investment if a company fails. Secured lenders enforce their rights against collateral through PPSA remedies. Personal guarantees, common in bank loans, expose founders to direct personal liability if the company defaults.
– - How can AMAR-VR LAW assist Ontario start-ups in structuring legally sound financing rounds?
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AMAR-VR LAW advises founders on optimal capital structures, drafts equity and debt agreements, ensures securities law compliance, perfects security interests, models dilution and liquidation outcomes, and tailors contractual protections to balance growth flexibility with investor expectations—all while protecting founders from unforeseen legal pitfalls in future rounds.