By Brian Prill
Do you know who your “close personal friends” or “close business associates” are? Do you know who is part of your family and who is not? Did you know that your aunt, uncle or cousin are not a member of your family?
You may also ask, why does it matter and who cares?
Well, if you are an officer or director of a start-up company looking to raise capital to finance that company, you should care.
The starting point for any company raising capital is that before they can receive money from anyone, whether through debt or equity, the company first needs to issue a prospectus. This is a costly and complicated process that is not even remotely practical for most start-up companies. To overcome the hurdles with respect to raising capital and to facilitate the development of business enterprises, the securities laws of Canada are designed to include certain exemptions from the prospectus requirement. These “prospectus exemptions” provide a legal way for companies to raise capital to finance their businesses without going through the process of preparing and filing a costly prospectus document. There are over 40 prospectus exemptions covering a multitude of business transactions; however, for the purposes of this article, I am going to focus on only one of them, the “Family, Friends and Business Associates” (“FFBA”) prospectus exemption.
By way of background, securities laws are based on achieving two objectives:
- to provide protection to investors from unfair or fraudulent practices
- to foster fair and efficient capital markets.
How are the above objectives achieved?
They are achieved primarily by restricting the access to capital such that individuals (or institutions) can only invest in companies when the investor actually fits within a certain set of specific criteria.
For example, when it comes to determining who your “family”, “close personal friends” or your “close business associates” are, you have to first look at the nature of the relationship and then determine if that relationship qualifies. If it does, then the investor is qualified to invest and can support you in your business venture. No matter how generous the person may want to be, a mere desire to help, to invest or to loan you money is not enough. The individual would first need to qualify within a specific prospectus exemption.
Under the FFBA prospectus exemption, “Family” is not just any relative; “Family” only includes your spouse, parents, grandparents, brothers, sisters, children or grandchildren (i.e. your direct family members). Family does not include your uncles, aunts, cousins, great grandchildren or any other relatives. If you have a relative that falls outside of the enumerated definition of “Family”, you need to search for another category of investor for this relative to qualify under.
You may want to see if this relative can qualify as a “close personal friend” or “close business associate”, however, with respect to this category, an individual is not a “close personal friend” or “close business associate” solely because the individual is: (a) a relative, (b) a member of the same club, organization, association or religious group, (c) a co-worker, colleague or associate at the same workplace, (d) a client, customer, former client or former customer, (e) a mere acquaintance, or (f) connected through some form of social media, such as Facebook, Twitter or LinkedIn.
In order for an individual to qualify as a “close personal friend” or “close business associate” of any director, executive officer, founder or control person of your company, the individual needs to be someone who: (i) knows the director, executive officer, founder or control person of your company well enough and has known that person for a sufficient period of time (a “close personal friend”) or (ii) has had sufficient prior business dealings with the director, executive officer, founder or control person of your company (a “close business associate”) to be in a position to assess the capabilities and trustworthiness the specific director, executive officer, founder or control person and to be able to obtain information from such individuals with respect to their investment in your company. Therefore, if you only see your aunt, uncle or cousin at family reunions, they will likely not qualify as being someone close enough to fit within the definition of “close personal friend” or “close business associate”.
In fact, unless your aunt, uncle or cousin qualifies under some other prospectus exemption, they may not be able to help you finance your company at all. If there is no other prospectus exemption available, you can actually find yourself in a position where you have to turn down their offer to finance your company.
Does it matter? Well, yes it does.
Not only does it affect your ability to finance the operations of your company, failure to comply with the investment criteria above can have significant personal repercussions for you as an officer, director of founder of your company. The executives of your company are charged with the responsibility of complying with the securities laws of Canada. In situations where company executives accept money from individuals who are not qualified to invest, those executives can be subject to a variety of monetary penalties and in some cases, even barred from acting as an officer or director in their current company or in any other current or future company.
To avoid experiencing any sanction or penalty for a breach of securities laws, the officers and the executives of your company need to have a working understanding of securities laws, how the respective prospectus exemptions work, who can access them and what qualifications any investor needs to possess in order to invest money into your company. National Instrument 45-106 – Prospectus Exemptions provides a list of most of the capital raising prospectus exemptions and Companion Policy 45-106CP – Prospectus Exemptions provides a more detailed explanation of how these prospectus exemptions are applied. The Companion Policy also includes a summary of your obligations as an officer or director of a company when it comes to raising capital, whether through debt or equity. However, it is always recommended that you consult your own lawyer with respect to individual situations, because the facts matter, and it is very easy to go offside securities laws without ever meaning too. Protect yourself, your business and your future and confirm that every investor or lender is qualified to purchase equity in your company (or to loan you money) prior to accepting their investment or loan. When it comes to accepting capital to finance the operations of your company, all that glitters is not gold.
The above is meant to be a general discussion of securities laws and part of the Family, Friends and Business Associates prospectus exemption and is not intended to be taken as legal advice as it applies to any specific situation. Readers are advised to consult their own legal advisors with respect to any specific questions regarding raising capital for their company.