“WARNING! This investment is risky”: New securities law
requirements coming this May/15 for Ontario businesses will put your Love
(Money) to the test!
In
many instances, the first source of funds for new ventures by Ontario
entrepreneurs is so-called “love money” from family members, friends and
business contacts. But there is no doubt the bonds of love and friendship
will be tested after May 5 2015 with the recently announced introduction in
Ontario of a family, friends and business associates prospectus exemption
(“FFBA Exemption”) to replace the current founder, control person and family
exemption, along with additional changes adopted by the Canadian Securities
Administrators to the accredited investor exemption (“AI
Exemption”). So don’t be caught off guard:
Ontario entrepreneurs embarking on capital-raising activities are advised to
seek advice well before the end of April on the changes described briefly below
to the exempt market landscape.
How
strong is the love or friendship of your start-up investors?
·
One
highly visible change is the requirement to provide investors with a risk
acknowledgement form that begins with the following words: “WARNING! This investment
is risky. Don’t invest unless you can afford to lose all the money you pay for
this investment.”
·
New
Form 45-106F12 to be completed by all FFBA Exemption investors requires the
investor to describe the relationship with the director, executive officer,
control person or founder of an issuer (“principal”) or spouse of a principal,
and must be signed by the investor, the principal and the issuer.
·
New
Form 45-106F9 to be completed by individual AI Exemption investors requires an
individual investor to confirm his or her accredited investor status using
certain “bright-line” income or asset tests, and for the issuer to confirm this
information.
·
In
both cases, the issuer is required to keep the relevant form for eight years
after the financing.
Will Ontario entrepreneurs need to keep detailed notes on their
close personal friends and close business associates?
So
how “close” are you and your personal friend or business associate?
Securities regulators have tried to give guidance as to who qualifies as a
“close personal friend” and “close business associate” for purposes of the FFBA
Exemption and the private issuer exemption described in National Instrument
45-106 (“PI Exemption”).
Securities
regulators suggest that issuers should gather details about the length of time
the individual investor has known the principal, and the nature of any personal
relationships between the individual investor and the principal, including, the
frequency of contact between them and the level of trust and reliance in the other
circumstances. With respect to close business associates, information is
also required regarding the nature of any specific business relationships
between the individual and the principal, including, for each relationship,
when it began, the frequency of contact between them and when it terminated if
it is not ongoing, and the nature and number of any business dealings between
the individual investor and principal, the length of the period during which
they occurred, and date of the most recent business dealing.
Who is considered a “close personal friend” or “close business
associate”?
A
close personal friend of a principal is an individual who knows the principal
well enough and has known them for a sufficient period of time to be in a
position to assess their capabilities and trustworthiness and to obtain
information from them with respect to the investment. A close
personal friend can include a family member who is not specifically listed in
the exemptions, such as the aunt, uncle or cousin of a principal of an
issuer. However, securities regulators have noted that an individual is
not considered a close personal friend if the individual is solely a relative,
a member of the same club, organization, association or religious group; a
co-worker, colleague or associate at the same workplace; a client, customer,
former client or former customer; a mere acquaintance; or connected through
some form of social media, such as Facebook, Twitter or LinkedIn. An individual
is also not considered a close personal friend if the relationship is primarily
founded on participation in an Internet forum. Similar criteria apply for
an individual to qualify (or not) as a “close business associate”.
Securities
regulators have indicated as well that they are interested in the number of
“close personal friends” and “close business associates” to whom securities
have been distributed in reliance on the FFBA exemption or PI exemption.
These
are merely a glimpse of the changes which
are scheduled to take effect on May 5, 2015. Securities regulators have
clearly stated that the responsibility is on the SELLER of securities to fully
understand the terms and conditions of the exemption being relied on as they
must be able to explain to an investor the meaning of the terms and conditions
of the particular exemption, including the difference between alternative
qualification criteria for the same exemption. The person relying on a
prospectus exemption is responsible for determining whether the terms and
conditions of the prospectus exemption are met, and should retain all necessary
documents to demonstrate that they properly relied on the exemption. Standard
investor representations in a subscription agreement or an investor’s initial
beside a category on an accredited investor form are not sufficient, unless
additional reasonable steps are also taken to verify the representations made
by the investor, including gathering background information about the investor.
Bottom line: There are now more rules around raising
love-money from family, friends and business associates and accredited
investors. Ontario entrepreneurs are advised to proceed with caution and
to obtain advice on the changes described above to understand the impact on
their capital raising activities and to avoid costly securities law mistakes.
