If you are just starting a business, it is likely that you have already dipped into your personal reserves to get up and running (bootstrapping). You might have also approached traditional lenders, like banks, depending on the nature of your business. Most businesses turn to family, friends and business associates (FFBAs) next. If FFBAs agree to lend assistance, then you should be aware of Ontario’s rules governing your relationships with FFBAs before you accept their financial support.

If you are simply borrowing money from a FFBA, then the loan should be documented in a promissory note or similar form. Your accountant will undoubtedly have something to say about recording the loan in your business records. Alternately, if you are planning on having your FFBAs invest in the company in exchange for shares, then the Ontario Securities Commission (OSC) has a lot to say about how that should be done.

As of May 5, 2015 (pursuant to Amendments to National Instrument 45-106), the OSC has instituted new rules about raising money from FFBAs; the OSC has created a new “exemption” for financial assistance from FFBAs. So why do you need an exemption and from what are you being exempted? The baseline rule for all companies is, as follows: if you are going to sell shares in your company to a prospective purchaser, then you need to provide the prospective purchaser with extensive documentation (a prospectus). The shares must also be sold by a registered dealer. This process is both time-consuming and extremely expensive for companies in their infancy. The OSC recognizes this reality and provides numerous exemptions to this rule as a result: the private issuer exemption, the accredited investor exemption, the offering memorandum exemption (also new in Ontario) and the soon-to-be-introduced crowdfunding exemption. This article looks exclusively at selling shares to FFBAs and the FFBA exemption, which replaces the founder, control person and family exemption, in Ontario.

Essentially, the OSC exemptions provide cost-effective ways to raise funds for early-stage companies. The FFBA exemption provides that there is no requirement for companies to provide investors with information at the time when the shares are sold and that there is no need for the use of a registered intermediary to handle the sale. It is up to the seller of the shares to verify that the purchaser meets the criteria of the exemption. In the FFBA exemption, this criteria is based upon the company’s relationship with the investor, although any particular investor might fit into other exemption categories as well. For example, a particular investor might be the founder’s father and meet the income test to be an accredited investor.

Limits

The amount of money that can be raised under this exemption and the amount of money that any one investor can invest in the company is not limited; however, the relationship of those being sold shares under the exemption in relation to the company is limited. Only investors who satisfy certain tests qualify. Moreover, there are also limitations regarding the resale of the securities in the future.

Close Personal Friend

A "close personal friend" of a director, executive officer, founder or control person of an issuer is an individual who knows the director, executive officer, founder or control person well enough, and 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. The term "close personal friend" can include a family member who is not already specifically identified in the exemptions if the family member satisfies the criteria described above.

The OSC considers the following factors as relevant to this determination:

(a) the length of time the individual has known the director, executive officer, founder or control person;

(b) the nature of the relationship between the individual and the director, executive officer, founder or control person, including such matters as the frequency of contacts between them and the level of trust and reliance in the other circumstances; and

(c) the number of "close personal friends" of the director, executive officer, founder or control person to whom securities have been distributed in reliance on the private issuer exemption or the FFBA exemption.

The OSC states that an individual is not a close personal friend solely because the individual is:

(a) a relative;

(b) a member of the same club, organization, association or religious group;

(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.

The relationship between the individual and the director, executive officer, founder or control person must be direct. For example, the FFBA exemption is not available to a close personal friend of a close personal friend of a director of the issuer. Notably, the OSC does not consider a relationship that is primarily founded on participation in an Internet forum to be a close personal friendship.

Close Business Associate

A "close business associate" is an individual who has had sufficient prior business dealings with a director, executive officer, founder or control person of the issuer to be in a position to assess their capabilities and trustworthiness, and to obtain information from them with respect to the investment.

The OSC states that it will consider the following factors as relevant to this determination:

(a) the length of time the individual has known the director, executive officer, founder or control person;

(b) the nature of any specific business relationships between the individual and the director, executive officer, founder or control person, including, for each relationship, when it began, the frequency of contact between them and when it terminated if it is not ongoing, and the level of trust and reliance in the other circumstances;

(c) the nature and number of any business dealings between the individual and the director, executive officer, founder or control person, the length of the period during which they occurred, and the nature and date of the most recent business dealing; and

(d) the number of "close business associates" of the director, executive officer, founder or control person to whom securities have been distributed in reliance on the private issuer exemption or the FFBA exemption.

An individual is not a close business associate solely because the individual is:

(a) a member of the same club, organization, association or religious group;

(b) a co-worker, colleague or associate at the same workplace;

(d) a mere acquaintance; or

(e) connected through some form of social media, such as Facebook, Twitter or LinkedIn.

The relationship between the individual and the director, executive officer, founder or control person must be direct. For example, the FFBA exemption is not available to a close business associate of a close business associate of a director of the issuer. As is the case with the close personal friendship category, the OSC does not consider a relationship that is primarily founded on participation in an Internet forum to be a close business association.

Verification

The OSC states that the seller of the shares needs to understand the key elements of the relationships and be able to evaluate whether the relationship claimed meets those key elements. It is not enough for the seller to claim that the purchaser self-identified to that relationship. The fact that a purchaser identifies as a close personal friend does not necessarily make them one. The seller is the one relying on the exemption, so the seller is the party that needs to be able to show that they took steps to verify that relationship. The seller should consider whether it is necessary to have the purchaser sign verification documentation before selling that purchaser shares.

The seller of the shares is required to obtain a signed Risk Acknowledgement Form from the purchaser and to keep that risk acknowledgement for 8 years after the sale.

Resale Restrictions

Purchasers of shares under the FFBA exemption may not resell those shares unless they are selling them under another exemption.

Risk Acknowledgement Form

The Risk Acknowledgment Form (Form 45-106F12) is required to be signed by all people purchasing shares under the FFBA exemption.

For more information, please see the OSC's Framework of the FFBA Exemption Chart (extracted from Amendments to National Instrument 45-106 for your ease of reference).

How Momentum Can Help

Momentum has expertise in corporate finance. We can advise you on whether your potential investors fit within any of the OSC exemption categories, and we can help you build a plan for financing that adheres to OSC regulations.