Securities law compliance vital for private firms raising money
By AdvocateDaily.com Staff
For small to mid-sized businesses, raising money can be a challenge — but technical compliance is crucial in this area, and private companies have to be careful not to run afoul of relevant securities laws, Vancouver corporate lawyer Jonathan Reilly tells AdvocateDaily.com.
“In every jurisdiction in Canada — and every province and territory has its own jurisdiction for this purpose — you cannot sell a security unless you issue a prospectus or there’s an exemption from that requirement available to you,” says Reilly, founder of English Bay Law Corporation.
As such, unless you are requesting donations, he says, the issuer — the person raising money — has to comply with securities laws in their own jurisdiction, as well as with the Securities Act in every jurisdiction from which they receive money.
“There may also be registration requirements and other fees that have to be paid to various securities commissions, and that depends on other factors,” he adds.
The most common exemption to the requirement to provide a prospectus when raising capital, says Reilly, is for accredited investors, such as licensed institutions, banks and brokers.
“Based on the amount of money they earn or the amount of assets they already have, they’re deemed to be able to withstand a loss, so they can invest without a prospectus,” he says.
Another exemption involves close friends, family or business associates, which he says can be a difficult area to navigate.
“If you’re asking, ‘Is this person a close friend or a close business associate?’ you have to ask yourself things like: ‘Would I lend them money? Do I know who their kids are? Have I ever been at their house?’ There actually has to be a close relationship and it’s not a bright-line test — it’s a sniff test.”
In some Canadian jurisdictions, there is also an “offering memorandum exemption,” which is similar to a prospectus but not supported by the same level of due diligence, says Reilly.
“It will contain details about the investment, what the purpose of raising money is and what the funds will be used for, it will contain details about who the management and directors of the company raising the money are and it will contain some information about the market or the industry, but nothing like the detail that’s in a prospectus.”
The offering memorandum, he adds, also comes with liability for the company directors who sign it — and if there’s an error, they can be held personally liable.
In Canada, says Reilly, securities laws are interpreted as consumer protection legislation — which means the Securities Act will generally be interpreted broadly and in favour of the investor.
Private companies often run afoul of the rules by raising the money and then finding out that they haven’t complied with the relevant legislation.
“They may have to give the money back, which will be a problem if they’ve already spent it,” says Reilly.
Another area where they may face challenges is with respect to prospectus exemptions and the definition for close business investor, family member or friend, he says.
“They all want to believe that everybody they meet is a close friend, and if you’ve only known someone for three or four months, chances are that a third party looking at that will conclude they’re not a close friend,” says Reilly.
“It’s very difficult to raise money and, of course, the people raising money are all optimists. And they believe in what they’re doing. So there’s a tendency to see lawyers in the process as complicating things, when actually we’re trying to save them from themselves,” he adds.
When working with clients to raise capital, lawyers will first become acquainted with the client and their business, get a sense of how much they are trying to raise and from whom.
“The client needs to get to know their potential market for raising money, and then would draft — it might be a partnership agreement, subscription agreement, it might be a debenture agreement, it depends on what the nature of the investment is. And after we get the basics of that down, if the client is having difficulty raising money, we may need to modify it, or the people they’re trying to raise money from may insist on modifications,” Reilly says.
“Sometimes they want modifications that the client either can’t or won’t give, and it’s all part of the negotiations. It’s a fluid, organic process. There’s no perfect agreement that fits all circumstances, there are always custom things in the agreements, but that also means there’s room to be flexible and creative.”
Ultimately, says Reilly, while the idea of consumer protection in this area is understandable, the actual regime in place is technical — making attention to detail and compliance essential.