By: Conflicts Analytics Lab – Securities Team
- Security has a broad definition, being aware of this will help you raise money legally
- Using the stock markets sounds cool, but Friends and Family are a great source of private capital
- Not all of your friends and family count for raising money under an exemption, so getting professional legal advice on this is crucial to ensure you comply with formal Securities Laws
It has long been tradition for people to go to their family and friends to get some financial help when they start a business. They tell them the business idea, they ask if the friend or family member can give them money to start, and they offer to pay it back later, with some interest of course. Or maybe instead of getting paid back in the future, they are given a small, likely inconsequential stake in the business that if the business is ever sold, they’ll get the value of their stake.
What if I told you that doing this is probably a distribution of a Security and would be captured by Ontario’s Securities Act. Most people don’t know exactly how a Security is defined, and don’t recognize that there are many instances where they are acting in a way that would be captured by the Securities Act. I hope to be able to explain a bit more about what a Security is, and whether raising money from Friends and Family is allowed in Securities law.
Securities are given a broad definition in the Securities Act, specifically, in section 1. Some relevant highlights include:
- Any document, instrument, or writing commonly known as a security,
- Any document constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company,
e. a bond, debenture, note or other evidence of indebtedness or a share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate, …
g. any agreement providing that money received will be repaid or treated as a subscription to shares, stock, units or interests at the option of the recipient or of any person or company,
i. any profit-sharing agreement or certificate,
n. any investment contract
As you can see, this is quite the list of things that are Securities. But this list isn’t exhaustive, nor is it the full list. So, take my word for it that Securities are defined incredibly broadly, and that it is possible to catch almost anything under the definition.
The Hypothetical Entrepreneur
Let’s return to our hypothetical entrepreneur who’s asking his family and friends for some money for his new business. If the friends and family give him money, are they getting a Security? It probably depends in part on the set-up. If the entrepreneur gives them a small share of the company in exchange for the money, they are getting a Security under section E. If he gives them a portion of profits, whether for a specified period of time or indefinitely, they are getting a Security under section I. What if the entrepreneur was selling them a big piece of land, that needed to be professionally managed to be profitable, and he would take care of managing the land. This too is probably a Security. As you can see, Securities is broad, and there is often a way to catch any course of action under the definition of Securities. That brings us back to the second question I wanted to explore: can you raise money from family and friends? Is it as expensive as raising money on the stock market?
Raising Money from Friends and Family
Luckily, you can raise money from Family and Friends, and you can do it much more affordably than raising money on the stock market. To raise money on the stock market, you have to file a formal prospectus, get professional audit services involved, and incur many other costly expenses. It will probably cost you a minimum of a few hundred thousand dollars to raise money on the public stock markets.
But raising from Family and Friends, it’s a lot cheaper. All you need is a good lawyer, close family and friends, and a few thousand dollars to pay the lawyer. In Securities law, there is a prospectus exemption for Family and Friends (as well as business associates, but I’m not going to get into that here). This exemption is in National Instrument 45-106 – Prospectus Exemptions, specifically s.2.5(1). This exemption allows a private business, like the new business our entrepreneur is starting, to raise money from Friends and Family without filing a formal prospectus.
The family member can be a spouse, parent, grandparent, brother, sister, child or grandchild of a director, executive officer, or control person of the company. It can also be a parent, grandparent, brother, sister, child or grandchild of the spouse of a director, executive officer or control person of the company.
What qualifies as a close friend is discussed in National Instrument 45-106 – Prospectus Exemptions, Companion Policy s.2.7. It isn’t exhaustive, and it will always be on a case-by-case basis whether someone is close enough. But generally, the closeness will be decided after examining whether the person knows the entrepreneur well enough, and if they have known them for a sufficient enough period of time to be able to assess their capabilities and trustworthiness. Other relevant factors include frequency of contact and level of trust.
I know I’ve said a lot so far, so let me try to simplify things. Entrepreneurs often raise money, but often do not recognize that they will be captured by Securities laws. Securities has a very broad definition, so it likely can catch many actions, even if you don’t intend to be governed by Securities law. Securities refers not only to stock markets, but to private capital as well. Business owners can, and should, raise money from Family and Friends. But only if Family and Friends understand what they are getting involved in, know the risks, get professional legal advice, and meet the relevant criteria.
 Securities Act, RSO 1990 c. S.5
 Securities Act, supra note 1, at s.1
 Halsbury’s Laws of Canada (online), Securities, “Prospectus Exempt Distributions: Specific Exemptions: Capital Raising Exemptions” (iv.2.1.d) at HSC-78 “Private Issuers” (2018 re-issue)