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 Before
I “defaced” myself from Facebook I had over a 100 “friends”. On LinkedIn
I currently have 150 business connections or “business associates”. Only
eight people ever made it onto both lists. Unfortunately for me, and for
you, being a friend of someone on Facebook or connected as a business
associate on LinkedIn is not enough to determine if someone is a “close
personal friend” or “close business associate” as defined by
National Instrument 45-106 Prospectus and Registration Exemptions (“NI
45-106”). Identifying someone as a friend or business
associate is not enough to allow them to make a private placement
investment in your company. They need to be a close personal friend or
close business associate.
Who is a “close
personal friend”?
Subsection 2.7 of the
Companion Policy to NI 45-106 (“45-106CP”)
state the regulators’ views of the meaning of “close personal friend” of a
person who is a director, officer or founder.
Essentially, a “close
personal friend” is someone, at the time of investment (1)
knows you well enough, and (2) has known you for a sufficient
period of time, to be able to (3) assess your capabilities and
trustworthiness. Your friendship must be also be a (4)
direct
relationship.
Someone is not considered a close personal
friend solely because they are a relative, member of the same
organization, association or religious group, or a client, customer,
former client or former customer or a
friend of a friend.
The four required elements to be
considered a close personal friend of someone seems fairly straight
forward. There are, however, a couple of twists.
I don’t know about you but I am still
friends with people I knew in grade one. I have also have added dozens of
friendships along the way I value dearly. I would not dare, however, to
consider all of these people close personal friends. Certainly they know
me well enough and for a sufficient period of time in which to be able to
assess my capabilities and trustworthiness. Our friendships are also
direct, but are we really close? Does it matter for the purposes of NI
45-106? I believe it does matter.
What I tell my clients is that if a person
does not know how to get to your bathroom in your home without directions
they are not a close personal friend for the purposes of NI 45-106. It is
not enough to be acquainted or social friends with someone no matter how
long the relationship or how well they know you socially. It is also
irrelevant how close you view your friendship. What is important is how
that person would describe their relationship to you to a third party.
More on that last statement a bit later.
Who is a “close
business associate”?
Under subsection 2.8 of 45-106CP a “close
business associate” is someone who has (1) sufficient prior
business dealings with you to (2) assess your capabilities and
trustworthiness. Again, this must be a (3)
direct
relationship.
Again,
someone is not a close business associate solely because they are a member
of the same organization, association or religious group, or a client,
customer, former client or former customer.
I would say about forty of my LinkedIn
contacts would meet all three elements required to be considered a close
business associates as defined by NI 45-106. Be honest, how many of your
business connections rise to the level of being a close business
associate? Again, this is only our assessment of our past and current
business relationship with each of these individuals. The key is how
these individuals would describe their business relationship to us to a
third party.
BTW: A number of my closest business
associates and friends are not LinkedIn or were ever part of my Facebook
group of friends. I don’t believe the Commission or any other securities
regulator has ever viewed the status of one’s online contacts on one of
these forums as evidence one way or the other of how “close” you really
are to one another for the purposes of NI 45-106. It will be interesting
to see if it ever is raised in the future.
How close are we? So
close I got it in writing.
The onus is on you as the issuer of
securities to confirm that an exemption is available (subsection 1.9 of
45-106CP,
Bilinski 2002 BCSECCOM 102 and
Limelight Entertainment Inc. 31 OSCB 1727). It is not enough for you
to know in your mind that you are a close personal friend or a close
business associate to a particular investor in your company. You need a
paper trail or documentation to confirm you made a proper determination
that each investor has the necessary relationship to you to be considered
a close personal friend or a close business associate as defined in NI
45-106 at the time of their investment in your company.
Subsection 1.9 of 45-109CP allows you to
rely on the factual representations by an investor as to whether they meet
the requirements of a particular exemption,
provided that you have no
knowledge or reasonable grounds to believe that those representations are
false.
Most issuers when conducting a private
placement sale of securities provide each investor with a subscription
agreement, investor questionnaire and certificate. The subscription
agreement usually contains representation and warranty requirements to be
affirmed by the investor. The questionnaire and certificate are required
to be filled out by the investor and are used to determine whether a
particular investor meets the requirements of a particular exemption.
These documents alone are not enough in order to safely rely on any
exemption.
When you are dealing with close personal
friends or close business associates you need to go one step further and
obtain a written paragraph or signed letter setting out what makes their
relationship to you a close personal friendship or close business
relationship within the meaning of the exemption. If you are truly close
personal friends or close business associates you will probably get an
“are you kidding me” response from your friend or associate. Explain to
them that the paragraph you are asking them for is for the company file
should a regulator ever knock on your door to confirm you properly relied
on that exemption. In an ideal world the paragraph or letter should cover
each of the required elements to rely on the particular exemption you
intend to rely on to sell and issue your securities. For example:
Date
Address of
Company
Dear Sirs and
Madams,
Re: My
relationship to Mr. Big, CEO of Company
I met Mr. Big
in September 1998 at the Faculty of Commerce at UBC. We were both first
year freshmen. (establish time, place
and context) We became instant friends.
(establish direct relationship and type
of relationship – friends). He was the best man at my wedding.
(establish how well you know him).
Over the years Mr. Big has shown himself to me to be capable and
trustworthy as a business person and as a friend.
(this may be too direct but you need
something that establishes belief of capability and trust is present in
the relationship).
Sincerely,
Commerce
Buddy
Same relationship
different understanding
I once dated a fellow for three weeks. It
was over Christmas and he brought me home to his family who welcomed me
with open arms. When we returned home he broke off our relationship over
the phone two days later saying “It’s not like we dated or were boyfriend
girlfriend or anything. Just two people getting to know one another.” I
was pissed and I do not get angry easily. We obviously had two very
different views of what type of relationship we had or were having and
totally different value systems.
Where issuers often go wrong and get into
regulatory trouble is that they too believe they are on the same page as
their investor who they see as a close personal friend or close business
associate. Unfortunately for them if or when that investor is asked by a
securities regulator “how you do you know Mr. X and company?” that
investor may respond with a vague I don’t really know him answer such as
“He plays tennis at my club and one day at a tournament he mentioned this
investment in his company” or worse “Mr. Who? Mr. Mutual Friend got me
involved with this investment.” Unless that investor confirms he is a
close personal friend or close business associate by positive affirmative
statements you as an issuer are in trouble.
Conclusion
A subscription agreement, questionnaire
and even a certificate alone are not enough to verify someone is a close
personal friend or close business associate. You need that extra hand
written or typed paragraph or letter verifying the three or four elements
necessary to rely on the exemptions are present. Better to find out at
the pre-investment stage than down the road that your investor and you
view your relationship in a totally different way. If the regulators send
a letter or call up your close personal friend or close business associate
you want to make sure he indeed views you exactly like a close personal
friend or close business associate and not some random person he runs into
every once and awhile in town.
In Part Two of this
three part series we will explore everyone's favorite private placement
exemption: the accredited investor.
Links to the other
articles in this series:
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