Startup Funding – Friends and Family Round – Legal Requirements
At the early startup phase, when the money from friends and family is being invested, entrepreneurs usually can’t afford good lawyers and may not have found experienced mentors. As a result, many entrepreneurs miss some of the legal requirements of the ‘Friends and Family’ financing.
Fortunately most jurisdictions now have modern securities legislation, which makes it reasonably easy for entrepreneurs to comply with the law when raising startup capital from friends and family. The current BC government has done a very good job upgrading the regulations in this area.
Entrepreneurs must remember that all securities transactions, even if you are just selling shares to your relatives, are covered by securities legislation and are subject to increasing investigation and enforcement. You can’t just "take their money" no matter how young your company is.
The general rule is that all sales of securities, which include any type of shares, require a prospectus. This is a very complicated legal document - often fifty pages long even for a startup. The costs to prepare and file even a simple prospectus are usually over $50,000. The good news is that there are specific exemptions for companies selling shares to ‘Friends and Family’, or accredited investors (i.e. Angels).
Anyone selling shares must be sure they understand the exemption they will be relying on. In BC the exemptions are:
- private issuer exemption
- family, friends and business associates exemption
- employee, director, officer and consultant exemption
- accredited investor exemption
- $150,000 exemption
- offering memorandum exemption
There are also reporting obligations. With the exception of the private issuer and employee, director, officer, and consultant exemptions, a company must file a "report of the exempt distribution" with the Securities Commission within ten days each time they use any of these exemptions.
The BC Securities commission has a good website, with reasonably readable regulations. The section covering startup funding is here.
It is absolutely essential that entrepreneurs read these regulations to make certain they understand the definitions of terms like "close personal friends or close business associates". The BC Securities Commission has been increasingly aggressive in enforcing these regulations in the past couple of years.
Other Legal Requirements
In addition, any company selling shares must be properly incorporated, have articles and maintain a share register. The shares sold under an exemption must include ‘resale restrictions’. To protect the company, entrepreneurs and directors, all investors should sign a modern subscription agreement designed for the specific type of financing and investor.
Unless an entrepreneur has done this type of financing several times and is familiar with the current legislation, they really need advice from a good lawyer and/or an experienced mentor.