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The most common way to end up with a securities violation is in the way that you raise money for your company. In general, most businesses get started with investments made by the founders who are involved in running the business. Additional capital may be raised through bank loans, small business loans, or from private investors, including friends and family.
You may also decide to get funds from private investors by selling an ownership stake in the company. The equity interest or debt instrument offered for sale to the private investor is considered a “security.” Security refers to any investment agreement where one person invests his or her money in a common enterprise and is led to expect profits that result from the efforts of the business owner or a third party. If a security is being sold then the company must comply with federal and state securities laws. Even if a sale is never made but the stock is offered for sale, the business is required to comply. It is important to know that selling or offering securities without registration or an exemption is a serious matter that can result in legal prosecution and fines. It can also lead to claims by investors, including a right to demand that their entire investment be refunded, even if the value has gone down. Many disputes among business owners can become more complicated when a securities violation is brought into the mix.
Luckily, there are many exemptions available, and most offerings do not have to register. In addition, if you are aware of the requirements, the sale or offering can be set up to take advantage of exemptions from registration. The most common exemption is a sale to “accredited” investors. Generally, this means a sale to people or companies that are either wealthy enough or sophisticated enough to watch out for themselves without government regulations. For an individual to be considered wealthy enough, they must have a net worth of at least $1 million or have earned at least $200,000 in the last two years. Even exempt offerings must file a notice with the SEC and the states where investors are located.
Exempt offerings do not avoid the securities laws rules against fraud. As a best practice you should prepare a document outlining the material information about the company and the offering. Your business plan can serve as a guide in collecting the core material required to prepare the disclosure document. This document should provide complete disclosure about the company and the offering to investors, a requirement under the securities laws. This document is commonly referred to as an Offering Memorandum, Private Placement Memorandum, or PPM, and in a public offering, a Prospectus. The disclosure document will generally provide detail about: (i) the type of security and terms of the offering; (ii) the company and its officers and directors; (iii) financial information; (iv) how the funds will be used; (v) the risks involved with investing in the company; and (vi) other information an investor may need to make an informed decision.
Conducting a securities offering can be a complicated process, but it can provide businesses access to sources of capital necessary to develop and grow. Companies must insure that they are well informed of both state and federal securities laws when funding your business. Experienced advisors, including attorneys and accountants, can help guide you through the process, help develop the necessary documents, and insure compliance with securities laws.
[Business Insights is hosted by the law firm of Kumar, Prabhu, Patel & Banerjee, LLC. Parth Munshi is a corporate securities, governance and transaction lawyer with the firm.]
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Funding a business through private investors
By Parth Munshi 
December 2011
The importance of registering or obtaining an exemption when selling securities to raise capital
Bernie Madoff, Rajat Gupta and Galleon Funds are all newsmakers who got on the wrong side of the Securities and Exchange Commission (SEC). It may be hard to imagine yourself in the same category but there are actions that you as a business owner take everyday that may put you in the same position—on the wrong side of the law.
The most common way to end up with a securities violation is in the way that you raise money for your company. In general, most businesses get started with investments made by the founders who are involved in running the business. Additional capital may be raised through bank loans, small business loans, or from private investors, including friends and family.
You may also decide to get funds from private investors by selling an ownership stake in the company. The equity interest or debt instrument offered for sale to the private investor is considered a “security.” Security refers to any investment agreement where one person invests his or her money in a common enterprise and is led to expect profits that result from the efforts of the business owner or a third party. If a security is being sold then the company must comply with federal and state securities laws. Even if a sale is never made but the stock is offered for sale, the business is required to comply. It is important to know that selling or offering securities without registration or an exemption is a serious matter that can result in legal prosecution and fines. It can also lead to claims by investors, including a right to demand that their entire investment be refunded, even if the value has gone down. Many disputes among business owners can become more complicated when a securities violation is brought into the mix.
Luckily, there are many exemptions available, and most offerings do not have to register. In addition, if you are aware of the requirements, the sale or offering can be set up to take advantage of exemptions from registration. The most common exemption is a sale to “accredited” investors. Generally, this means a sale to people or companies that are either wealthy enough or sophisticated enough to watch out for themselves without government regulations. For an individual to be considered wealthy enough, they must have a net worth of at least $1 million or have earned at least $200,000 in the last two years. Even exempt offerings must file a notice with the SEC and the states where investors are located.
Exempt offerings do not avoid the securities laws rules against fraud. As a best practice you should prepare a document outlining the material information about the company and the offering. Your business plan can serve as a guide in collecting the core material required to prepare the disclosure document. This document should provide complete disclosure about the company and the offering to investors, a requirement under the securities laws. This document is commonly referred to as an Offering Memorandum, Private Placement Memorandum, or PPM, and in a public offering, a Prospectus. The disclosure document will generally provide detail about: (i) the type of security and terms of the offering; (ii) the company and its officers and directors; (iii) financial information; (iv) how the funds will be used; (v) the risks involved with investing in the company; and (vi) other information an investor may need to make an informed decision.
Conducting a securities offering can be a complicated process, but it can provide businesses access to sources of capital necessary to develop and grow. Companies must insure that they are well informed of both state and federal securities laws when funding your business. Experienced advisors, including attorneys and accountants, can help guide you through the process, help develop the necessary documents, and insure compliance with securities laws.
[Business Insights is hosted by the law firm of Kumar, Prabhu, Patel & Banerjee, LLC. Parth Munshi is a corporate securities, governance and transaction lawyer with the firm.]
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