Being an entrepreneur and starting a business is one of the greatest expressions of the American dream. If you have accomplished this impressive feat, or are doing this now, I applaud you. You are quite literally helping to build the US economy. But you may also be experiencing the limitations of your own personal economy. Almost all startups need capital, and the entrepreneur often doesn’t have sufficient personal resources to self-fund her great innovation. This means you will likely need to look to others for investment. Some of us are lucky enough to have wealthy friends or family that we can tap for funds. Or, it may be more likely that you have sought to raise capital from professional investors like angels and venture capitalists ( see For New Businesses: Top Things to Watch Out For When Looking For Investors).
Whether you have raised capital from friends and family or hooked a whale to fund your startup, you may have already broken the law. If you have taken any money at all, even if it’s just $1,000 from your dear Uncle Bill or Aunt Beth, in exchange for a piece of your business (equity) or a promise to pay him or her back with interest (debt), you have carried out a securities transaction that is not only regulated by the U.S. Securities and Exchange Commission (SEC) but also the securities commission of the state where the investor(s) resides. And, if you carried out this securities transaction without providing proper information or making the requisite regulatory filings at the state and federal levels, you could be violating applicable federal and state securities laws.
To be clear, under federal securities law, taking anything of value from an investor in exchange for debt or equity in your business is a regulated act known as a securities transaction. And all such securities transactions are subject to a specific and complex body of law known as the Securities Act of 1933.
So, what is the law and what exactly must you do when seeking an investment from someone? The general rule is pretty straightforward: simply put, you may not offer or sell securities (equity or debt) without first registering with the SEC. This general rule would essentially preclude you from raising capital without conducting an expensive and protracted IPO. So (and here’s where it gets complicated) in order to make it possible for startups to raise capital without conducting an IPO, the SEC has enacted certain exemptions to the general rule. There are in fact numerous exemptions to this general rule that may allow you to raise funds from Uncle Bill or anyone else, provided you fulfill and fit into certain requirements of the applicable exemption. These requirements include making important disclosures in the form of an offering document or private placement memorandum (PPM) ( see What is a PPM?) as well as making certain filings with the SEC as well as with the various states.
If you fit into an exemption but otherwise fail to carry out the requirements under that exemption, the results could be disastrous, including serious civil and criminal penalties, and you could even be precluded from ever raising money in this way again. So, before you set out to fund your startup, be sure you know the law. Consult a lawyer who is experienced in this area and is qualified to properly advise you. If you heed the foregoing, you can raise capital with confidence, help build the US economy, and fuel your own American dream.
About the Author: Erik P. Weingold
Erik P. Weingold ( see Message From the Founder)is an entrepreneur and corporate securities lawyer with over 20 years experience. He has been practicing law since 1995, and since 1998 has been drafting PPMs that have been used to raise millions upon millions of dollars for startup companies and small businesses throughout the US. Erik is the founder, CEO, and General Counsel to PPM LAWYERS ( see ppmlawyers.com).