Caution: Securities Transaction Ahead

Do you know what constitutes a securities transaction? Do you understand the implications of engaging in securities transactions without proper legal authority or understanding the do’s and don’ts of the pitch?

When does a conversation with someone interested in investing in your business become a securities offering? Can you say “I guarantee that by the end of the first year you’ll have a 30% return in investment”?

Securities Transactions: What Are They?

You form your company on day one. The founders contribute their funds on that day. On day two you realize you need more funds to develop the product, run the business, and start marketing and sales efforts. You go out to ask your friends, family, and other people you know (and some you don’t) to invest in the business (equity) or loan you money (debt). You are now engaged in fund-raising activities, offering securities (equity or debt securities) in exchange for funds. You are engaged in regulated securities transactions.

If your friends and the others are all located within the same state as your company and you, then generally speaking these securities transactions are regulated by that state. If your conversations and offerings are taking place across state lines, then you are talking about transactions that fall under Federal jurisdictions.

Securities transactions are the raising of funds by a company after it has been formed and are regulated by state and/or Federal governmental agencies. Many early-stage companies are unaware or overlook the details of complying with securities regulations in the early days of funding the business. After all, it is only the family, friends, and people you sort of know through friends and family, so what does it matter? It matters!

Cleaning Up the Non-Compliance, Slowing Down the Process

There will hopefully come a time when you are ready to raise “serious” money for your business. You are ready to talk to the angel groups, venture capitalists, or institutional investors. Maybe you will even be approached to be acquired by another entity. Then comes the due diligence process where the potential investors or acquiring company check out your books and your “housekeeping.” They examine your records of previous investment activities and find these rounds were not done under the appropriate registrations or exemptions.

Now you have to take the time to clean up after yourself, and the question becomes: Can you? Sometimes you can—but sometimes you can’t. It all depends upon what you’ve done, how serious it is, and how cooperative everyone involved is. Are there a few transactions performed within a single state? Or do you have over a hundred people involved in multiple states,which becomes a Federal regulatory issue? Did you make representations as to guarantee outcomes to the investors? Were these investors accredited or unaccredited investors? Did they know what they were doing? What information did they rely on to make the investment? What documents did you use and did they sign? Did you issue preferred stock in an LLC? In other words, were mistakes made beyond noncompliance with securities laws?

What are your potential investors or acquirers doing while you are cleaning up? Are they willing to wait? At what price? For how long? Or are the risks and issues going to lead to them saying, “Call us when you have this resolved and we’ll see if we are still interested”?

Simple to Get It Right

It is much simpler to get it right from the beginning. It is also much more cost effective to begin your fund-raising process in compliance. Sitting down with a knowledgeable, experienced securities attorney to understand the process of raising capital within the bounds of securities rules is a necessary first step for the savvy entrepreneur going places fast. You can understand the housekeeping requirements, the types of funding, the parameters of what to say, and the do’s and don’ts of the process. An hour or two upfront can save you many hours and thousands of dollars later, and it may just keep you from missing out on a can’t-miss deal that won’t wait for to get your house in order later.

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