(Part I – The Basics)
Is your startup planning to raise money from outside investors? Then you might want to have a basic understanding of securities law.
Don’t worry. You don’t have to become an expert.
But you do need to know what securities are and how (and why) they are regulated.
In today’s post we are going to get you up to speed on the basic securities law issues that startups face. In a future post, we will show you how to raise capital using the major federal and state securities law exemptions.
What are securities?
When you start your business you may decide to sell stock to raise money to get your venture off the ground.
So you form a business entity and break it up into shares, ownership interests that you can issue to investors. This process is called “securitization.” The shares of stock or other “ownership interests” are “securities.”
What are securities laws?
Every state in the Union has securities laws called “blue sky laws.” Of course, the federal government has its own securities laws. But what are securities laws and why do they exist?
Securities laws are set up to protect investors from fraud and unscrupulous scammers. Minimizing fraud makes it easier for legitimate businesses to raise capital.
If there weren’t securities laws people wouldn’t be as likely to invest in businesses. There would be a lot of fraud with little or no protection for investors. Investors might not feel as comfortable investing in your startup. Businesses would have trouble raising capital.
Because of securities law investors are much more willing to invest in corporate stock and other ownership interests.
The danger of not complying with securities law
If you do not comply with securities laws, investors have a right of rescission. That means that the investor can get her money back plus interest. She can do this at any time and it is relatively easy to do even if there is just a “technical” violation of securities law.
The bigger danger is that the investor can get her money back not only from the business she invested in, but also from anyone responsible for selling securities for the business.
This is an area of law where the corporate or other entity shield does not protect an officer, director, or employee of a corporation or other entity.
It is important to take securities law seriously. Even just a technical violation can land you in a lot of trouble.
Even if you do not intend to violate securities law but you make a technical mistake in complying with securities laws you may be liable. Perhaps you forget to give an investor the proper information or documents or you sell stock to an investor who does not meet specific guidelines. Then all of the investors in your company could potentially get their money back plus interest even though you were honest in every way about the business and its risks.
Even worse is if there has been securities fraud – that is if someone has been misrepresenting the business or the business opportunity – then the investors can sue the corporation and anyone involved for fraud.
So you always want to do everything you can to comply with securities law.
How do you comply with securities law?
On both the state and federal level you must register your security or get a permit to sell those securities.
It can cost a lot of money to file all the applications with the proper state and federal agencies. Often a startup will not have the resources to do this.
When this is the case the best path is often to raise capital under a securities law exemption.
We will discuss these exemptions in a future post.
How to get help with securities law issues
Now you know that securities laws exist and why you need to comply with them.
But be careful. Securities law is not simple. If you are thinking about selling stock to raise money for your business, then you need to work with a lawyer. A good lawyer will ensure that you don’t unintentionally violate any securities laws.
When you are ready to start raising capital we can help guide you through the process. Send us an email and we can meet to discuss your options.
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