What You Don’t Know Can Hurt You When it Comes to Raising Money for Your Business.
Friday, October 28, 2011 at 1:58PM My experience suggests that many, if not most, entrepreneurs and small business owners don’t fully appreciate the requirements and the risks of violating securities laws when raising capital for a business.
State and federal securities laws regulate offers and sales of securities and require companies (as well as others) who sell securities to meet certain requirements for registration or disclosure as well as other criteria. These laws also contain stringent anti-fraud provisions.
Securities are more than Shares of Stock.
First, entrepreneurs often don’t know that a security is more than just shares of stock.
Securities include promissory notes (whether convertible or not) and profit participation arrangements as well as any other arrangement where an investor provides money and expects a greater return through no effort on their part.
One business owner (not a client) strenuously claims he did not have to follow the securities laws because all he was selling was 1% of the profits of his company. Unfortunately for him, that’s not correct.
Likewise for promissory notes – secured or unsecured – sold to individuals and certain entities.
Securities Fraud Isn’t Your Grandfather’s Fraud.
They also don’t fully appreciate the stringent anti-fraud requirements. Where business owners correctly think of fraud as an overt act, securities fraud has a much lower threshold. In the securities context failing to say enough can rise to the level of a fraud.
This is a particular problem for passionate entrepreneurs. As you can imagine, when you’re committed to making the business work, it’s difficult to see the warts.
But, it’s critical to disclose everything – the good, the bad and the ugly –about the business in writing when raising capital. The worst thing that can happen is for an investor to say “If I only knew” and for you not to be able to point to a written disclosure to that investor.
Ramifications of Violating Securities Laws.
Failure to follow the securities laws has a significant downside. Investors could have the right to rescind their purchase – meaning the company has to return the money (possibly with interest). Of course, no one asks for their money back if things are going well. So, its usually the case that the company doesn’t have the money to pay.
It might also mean the company isn’t able to attract additional investors. They won’t provide additional capital because of the prior mess and because they see the prior mess as being the proverbial tip of the iceberg. ‘What other skeletons are in the closet?’ they usually wonder.
Violating the securities laws can also mean personal liability for the founders. In these deals founders are almost always the ones promoting the securities to prospective investors. The founders are certainly always involved in negotiating and dealing with the investors.
As a result, the corporate limited liability veil doesn’t protect them. They can be held personally liable for the investors’ damages.
Of course, depending on the infraction, there can be criminal penalties, as well.
Every entrepreneur looking to raise capital for a business must understand and comply with securities laws to ensure her company gets the full benefit of the investment and she doesn’t end up personally liable for the investors’ money.
If you’d like to raise capital for your business and need to know where to begin, we may be able to help. Give me a call at 407-649-7777.
Reader Comments (1)
Ed Alexander Esq seems like a great esq for start up companies,Dennis j Cooper 407 461 4161