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Sunday, December 1, 2013

Mistake #6 of 7: Failing to abide by the security laws.

This is part 6 of a 7 part series highlighting common legal missteps of small businesses.

Mistake #6: Failing to abide by the security laws.

Often entrepreneurs accept investment from friends and family in order to get their business started.  While this appears innocent, by accepting money in exchange for an ownership stake in your company, you are engaging in a sale of securities.  This activity is subject to significant regulation.  In fact, the Securities Act of 1933 contains a blanket restriction upon the sale of securities unless you file a registration statement with the Securities and Exchange Commission or the transaction is exempt from registration.  

The most frequently relied upon exemption from registration is a sale of securities that does not involve a public offering.  This is referred to as the 4(2) exemption.  This has created much ambiguity as the term “public offering” is not defined by Securities and Exchange Commission.  Thus, in order to assist companies with complying with this section, the SEC published Regulation D and made it clear that if a company complies with Regulation D, it has not engaged in a public offering.   However, this safe harbor, Regulation D, is non-exclusive.  In other words, a company can rely upon the 4(2) exemption without complying with Regulation D.

This is a “hot” area of law.  As you may know, the Jumpstart Our Business Startups Act, or JOBS Act, was recently passed.  The JOBS Act has made many drastic changes to this area of law, only a few of which will be discussed here.  First, the JOBS Act allowed “crowdfunding” or the collective pooling of investment via the internet through investing portals.  A company seeking to raise capital through crowdfunding can raise $1,000,000 per 12 month period and is subject to significant disclosure requirements.   Each investor is limited in the amount of his or investment depending on his or her income.  To date, crowdfunding has not been widely used.

While conceptually similar, portals like kickstarter and indiegogo are fundamentally different.  These portals do not result in you receiving an ownership interest in a company in exchange for your investment.  Rather, the investment is treated as a donation and the investor receives a reward or perk that varies upon the campaign.

Finally, another hot topic is the removal of the prohibition of “general solicitation”. Traditionally, in order to comply with Section 4(2) a company could not engage in “general solicitation”.    In other words, a company could only sell securities to persons with whom a pre-existing relationship existed.  Rule 506(c) removes this restriction allowing a company to advertise that it is selling securities.  However, only accredited investors can purchase securities in a 506(c) offering.   In addition, the issuer needs to take reasonable steps to verify that the investor is an accredited investor.

Moisan Legal P.C. is a boutique law firm focusing on representing entrepreneurs and businesses in a variety of legal issues.   Matthew J. Moisan can be reached at 646.741.5222.


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