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If you’re considering ways to raise capital for your company, pay attention. While an average straight-forward loan runs the usual financial risks, you might risk prison time if you sell stock or an ownership in your company. Sales of stock and qualifying interests in an LLC are subject to the securities laws. Below is a brief overview; this is not a comprehensive lesson. If you plan to sell stock, you would be well advised to consult an attorney.
What is a security?
The definition of a “security” is very broad and includes almost any investment in a common venture where the investor expects some profit and does not otherwise participate in the joint venture. Examples include: notes, stocks, bonds, and investment contracts.
Similarly, selling an ownership interest in an LLC could be subject to securities laws if the investor expects profit and would be passive – that is, if the investor will not actively participate in the management or running of the business. This could also include loans that are secured by ownership interest in the business.
What is not a security?
A loan secured by your residence, or a piece of equipment is not a security.
Be sure to also check your state’s specific laws on securities. Many states employ a slightly different definition of securities.
What to do if you will be selling a security to raise capital.
Selling stock in your company to the public is also known as “going public.” One of the first steps is filing a registration statement with the Securities and Exchange Commission (SEC). The required information for this registration includes your business operations, financial condition, and management. Much of this information will be made available to investors.
After the initial filing you will have to continue with regular public disclosures.
Selling Securities without Registering with the SEC.
There are some exemptions from the registration requirements. A few exemptions include:
Intrastate Offering
To qualify for this exemption, your company must:
- Be incorporated in the same state as the where the offering occurs
- Perform most of its business in that state; and
- Make offers and sales only to residents of that state.
Private Offering
To qualify for this exemption, the purchasers of the securities must:
- Be savvy to financial and business matters, or be able to handle the economic risk.
- Have access to the type of information normally provided in a prospectus; and
- Agree not to resell the securities to the public.
Rule 505 Offering
To qualify under Rule 505 the total of offers and sales of securities must not reach $5 million in any 12-month period. In addition, the offer and sale is limited to select classes of people, including:
· A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
· A natural person with a net worth of at least $1 million.
These exemptions and others have additional restrictions such as a limited right to resell.
Securities regulation and compliance is complex and carries heavy civil and criminal penalties for noncompliance. Purchasers may even have a right to a refund if all conditions of an exemption were not met. Finally, even if an offering is exempt from federal notice and filing obligations, it may not be exempt from State requirements. Make sure to consult with an attorney or check with the appropriate state securities administrator before proceeding with your offering.
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