by Christopher Branson, Partner
“I’m just a business owner – what do Securities Laws have to do with me?”
You have a business, or are launching a business, and you are turning to family and friends for the money you need. One friend offers to lend you some money to be repaid over 5 years, and an uncle offers to put up some money in return for a 25% ownership stake in the business. Or maybe you were introduced to some people who offer to provide “venture capital” to pay for your equipment and other start-up expenses in return for a 50% ownership stake in your business. This is America, the land of free enterprise – you can accept any of these offers if you want to, right? Ummm, not so fast.
From a legal perspective, an important initial question is whether any of the people putting up money for your business are becoming “investors” in your business. If so, you need to understand and comply with state and federal securities laws before you use any of these funds.
When is someone an “investor”?
Generally speaking, an “investor” is anyone who both provides money to be used in your business, and is not active in the day-to-day operation of your business. This is true whether the money is provided in the form of a loan or in return for an ownership interest.
What is the legal consequence of having an investor?
When you are seeking investors for your business, you need to comply with state and federal securities laws. State and federal securities laws are triggered, and automatically apply, whenever someone who has no active role in a business invests in that business. Note that in order to comply with these laws, you need to take a series of prescribed actions before you accept the money. If you wait until after you accept the money, you are too late and may have violated the laws.
What are the purposes of securities laws and who do they protect?
One purpose of securities laws is to protect investors from bad investments. The laws do this by requiring that the business owners make full and accurate disclosure of all relevant information to potential investors so that they can make an informed decision whether to invest. The securities laws also are designed to ensure that businesses do not take investments from people who cannot afford to lose their money. A simple example of that is that businesses generally should not allow investors to use their retirement savings as a source of funds and thereby risk their retirement.
Does the amount of the investment matter?
Yes and No. Securities laws apply to any investment, no matter how small, and require that the business make accurate and complete disclosures to investors before they make their decision to invest. However, the larger the investment, the greater the scope and depth of the disclosure requirements and the more thorough the investigation by the business should be to ensure that the investor can afford to lose the amounts he or she is risking through the investment.
You say there are both state and federal securities laws? With which ones do I need to comply?
The answer depends upon where your business is located (its primary place of business) and where your investors reside. Generally, if both you and your investor(s) are in the same state, then federal securities laws may not apply, but you need to comply with the securities laws of the state where you both are located. Alternatively, if your primary place of business is in one state and some of your investors reside in other states, then you need to comply not only with the state securities laws for each state in which any of your investors reside, but also with federal securities laws due to the interstate nature of the investments.
What do I need to do to comply with securities laws?
The precise requirements vary depending upon a number of factors, but generally speaking compliance with securities laws is accomplished in 3 ways:
- The business must provide complete and accurate advance written disclosures to the potential investors about the business, the terms of the investment and the risks of the investment
- The business must investigate the net worth and sophistication of the potential investor to ensure that the investor can afford to lose his or her investment
- In some circumstances, a written filing or registration needs to be filed with the applicable state and federal agencies together with applicable filing fees.
What are the consequences if I fail to comply with securities laws?
The penalties for failure to comply with securities laws can be severe. In most cases, failure to comply will mean that the owners or managers of the business responsible for accepting the investments will become personally liable for returning those funds to the investor, particularly if the business fails or is unable to repay those funds. In circumstances where the failure to comply with securities laws was intentional, or where inaccurate or incomplete information was provided, criminal sanctions can be imposed.
How can I learn more about securities laws and how to comply with them?
Of course, a qualified attorney can help you understand and comply with securities laws. But you also can learn a lot on your own. The SEC website has some good resources on federal securities laws https://www.sec.gov/info/smallbus/qasbsec.htm. Similarly, most states have good online resources, including the one for Maine: http://www.maine.gov/pfr/securities/small_business/index.htm.