The most common way to fund your business is from friends and family.  So, how do you go about approaching people for their investments and stay compliant with the laws in place to protect investors?

SEC Regulations APPLY!!

Nearly all investments are regulated by the SEC at the federal level and by individual states at the state level….even when you are soliciting investments from family and friends, you need to be aware of the rules.

For example, if you offered an ownership interest (stock or membership units), or signed a promissory note then the SEC regulations apply.

Those security laws require a startup to:

  • either register the offering with the SEC and the state or;
  • find an exemption that allows the startup to complete the offering with without violating the law or undertaking a great deal of regulatory compliance work.

So, how do small businesses raise money?  Find the exemptions and take advantage of them!

Common exemptions to the SEC regulations:

Ten or less Ohio investors. 

This is the most common exemption, and really convenient and simple.   The recipe for this secret sauce is exactly this:

  1. The business is an Ohio business
  2. The investors live in Ohio
  3. The investors are purchasing for investment; in other words, they are not trying to resell their investment.

If you seek investments under this exemption, there is no limit on the dollar amount, and you don’t need to worry about whether your investors are “accredited.” However, and this is super important…. you cannot generally solicit for these investments.

If the above is not your situation, there are other ways to deal with investors and securities compliance. But, they are more complex.

The 506(B) and 506(C) exemption and “accredited” investors…AKA Only ask your rich friends!

The big hurdle when taking money from friends and family is dealing with the concept of accredited investors.  An accredited investor means the investor meets one of eight qualifying criteria as defined under Rule 501 of Regulation D.

Below are two of the most common cited criteria:

  • The investor had an income of $200,000 or more for the last two years and has a “reasonable expectation” of reaching that income for the current year. If married the joint income must be $300,000 to qualify as an accredited investor.
  • The person’s net worth exceeds $1,000,000, not including the value of their home.

If you are seeking an exemption under Rule 506(B), you can raise an unlimited amount of money from an unlimited number of accredited investors, and you don’t need to disclose certain information or address an accredited investor’s level of sophistication.  However, many people in your network do not fall into the definition of an accredited investor, so let’s look further.

Don’t have a bunch of Millionaires in your back pocket! Don’t worry!

506(B) allows you to accept investments from unaccredited investors. If you are dealing with unaccredited investors, you are limited to 35 or less investors and you have to document that the unaccredited investors are “sophisticated.”  To be considered sophisticated, an unaccredited investor (alone or in conjunction with lawyers and accountants) must have experience or knowledge in business and financial matters and is capable of evaluating potential risks. This means you must show them the financials and make sure they understand those financials.

Additionally, if you are trying to raise money under 506(B) exemptions, you cannot generally solicit the funds. So, avoid mass mailings, e-mail blasts, cold calls, and advertisements seeking investors.

Rule 506(C) permits Ohio businesses to raise an unlimited amount of money.  The key difference is that under Rule 506(C), businesses can only raise money from accredited investors.  Additionally, you are required to take “reasonable steps” to verify accredited investors status. This can include review of W-2, tax returns, bank statements. Finally, Rule 506(C) does allow general solicitation, so email blasts, and any other solicitation is acceptable.

As always, it is best to consult with a lawyer about the finer points and best practices when dealing with investors. And, if you have investors that you gave equity to, you need to have an attorney draft comprehensive governing regarding how much control an investor has in the running of the company.

Ok, friends, if you are interested in FUNding and want to know more, Call me! 614-572-6366. Email me! mwick@mwicklaw.com.

 

Wick Law, LLC is a small business legal practice, representing owners, investors, and entrepreneurs in all aspects of commercial, corporate, and business law, estate planning, contracts and negotiations, business litigation, and real estate. For more information: Contact 614-572-6366, visit www.mwicklaw.com, or email us at mwick@mwicklaw.com.  Wick Law, LLC is located in Columbus, Ohio.

(Materials in this article have been prepared by Wick Law, LLC for general informational purposes only. This list is for educational purposes and is not to be considered exhaustive. More items could be added to this checklist based upon the type of transaction or industry standards. These materials do not, and are not intended to, constitute legal advice. The information provided is not privileged and does not create an attorney-client relationship with Wick Law, LLC or any of the firm’s lawyers. This checklist is not an offer to represent you. You should not act, or refrain from acting, based upon any information in this checklist. Wick Law, LLC maintains offices in Columbus, Ohio, and has lawyers licensed to practice in Ohio and in the United States District Court, Southern District of Ohio. The firm does not intend to practice law in any jurisdiction where the firm is not licensed.)

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