It’s exciting to find ways to fund your business. Here’s how you can do it the right way and not get in big trouble with the Feds.
If you can’t get a bank loan for your business, or don’t want to, there may be other options you have not considered. For many small businesses that are just getting started, friends and family or angel investors are the best source of funding. However, anytime a business seeks to raise money by promising a return, then federal and state securities laws apply. 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 without violating the law or undertaking a great deal of regulatory compliance work
How do businesses raise money? The answer is that they find and take advantage of 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:
- The business is an Ohio business
- The investors live in Ohio
- 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, (read: 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.
TAKING INVESTMENTS UNDER 506(B) and 506(C) EXEMPTIONS
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.
If you are dealing with unaccredited investors, you are limited to 35 or less investors and you must 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.
Additionally, if you are trying to raise money under 506(B) exemption, 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. Contact an attorney at Wick Law today for assistance.
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 email@example.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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