Raising Money Without Getting In Legal Hot Water
Some fundamentals of capital raising
As a lawyer that helps a lot of companies raise money I see a lot of stuff. In fact I see many of the same issues over and over again.
I thought I would take some time and write down the basics of raising money for you the business owner or leader who might be getting involved in the capital raising process. I’ve geared this guide to US businesses or companies that might be making offering to US investors. And while I can’t give you legal advice in this article I can help familiarize you with some common terms and issues so that you can speak more knowledgeablely with the lawyer you choose to work with.
We start with the basics which is that the sale of interests in companies that are connected to the profits of the enterprise are considered “securities.” The key in determining what is a security and what is now is the “Howey Test” which was set by the U.S. Supreme Court in the 1946 case of SEC vs. Howey.
So if someone is investing in your business and taking a payment based on the future profits you probably have a security (at least assume that until an experienced lawyer confirms otherwise). And that brings a whole new layer of regulations.
Securities regulations are in addition to a host of other laws that already apply to your company such as state corporate laws, consumer regulations and general commercial laws. So think in terms of complying with a network of laws, not just securities laws.
But if we are going to raise money we need to understand at least the basics of securities laws.
Securities Law 101
The basics of securities law is simple. Every issuance of securities must be registered or exempt (from registration).
Registration means filing with the Securities and Exchange Commission (SEC) or, in some cases, a state authority (this is less common). Registration is generally intense, detailed, time consuming and costly. Generally only large private companies or public companies are going to knowingly want to register.
Most companies elect to use an exemption. Using an exemption means you don’t have to register your issuance with the securities authority (you may still have to do a filing with them) which generally means a lot less trouble and lower costs. But the exemptions are conditional. You have to comply with the conditions of the exemption you choose in order to be legally complaint.
How do you find an exemption? Let’s look at this next.
Looking For An Exemption
Smart companies start looking for an exemption before they start taking action on selling their next round of stocks (or bonds). There are a variety of exemptions out there these days. The JOBS Act, signed in 2012, expanded the list of available choices.
Each exemption, like each person in the world, comes with their strengths and weaknesses. Some require more documentation, some require the use of an investment portal, and some require you not publicly disclose your offering terms (meaning you have to keep your terms to a small, private group of listeners). There truly is no one size fits all.
“Crowdfunding” has been, perhaps, the exemption which has gained the most public fanfare. With the release of the JOBS Act and the related media coverage many people know the possibility of getting a securities exemption from Crowdfunding is possible.
But Crowdfunding is not the only game in town. You really need to look at all of the exemptions and see which ones might fit your needs.
Not All Exemptions Are The Same
Many people find the dollar limits on Crowdfunding (about $1,000,000 raised) and the strict requirements of using a funding portal makes the exemption somewhat impractical. The cost of using the exemption is not worth it in light of the amount of money that can be raised for many issues.
For other companies other exemptions are problematic. For instance Rule 506 under Regulation D has long been a popular securities law exemption. After the JOBS Act Rule 506 has two different flavors. One version of Rule 506 allows public discussion of your offering and one does not. But the one that does allow public discussion of your offering terms has more due diligence requirements around your investors.
The long story is that you’ll need to study all of the possible exemptions and find the one that is right for you and your situation. And once you pick the exemption you’ll need to strictly comply with the terms of that exemption from the start to the finish of your capital raising.
Paying People To Find Money For You
As part of the capital raising process we often see that a lot of people want to help the issuer find money. And, understandably, these people want to be paid for helping to raise money. It might be an employee, a consultant or someone just well connected that wants money for helping the company find money.
This typically leads to a big problem. The SEC (and other state authorities) requires that brokers and dealers be registered with them and regulated. And those registration requirements and regulations are costly and time consuming to comply with. So many people that want to get paid don’t do the legal documentation to get the right licenses.
This means that the companies that are issuing securities need to be really careful. You can’t just let anyone raise money for you and give them a percentage. Almost every version of such arrangement will lead to a securities law violation unless you are dealing with a fully licensed broker/dealer.
Make sure you look carefully at any compensation arrangements connected to your capital raise to make sure you are compliant.
Protecting Yourself For The Future
Securities law compliance is not fun. Compliance is often costly and burdensome. And many are frustrated to see that while they spend a lot of time on compliance others are violating the law and being open about it. As Anessa Santos says “crimes are committed every day. Just because others get away with murder doesn’t mean you will too.”
But good compliance is about your future. It’s a way to make sure you don’t have fine, penalties or even criminal charges in the future.
Make sure you start early on the process. If you start thinking about the law and how to find your right exemption early on you’ll be off to a great start. It’ll be much easier to comply from the beginning.
Are you frustrated by the complexity of raising money? Are the laws holding you back from what you want to do in your business? Join us in the comments below and let us know about your experiences.
**NOTE: Any discussion of legal ideas in any of my public facing materials is not legal advice. You must consult counsel to get legal advice based on your facts and circumstances. Do not rely on the content of this message without consulting a lawyer. No attorney-client relationship is formed by this content (video, blog, etc.) Unless you have retained my firm and I have specifically acknowledged I am your lawyer you should not rely on any of my statements as legal advice.**
By: The Our Shawn McBride, is the man you call when you want a keynote, training or a consultant to get your business ready for The Future of Business. He’s the host of The Future Done Right(TM) Show and a long-time business attorney. If you want regular content on the future of business subscribe to get new blog posts from us here.