Legal Traps for the Entrepreneur to Avoid.
Mr. Inventor has the greatest new business plan and is ready to start financing his new venture. He has two former colleagues that are going to go into business with him. The inventor has a nest egg he plans to contribute, one of his future business partners is going to contribute the real estate and the other is going to forego a salary for a year. The bank is putting up a loan, but the business still needs startup funds to make the business plan complete. Mr. Inventor’s golfing partners want in on the idea, his sister and brother in law, his physician and a couple his partner knows from church. Mr. Inventor takes his business plan and financial projections his CPA ran for him and meets with the various individuals over coffee. The company gets set up and is running.
Mr. Inventor does not know it but he has exposed himself to great financial risk. Under what are commonly referred to as Blue Sky laws, the law require that companies seeking to sell stock or interest in a company to the public submit information to officials who oversee corporate activity and make certain legal disclosures to potential investors in a specific manner and limits who can be investors in particular situations. These laws seek to protect people from investing in sham companies that offer nothing but “blue sky.”
The Federal Securities laws come into play when potential investors are in multiple states and each state has its own securities laws. Yes, even when you are not trying to sell stocks like a broker dealing in the Fortune 500 securities laws can be triggered. There are exceptions and different triggers for the securities laws to come into play. Goosmann Law attorneys can identify these business matters and help you accomplish your business goals.
For example, if the entrepreneur is the sole owner of his venture and did not plan to take investments from outsiders the ownership interest in the company would not be considered a “security,” under the law. For co-owners of businesses, the applicability of the securities laws can become quite complex. In general, a security is an investment in a profit-making enterprise that is not run by the investor. If a person invests in a business with the expectation of making money from the efforts of others, that person's investment is generally considered a "security" under federal and state law. Conversely, when a person will rely on his or her own efforts to make a profit as an active owner involved in operations, that person's ownership interest in the company will not usually be treated as a security. Typical of most small start-up companies, if all of the owners will actively manage the company, the company ownership interests will not be considered securities. But if one or more of your co-owners will not work for the company or play an active role in managing the company, like start-ups that are seeking “silent investors” that accept money from friends and family or that are run by a special management group, these ownership interests may be treated as securities by the state and by the federal Securities and Exchange Commission (SEC). In the example above, the interests of the golfing partner, sister and brother in law, physician, and couple from church are all securities.
If the ownership interests are considered securities, the business must qualify for an exemption from the state and federal securities laws before the initial owners of your company invest their money or comply with the law before you propose the investment. If the business does not fall within an exemption to the securities laws, the business must register the sale of ownership interests with the SEC and the state.
Fortunately, smaller companies, even those that plan to sell memberships to passive investors, usually qualify for securities law exemptions. For example, SEC laws exempt the private sale of securities if all owners reside in one state and all sales are made within the state. This is called the "intrastate offering" exemption. Another federal exemption covers "private offerings." A private offering is an unadvertised sale that is limited to a small number of people, 35 or less, or to qualified investors with a certain high net worth or income earning capacity that can reasonably be expected to be able to take care of themselves in the investment process. Most states have enacted their own versions of these popular federal exemptions.
For more information about SEC exemptions and state blue sky laws contact Attorney Jeana Goosmann. If your business doesn't qualify for an exemption, you may want to explore other ways of raising money or find yourself in violation of the law and risk your business and yourself to legal exposure.