Securities are Stocks, Debentures, Viatical Settlement Contracts, Straddles, and More

You are on your way to raising money for your startup and you want to offer investors a chance to get in on a great business opportunity.

Or you have an idea for raising money that doesn’t include forming a corporation and you are only selling investment contracts.

Maybe you are just selling promissory notes where your company promises to pay back the investors’ monies at a certain percentage rate of interest on a certain due date.

How about option contracts?

Offering viatical settlement contracts?

It could be that your fast food restaurant has taken off.  You have locations 1 through 20 going strong and now you want to start franchising the restaurant to would-be restaurant owners.

There are many other ways that a business can solicit money from someone in return for a promise of some kind of return, or potential return, on the investment.

In a very broad sense, that is the core principle behind a “security” that is regulated by securities laws.  Once you have a security that you are offering or selling, you will need to make sure you are complying with federal and state regulations.

What types of investments are considered “securities” that are subject to regulation can vary quite a bit.  California law is typical in this regard.

Under California law, a security includes a debenture.  A debenture is essentially a type of bond.  It is debt that is sold to the investor (who becomes a creditor) and the debt has no collateral.

The investor only has the good faith and credit of the issuer of the debenture to rely on.

So with a debenture, the issuer is the debtor and sells these “securities” to investors who are guaranteed a certain rate of return in a certain amount of time.

So if you are thinking of selling an investment in your business to someone and want to characterize it as a loan to your company, you may need to ensure the securities laws are satisfied.

Viatical settlement contracts are akin to betting on when someone will die.  This is an insurance related transaction wherein a third party buys out a life insurance policy to cash out the person whose life is insured.

Because these types of contracts are generally used to help individuals who are terminally ill, and because they involve highly regulated insurance policies, it is no surprise that the offer and sale of such contacts would be regulated.

But why are they considered a “security?”

The seller of such a contract is offering for sale a right to receive payment pursuant to the underlying insurance policy.  Because there is no certainty as to when the person whose life is insured will pass away, there is plenty of risk involved.

When someone offers for sale an investment, whatever the form (usually signified by putting money at risk), that will trigger some kind of regulation under securities laws.

Straddles are simply a particular type of option transaction in securities (usually stocks).  Options are derivatives because they are based on the underlying securities.  But even so, they are regulated securities.

Options to buy, or sell, stock can be very easy to create even for a privately held corporation.

You may decide to offer an incentive plan to key personnel and offer them an option to buy your company’s stock at a later time at a predetermined price.

This creates a nice “carrot” incentive for good employees.

But it also can lead to problems with securities regulations.

There are usually some exemptions for employee plans, but it is best to be sure about that.

A franchise is one of the clearest investments that would qualify as a security covered by regulation.  However, a franchise also involves licensing the franchisor’s trademarks and business methods and involves participation in a standardized system of marketing, etc.

Because of the added layers of franchise sales, it amounts to more than selling stock in your company to an investor.  And because of that, many states, California for example, have developed elaborate franchise laws that cover offering and selling franchises.

So if your Mexican fast food restaurant chain has taken off and you are ready to offer and sell franchises, the main thing to look into is the franchise sales laws.

Bottom line, if you are offering or selling any kind of investment (some of you might call it a “business opportunity”), even if it is in the form of a debt that your company promises to pay back, you may be offering or selling securities that may be subject to securities laws registration and disclosure requirements.

In other words, whenever you are trying to raise money for your business, no matter how creatively you have structured the investment, odds are you are really just offering or selling securities that will likely need to be registered or otherwise exempt from registration.

References: California Corporations Code section 25019.

This discussion is not legal advice, a solicitation of you as a client, nor the engaging in the practice of law in any jurisdiction.

This discussion is merely for information/education and should not be relied upon for legal advice by anyone because the facts discussed may be different from your own situation.  If you need legal advice, consult a qualified attorney.

For more information please visit my website at www.palacioslawoffice.com.

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About Elio Palacios, Jr.

Attorney Elio Palacios, Jr., represents individuals, corporations, entrepreneurs, small businesses, startups and early stage businesses, physicians, dentists, and healthcare businesses in corporate, business and commercial transactions and litigation. He also counsels employers and individuals on visa, immigration and naturalization matters. Visit www.PalaciosLawOffice.com to learn more.
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