A great way to raise money for your growing business is by selling a small interest to a family member or friend.
After all, they know you better than anyone and trust that you will give them a fair deal.
And even better, when you are the only owner of the business you don’t need to get the approval of any co-owners before selling an investment in your business.
Or maybe you and a coworker decide to make the break from your jobs to start a business together. You form a corporation where it is just you and your co-founder as the only shareholders.
Can you just take the money from your friends or family? Can you and your coworker invest freely in your new corporation? It depends.
Your business is not (yet) Amazon or Berkshire Hathaway or any other kind of publicly traded company.
But under any of these circumstances you or your company may be caught selling “securities” that might need to be registered under federal law or qualified under California law. Other states may also have their own requirements to satisfy before even offering for sale any securities.
This means that you may need to comply with federal or state securities laws even if it is just you and your work buddy starting a business together.
Or even if you are selling a small portion of your business to your wealthy aunt, you may still be subject to the securities laws.
More red tape on your way to starting or growing your business.
Fortunately, there is a way to cut through some of that red tape – legally.
California law requires that any “securities” offered or sold by the “issuer” must be “qualified.”
“Securities” basically means any investment resulting in an ownership interest by the buyer (e.g. stock).
The “issuer” is usually the company or corporation in which said ownership interest is granted.
“Qualified” is similar to registration of securities under federal law but is the term used under California law. Once qualified, you will have permission from the applicable regulatory agency to offer or sell the securities.
As you can see, you cannot even offer to sell securities without first qualifying the securities.
Qualifying (or registering) securities is very costly and time-consuming. You need to make extensive disclosures about finances and the risks involved with the investment.
The idea is to protect the average person from being defrauded by scam artists.
But if you know the persons who are investing in your business or your investors are savvy about finance and investment, shouldn’t there be a way to avoid the need to qualify the securities?
The red tape can be cut a couple of ways but only one way really matters to the situations we are looking at.
If the conditions are right, you can offer or sell an investment in your business to your wealthy aunt or start the corporation with your coworker.
The first condition is that the sale of the securities by the issuer (your corporation, for example) cannot involve more than 35 total buyers.
Also, the buyers must have a preexisting relationship with the corporation or its shareholders, officers, etc.
Alternatively, if there is no preexisting relationship, the buyers should have the ability to protect themselves in the transaction. This really means that the buyers should be savvy in finance or have experience making similar investments.
Your buyers must also promise that they aren’t buying the investment to flip it (i.e. resell). The buyers must truly be making an investment for the long-term.
And you can’t advertise the investment. If you are selling to your family or friends this should not be a problem because you know these people and don’t need to publicize the offer or sale.
Some people, though, get overly optimistic and run advertisements or send out mailers to mailing lists. Don’t do this unless you first consult a qualified attorney. Advertising could eliminate the exemption protection altogether.
So if you are offering an investment in your business to people you know, family or friends, you should be basically fine making the offer and sale.
Make sure you are honest with your investors and don’t hold back any material information from them because the anti-fraud laws still apply.
And don’t forget to file the proper notice of exemption with the state regulatory agency.
References: California Corporations Code sections 25102(f) and 25110.
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.