Watch Yourself Entrepreneur…

As a corporate and business law attorney, whether I’m working with a client that is completely new to the business realm (like a first-time entrepreneur) or a client who owns a massively successful company, one thing seems to be consistent across the board: entrepreneurs of all shapes and sizes often do not really understand (or care about) securities law as much as they probably should.

Well, hopefully that is going to change for some of you today because I’m going to tell you all about the wonderful world of securities law (well actually, I’m not going to tell you all aboutsecurities law because that would probably put most of you to sleep…). Instead, let’s just start with the basics and hopefully, by the end of this article, you’ll understand this area of the law a little bit more and (even more importantly) why this area of the law should matter to you as an entrepreneur.

What is a Security?

So let’s start with the most basic question of all: what the heck is a security? Great question. Why is it such a great question, you ask? Because securities law only applies if a transaction involves a security! If no security is present, then we do not really need to worry about securities law.

The bummer is the definition of “security” is pretty broad. Are you ready for it? It’s a bit intense:

The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.” 15 U.S.C.A. § 77b

I’m sure I lost most of you up there at “It’s a bit intense,” so let me help simplify things a bit more for all you busy entrepreneurs out there: if a transaction involves (in almost any form) the purchase or sale of stock or membership interest in a company or the borrowing or lending of money from/to a person or business (excluding banks), there is a really, really good chance the transaction involves a security in some form and is therefore governed by securities law.

But in reading that simplified description above, I’m thinking I need to break it down even further just to make sure it’s clear:

  1. Your best friend gives you some cash in exchange for 10% of the stock you own in your business – that’s the sale of stock and securities law governs that transaction!
  2. Your mom (oh how we love our mothers) loans money to your business because you’ve hit some hard times – that’s the issuance of a promissory note and securities law applies!
  3. You sit down and ask a friend of a friend to invest in your new company that’s going to revolutionize the widget industry – that’s the solicitation of an investor and securities law governs.

Wait, seriously? Securities law applies in all those situations? Even with mom?! Even when I’m just starting out?! Even with my friend?!


Securities law applies to all those situations, whether you want it to or not, and whether you know it or not.

Why Should You Care About Securities Law?

So, let’s get to the next important question: why should I (a very busy entrepreneur that is focused on building my business) care about securities law? The simple answer to that question is because the courts, the division of securities in your home state, and the Securities and Exchange Commission (SEC) all care about securities law (and if you do not watch your step, they can make your life pretty miserable).

Given that all these government authorities care about securities law, let’s talk a bit more about what you need to do to keep all of them happy and off your back.

Securities are regulated at the federal and state levels (i.e. double trouble). There are two different components to the regulation of securities that exist and are enforced at both levels.

1. Disclosure Requirements

The first component is anti-fraud/disclosure. Federal and state securities laws include anti-fraud and disclosure provisions which require that any person or company that is selling securities (generally called an issuer) provide any person or company buying those securities (generally called an investor) with sufficient information about the investment opportunity to ensure the investor can make an informed decision on whether or not to invest. There are strict penalties (criminal, civil, and regulatory) for issuers that (1) do not provide investors with all material information when inviting them to purchase securities or (2) lie to investors to induce them to invest. Thus, if you are trying to raise money for your new company by bringing in debt or equity investors, if you do not follow the anti-fraud and disclosure rules, you could find yourself in a pretty deep mess down the road.

2. Registration Requirements

The second component to the regulation of securities at the federal and state levels is registration. The general rule is that a security can only be sold if that security is registered with the SEC and/or your state securities division, unless a registration exemption applies for that security or the transaction in which the security is sold. Now, registering a security is a massive pain in the you-know-what and really isn’t worth the hassle in a lot of situations (especially for startups and small businesses), so finding an exemption to the registration requirement is pretty important if you want to be able to affordably sell securities. The reality is, there are a lot of exemptions that allow you to avoid registering your security, but there are so many nuanced rules for those exemptions. Thus, you really need to make sure that you have assistance in navigating those exemptions before you start offering securities to investors to ensure the registration exemption is actually available for your particular situation. If you fail to follow these rules and you get caught, you’re again looking at some pretty hefty fines and other potential liability.

Rolling the Dice

“But how would any regulatory body ever find out that I’m not complying with their rules – it’s not like I’m raising that much money or soliciting that many investors?” Well, let’s be honest – lots of entrepreneurs roll the dice on securities law compliance. In fact, many (if not most) do it in complete ignorance. And the reality is, the SEC and many state securities divisions do not have the resources to ensure there is a significant level of compliance in the marketplace. However, there is one situation in which these regulatory bodies often catch unwitting entrepreneurs:

When things go wrong.

Believe it or not, businesses do fail. And when people that have loaned money to or invested money in a business, do not get that money back, if there was a violation of securities law, one of the first places these investors’ attorneys call is the SEC and/or the applicable state regulatory bodies. And then the SEC and/or the applicable state regulatory bodies call the entrepreneurs that raised the capital from the investors (and that is not a call you never want to receive – trust me).

So, if you are an entrepreneur that is looking to raise capital for your business – no matter your level of sophistication and no matter the stage of your business – please be sure to think through the securities law implications of your capital raising plan. Please also make sure to talk with legal advisors that can help ensure you are as compliant as you can be with all applicable securities law so that you can avoid any issues with investors and securities regulators down the road.