When you were pacing your room at midnight dreaming up the idea that would be the next big thing, you probably were not thinking about the securities laws, and, honestly, who can blame you? Now that you want to make that dream a reality, however, you will need to know something about this complex area of the law because it will play a critical role in the success or failure of your startup. The reason the securities laws are so important to your startup is because these are the laws that will allow your startup to raise, or prevent your startup from raising, money from investors. Consequently, whether you are a software startup or a medtech firm, whether you have four cofounders or are running your business alone, whether you are a local business or a national company, if you plan to have investors, the securities laws matter to you.
The purpose of the securities laws is to protect investors, and, to provide as much protection as possible, these laws have a very broad reach, applying to any “security” (as defined by law) offered for sale to investors, including, among other things, stock, interests in LLCs, and some types of promissory notes. These laws also apply to nearly every company, no matter how small, and to nearly every offering of securities, even if a founder is only offering to sell a few shares to a friend or a family member.
The securities laws protect investors primarily by requiring extensive disclosure of information about the offering company. Under the federal securities laws, for example, whenever a company offers to sell securities of any kind, it must file a special form of disclosure document called a registration statement with the Securities and Exchange Commission unless a specific exemption to this registration requirement applies.
The exemptions to registration allow a company to sell securities without filing a registration statement, but still require the selling company to satisfy other specific and detailed requirements. These requirements vary, from exemption to exemption, and may include, among other things, a limit on the maximum amount of securities that can be sold pursuant to the exemption during a certain period of time, specific and detailed disclosure requirements and/or prohibitions on the resale of the securities. Most, but not all, exemptions also prohibit any advertising or general solicitation.
Since filing a registration statement is a very expensive and complicated process, most early-stage companies offer their securities for sale pursuant to one of the exemptions, so that they will not have to file a registration statement. Unfortunately, selecting the right exemption for an offering and complying with all of its requirements is not easy, so, while offering securities pursuant to an exemption is faster and less expensive than filing a registration statement, it still requires substantial knowledge of the securities laws. Consequently, no startup should ever sell shares to anyone, even a relative or friend, without first consulting with an attorney. Securities law compliance is not a place for DIY. Not only are the risks and penalties for noncompliance significant; offering your startup’s securities without complying with the securities laws may delay, or even prevent, future sales of the securities of your company.
Fortunately, the cost of seeking legal advice for a securities offering will vary with the type of offering. An experienced attorney will be able to help you sell a few shares to a friend for a very reasonable fee. If, on the other hand, you want to offer $1,000,000 of shares to multiple investors, you can expect your legal fees to be significantly higher. In either case, you should never sell, or offer to sell, your startup’s securities without first getting the advice of an attorney. There is simply too much at stake.
This article was written by Janice L. Gauthier, Esq. Ms. Gauthier has an A.B., cum laude, from Harvard University and a J.D, cum laude,. from Harvard Law School. She is a startup lawyer and the owner of The Gauthier Law Group, LLC, a boutique startup law firm that represents founders, entrepreneurs, startups and early-stage businesses in Wisconsin and Illinois, including the Greater Milwaukee, Chicago and Madison Areas. You can contact Ms. Gauthier at 414-270-3855, ext. 101 or by email. To learn more about Ms. Gauthier’s background and experience, visit her Google or LinkedIn profiles.
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