Risks to Avoid When Raising Investment Dollars

Raising dollars for your business venture? Be wary – the government has rules on almost every kind of business/enterprise fundraising. If you aren’t careful, your investors can sue to get their money back based upon your not following proper procedures. 

The easiest way to avoid burdensome securities regulation is to forego securities altogether and instead treat investments as loans; however, this is often unrealistic. Because the definition of “security” is so broad, your investment strategy might be subject to SEC regulation without you even realizing it.[1] If you are selling investment shares in your company, you are likely subject to SEC and state securities rules; in all cases, you are subject to the “anti-fraud” statutes and court-imposed rules to protect investors. You can reduce this burden, however, by engaging in an unregistered “private offering.”

A company can raise money through a private offering under the following conditions, among others:[2]

  1. If a company is not:
  2. An Exchange Act reporting company;
  3. An investment company;
  4. A company with no specific business plan or that has indicated its business plan is to engage in a merger or acquisition with an unidentified company or companies; or
  5. A company disqualified as a Rule 504 “bad actor,”

… then the company may offer up to $5,000,000.00 in any 12-month period to any number and type of investors.

  • If a company:
  • Is organized in a U.S. state;
  • Carries on a significant amount of business in that state; and
  • Only makes offers to people within the state,

… then the company can raise an unlimited amount from an unlimited number of investors provided that all investors are within that same state.

  • If a company is not:
  • Generally soliciting its offering or
  • Offering to more than 35 non-accredited investors,

… then the company can raise an unlimited amount from an unlimited number of accredited investors. However, the company must provide non-accredited investors with additional information that is nearly equivalent to a full offering.

Most private offerings still require that your company file a form with the SEC and likely with your state securities department as well. All securities offered under private offerings are also usually “restricted securities,” meaning that there are limits on how and when they can be traded.[3] Most importantly, any effort to raise money must still warn of the risks of investing in your company.[4] If you fail to disclose enough information and the company fails, investors can sometimes sue you for fraud or misrepresentation. To protect yourself, you should disclose as much information as possible, including:

  • Business plan and budget
  • Projected rates of return
  • Market and economic factors
  • Legal and policy factors
  • Tax consequences
  • Management and operation
  • Powers and rights of investors
  • Dispute resolution processes

Crucially, you should also warn prospective investors that you are promising nothing and that they should expect nothing.

What repercussions might you face if you fail to file and disclose properly?

First, if you don’t properly disclose, you are inviting a lawsuit from investors who are unhappy about any aspect of their investment. Repercussions could include a full refund of their investment, punitive damages, attorney’s fees, and imposition of all of the above on not only the company, but also all principals raising the money. Further, if you don’t properly seek an exemption, you risk all of the above repercussions and will be barred, for a period of time, from participating in raising money for a business in the future.

The goal is to protect yourself by being proactive. In doing so you will reduce the likelihood of a lawsuit, as well as reduce the likelihood of Government involvement in your business affairs. Government prosecutions and audits can be detrimental, as the costs are staggering, and thus is it important to protect yourself before such a situation arises.

            Virtually any effort to raise money for your business will be subject to federal and state securities regulation, but you can minimize the costs with proper planning. Securities law is complex, and if you choose to undertake it alone, you will place yourself at risk of criminal and civil liability. Instead, no matter which option you think is best, you should consult a securities law professional who can help to create the strategy best suited for you and the needs and goals of your business. Contact Weiss LLP for further information.

[1] https://www.americanbar.org/groups/business_law/publications/blt/2017/04/06_loev/

[2] https://www.sec.gov/smallbusiness/exemptofferings

[3] https://www.sec.gov/smallbusiness/exemptofferings/faq?auHash=rh5WfJi9h3wRzP6X2anOmgYLdhPHNuo-3Vw0YNZyR_M#faq2

[4] Id.