If your startup company is planning on raising capital, it is crucial that you have a basic understanding of U.S. securities laws. If you plan to raise money from investors you are likely going to be issuing securities, and if you issue securities without complying with both federal and state securities laws, the transaction may result in liability for your company and personal liability for yourself.

While securities laws are quite complex, it’s essential to know and follow a few simples rules to avoid making any serious mistakes. However, each startup has a unique situation and we recommend working with a trained securities lawyer if your small business is planning on raising capital.

What Is a Security?

A security represents an investment in a business. It can take the form of shares of stock, bonds, a package of loans or mortgages offered for sale by a financial institution or a financial instrument representing investment in a company or an international project. Shares of stock, convertible notes and stock options are all securities. Securities can be broadly categorized into two distinct type: equities and debts. However, some hybrid securities combine elements of both equities and debts.

What are Securities Laws?

Securities laws exist both at the federal and state level to help govern the sale and issuance of securities. The Securities Act of 1933 is the federal law that requires that securities sold to the public be registered with the SEC and that complete information about the seller and the stock offering is made available to investors. The Securities Act of 1934 regulates the operation of stock exchanges and trading.

The Securities and Exchange Commission is the federal agency responsible with enforcing the federal securities laws. Each state has an equivalent agency responsible with enforcing each state’s securities laws.

Why do Securities Laws Exist?

Most financial transactions requires the issuance of securities. Securities laws and regulations aim at ensuring that investors receive accurate and necessary information regarding the type and value of the interest under consideration of purpose. Securities are not inherently valuable, their worth comes only from the claims they entitle their owner to make upon the assets and earnings of the issuer or the voting power that accompanies such claims. The value of securities depends on a multitude of things, such as the issuer’s financial condition, products and markets. Management, and the competitive and regulatory climate.

These rules are designed in part to prevent fraud, insider training, and market manipulation, while also promoting transparency through a complex system of reporting and enforcement.

How do you raise money in compliance with securities law?

While the legal requirements of securities law are intricate, compliance should be entirely manageable for small businesses.

Securities law compliance entails the following:

  1. Registration of securities
  2. Prohibition of fraud

Both federal and state law requires that any company selling a security must register that security with the SEC and state securities commissioner, unless an exemption to the registration requirement applies. Most exemptions require, in order to qualify for them, that the company undertake certain actions or refrain from certain other actions. In addition, exemptions often involve significant limitations on selling activity.

In addition to the registration requirements, companies must also take steps to ensure they don’t engage in fraudulent selling practices. While this may sound simple, it can be very challenging in practice. Companies can be found liable for committing securities fraud even in the absence of an intern to defraud. Making any unintentional misleading statement, in certain cases, can be enough to establish liability.

What could happen if your company does not comply with securities law?

One of the things that new entrepreneurs often find most shocking is the degree of restrictions that both the federal and state governments impose on their capital raising activities. Securities law is something they associate with large public companies, not the small nimble companies that they started. Once they realize that, yes indeed, securities law applies to their company, their next question is usually: are there really any consequences for not following these seemingly silly and intrusive regulations? Unfortunately, there are.

A failure to comply with the securities laws can result in civil and criminal penalties. In addition, a compliance failure may increase the risk that a disgruntled investor will be successful in any litigation against the company. In addition to fines and lawsuits, violating securities laws could negatively impact the ability of a company to raise capital in the future. Investors almost always preform due diligence on the company, which involves a review of any prior securities offerings. Previous compliance issues may be viewed as a “red flag” causing the investors to pass up on the deal.

The Bottom Line

Securities law is the field of U.S. law that aims to regulate the various aspects of transactions and other dealings with interests under consideration for purchase. Failure to comply with securities laws can wipe out your startup’s cash, and then some. At the most extreme, offenders can face criminal charges on both the state and federal level. It is essential your small business has an understand of the laws before raising capital, and should consider hiring a securities law attorney for assistance.

Exemplar Securities Law Attorneys for Small Businesses Raising Capital

Exemplar’s securities law team has extensive experience helping small businesses, startups and early stage companies navigate business law matters, M&A transactions, capital raises, business formation and securities law compliance. Our attorneys assist clients with preparing and filing registration statements, proxy statements, annual and quarterly reports, private placement memoranda and related private offering materials and other required documents. For additional information please contact our team at rise@exemplarcompanies.com.



Christopher Marston

Christopher Marston

Chief Executive Officer, Exemplar Companies, PBC

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