The SEC — Not Just a Sports Organization!

Financing your business — particularly a start-up — can be difficult.  Starting a business can be expensive, and frequently (much more often than not!) the business owner just doesn’t have a lot of money to pour into it to get things up and running.  This can wind up causing a whole host of problems, if a business attorney isn’t involved from the get-go to help the budding entrepreneur avoid the traps and pitfalls.

To solve this cash-flow problem, I frequently hear clients and potential clients say, “I’m going to sell stock (if it’s a corporation, or membership interests if it’s an LLC) in the business to raise start-up money.  This is, in fact, a good solution to the problem, if done carefully and correctly.  However, here’s what our new business owner may not understand: corporate stock and LLC membership interests are both considered securities according to the Federal Securities and Exchange Commission, as well as the Alabama Securities Commission.  Therefore, any issuance of stock (or LLC membership interest) involves the issuance of a security under the Alabama Securities Act (Ala. Code § 8-6-1, et seq.), as well as the Securities Acts of 1933 and Securities Exchange Act of 1934.  That means that any offers to sell, and subsequent purchases, of these types of equity are regulated by both the federal government, and the state, and the sale, and securities themselves, must be registered.  The penalties for violating these regulations can be exceedingly strict!

Now that I’ve gotten your attention, the good news is that most of these types of “relational” offerings and sales (i.e. investment from your parent, or your wife’s brother, or your rich aunt Melba) are specifically exempt from most federal securities laws by a regulation called “Regulation D,” and from state registration under Ala. Code § 8-6-11(a)(9).   There are other, additional state and federal exemptions that may apply to certain equities and transactions as well.  The conditions and requirements for each of these are too complex to address in this post, which is why it is highly advisable to consult with a knowledgeable business attorney prior to selling any business equity or debt.  Note, too, that registration requirements (and exemptions) can apply both to the offer and sale (the transaction), and the securities themselves.

These exempt sales of securities are commonly referred to as a “private placement.”  Private placements can frequently be done very quickly, and can come in a myriad of variations, e.g. straight equity, convertible debt, secured debt, preferred stock, and so forth.  However, even in private placements, it is usually advisable to take some basic steps to ensure that the purchase knows what they are getting for their money, and to avoid allegations of fraud.

This is a very complex area of the law, and the penalty for missteps can sink your business before it gets started.  Let us help you avoid a penalty flag, and help you get across the goal line.