SEC Registration and Exemption
When considering securities law issues in forming your business, you'll need to be aware of the impact of federal regulation.
Generally, before an entity can issue securities, it must first register the offering with the federal Securities and Exchange Commission (SEC) and with the SEC's counterparts in each state in which the securities are being sold, unless an exemption applies.
For a small business owner, there are two common ways to do this:
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Warning
From the perspective of limiting exposure to liability in your business structure, it is extremely important that the small business owner either properly register an offering of securities with the federal and state governments, or ascertain that an exemption applies. Failure to comply with federal and state securities laws can result in large civil fines and the likelihood of personal liability for losses suffered by investors.
If a small business owner has raised capital from investors and the business fails, there is a likelihood that the business owner will be sued. One of the first things a plaintiff's lawyer will examine is whether the business owner complied with federal and state securities laws. If there is a failure in this respect, the small business owner will likely lose. Conversely, if the owner has complied with these laws, the small business owner will likely win, even though the investors suffer a total loss.
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Fortunately for the small business owner, an issuance of securities to himself, his immediate family members and a few other partners will usually be totally exempt form both federal and state securities laws. In this case, the exemption generally is "self-executing"--that is, the exemption is automatic.
Generally, an automatic or self-executing exemption will apply when the offering of securities has all of these attributes:
- limited to 10 or fewer individuals who are all organizers of the business or who, alternatively, invested through direct in-person solicitation
- did not involve any use of the mails, telephones or the Internet in solicitations
- limited to one state
A self-executing exemption does not require the filing of any documentation with the federal or state governments.
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Warning
Unfortunately, each state's securities laws (termed "blue sky laws") are, in fact, unique--even though they are modeled after the federal laws.
Some states may require that a simple notice of a sale be filed when sales are made to individuals who are not organizers of the business, even though all of the conditions for the exemption described above are met. If you are offering securities under this set of circumstances, it is wise to first check with the state agency that regulates securities offerings in the particular state involved.
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