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Funding Your Start-Up Part 1: Understanding Whether Federal Securities Law Applies to You

January 11, 2011 in Articles | MARTIN WREN, P.C. | LEAVE A COMMENT

So you’ve designed a digital widget that will revolutionize the widget industry.  Now you just need capital to make your start-up a reality.  If you’re planning to raise any portion of that capital by allowing people or entities to invest in your company, you need to take care not to violate the Securities Act of 1933 (the “Act”).  The primary goal of the Act is to make sure that companies disclose to potential investors enough information for the investor to make an informed decision.  It does this by requiring these companies to file registration statements and other periodic information with the U.S. Securities and Exchange Commission (SEC).   The thought that your digital widget engineering business would be within the scope of SEC regulation may not have even crossed your mind, but the Act’s extremely broad definition of a “security,” or an ownership interest in your company, means that it probably is subject to SEC regulation, and inventors, entrepreneurs, and business owners therefore must be sure that they are in compliance with the Act.  Securities that trigger registration requirements include not only stocks, but also notes, bonds, profit-sharing agreements and investment contracts, as well as put and call options.

The Act requires any offer to sell securities to be registered with the SEC if it does not meet one of the exemptions to registration which are set forth in the Act. This means that, if you choose to raise capital by selling “securities” in your company and you do not fit into one of the Act’s exemptions, you will be “going public” with your offering.   Going public can be time-consuming and prohibitively expensive, usually costing a minimum of $100,000.00 in legal, accounting, and other fees.  It also involves disclosure of detailed financial information and imposes continuing obligations to disclose this information.  For these reasons, going public may not be ideal or even feasible for a start-up or emerging company, and most start-ups who generate capital from investors ensure that their securities offerings to those investors meet one of the Act’s exemptions, most commonly, the exemption know as Regulation D.  I will discuss Regulation D in more detail in a separate article.

Understanding the applicability of the Act and its exemptions may influence many of your business decisions, including how you decide to raise capital for your business, and what types of investors you solicit or accept, so this understanding is crucial in the early stages of developing your business plan.  This is one reason why it is important to involve your business attorney in the infancy of your start-up, and keep him or her involved in every transaction.  It can also be helpful to develop a capitalization chart with your attorney prior to the issuance of any ownership interest in your company, as this will help you understand how future security transactions will impact the ownership structure of your company and the value of its ownership interests.  It is never too early to plan for the growth of your company, or to make it attractive to investors.

MartinWren, P.C. is an AV-rated Virginia law firm, and its Business, Corporate & Tax Law section represents business from every stage of a business’s life, including formation, financing, maintenance, dissolution, ownership transactions, and intellectual property and technology law.  For more information about how MartinWren’s attorneys can assist your business, please contact Robert E. Byrne, Jr., the managing attorney of the firm, at 434-817-3100 or by email at byrne@martinwrenlaw.com.

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