When Family And Friends Become Investors
Cliff Ennico
www.creators.com
#147;I am trying to raise $500,000 for my limited liability company (LLC). So far I have verbal commitments totaling $200,000. My attorneys are telling me that because this is a #145;private placement of securities#146; under the federal securities laws, I have to prepare a detailed prospectus and other disclosure documents and give them to my investors before I can take their money. These attorneys are quoting me between $10,000 and $15,000 to do the necessary paperwork. Do I really have to comply with the securities laws, when all of the investors will be friends and family members who are exceedingly wealthy and can easily afford to lose their entire investment if my company goes under?#148;
Just because your investors are friends and family members does not exempt you (or them) from complying with any law #150; federal, state or local #150; that regulates a company#146;s capital raising efforts. Whenever you hit up a friend or relative for seed capital, you are engaged in an offering of your company#146;s #147;securities#148;, and sadly, you have to at least consider whether or not you are required to comply with federal and state securities laws.
If you were raising more than $1 million for your business, you would have to file paperwork with the federal Securities and Exchange Commission (SEC) to register your offering as a #147;private placement#148; under the SEC#146;s Regulation D. The good news is that you#146;re looking for only $500,000, so you shouldn#146;t have to deal with the Feds.
The bad news is that each state has its own securities law #150; known as a #147;blue sky law#148; #150; regulating offerings of securities that are less than $1 million. These laws are literally #147;all over the place#148; #150; just about every state has adopted its own unique rules about what you have to do before you can take investment capital from a resident of that state. In most states, you will have to prepare a legal disclosure document called an #147;offering statement#148; (similar to a stock prospectus), and give it to your investors at least several days (the exact number varies from state to state) before you can legally take their money. In some states, you may be required to file a draft of your #147;offering statement#148; with the state securities agency and have it approved by the agency before you can give it to any of your investors. Special rules apply if you are raising capital for real estate development, oil and gas drilling, and other tax-advantaged investments.
You will need to identify the state in which each of your investor friends and family members resides, and find out what you have to do before you can legally take their money.
Here#146;s a way to save money #150; count the number of investors you think you will have in each state, and ask your attorney to tell you what the #147;de minimis#148; rule is in each state. Each state has such a rule (#147;de minimis#148; is Latin for #147;really small#148;), which when translated into plain English says #147;if you#146;re selling your securities to fewer than X residents of our great State, it#146;s not big enough for us to care about, so you don#146;t have to prepare or file any particular paperwork here.#148; The X, of course, varies from state to state. So, for example, in Connecticut you don#146;t have to do anything if your company has fewer than 10 investors total (including you), while in neighboring New York you can have up to 40 New York investors and an unlimited number of investors in other states. It may cost you a few hundred dollars to get this legal advice, but as long as you stay below the #147;de minimis#148; ceiling in each state where your investors reside, it may save you tens of thousands of dollars in compliance costs.
I#146;ve said it before in this column and I#146;ll say it again now #150; when borrowing money for your business from friends and family members, do not treat them as #147;friends and family#148;. Treat them the same way you would treat total strangers, and give them all the paperwork the law requires. Good contracts make for good business relationships.
Cliff Ennico (
cennico@legalcareer.com
) is a syndicated columnist, author and host of the PBS television series 'Money Hunt'. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at
www.creators.com
. COPYRIGHT 2005 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. Permission granted for use on DrLaura.com.
