Many people may be surprised as to what all qualifies as a “security” under the federal securities laws, and the Indiana Securities Act (ISA). A security is often thought of as a stock or bond, but can also include “promissory notes, investment contracts, and interests in limited liability companies, to name a few,” according to Indiana Secretary of State and the seminal U.S. Supreme Court Case of Howey.
One of the main applications of securities law can be seen when the founders of a start-up seek to raise funds by selling stock, royalty agreements, convertible notes or debt, or other forms of equity in business to investors. The sale of stock is subject to federal and state laws that govern the sale of securities. It is important to be cognizant of these regulations as your business navigates through raising capital and selling securities. Failure to comply with securities laws could result in civil and criminal penalties.
To avoid these implications, here are three things to keep in mind when dealing with the sale or purchase of securities:
- Try to structure the securities offering to comply with a form of registration or exemption.
Carefully research the registration and exemption requirements under the federal and state securities laws. If you cannot comply with a particular form of registration, try to satisfy the requirements for an exemption from registration. One of the most commonly used exemptions are those contained within Regulation D of the Securities Act. For instance, Rule 506 of Regulation D allows the company to sell securities to an unlimited number of “accredited investors,” or individuals and companies who meet certain defined income or net worth requirements.
- Give full disclosure of material facts to prospective investors.
Under the ISA, there is no requirement of due diligence on the part of the buyer of the security. Rather, the seller of the security has an affirmative duty to make full disclosure to the buyer of all material facts, and cannot make any untrue statements of fact.
The information you should provide to prospective investors depends on the needs of the investors you are targeting. It is usually advisable to use a written disclosure document even if none is technically required. The disclosure document should include, at a minimum, a business plan, statement of risks, sources and uses of funds, rights of investors, transfer restrictions, and financial statements (when available).
- Use caution when paying others to identify, contact and solicit potential investors.
Issues can arise when new business owners pay other people to identify, contact and solicit potential investors. Engaging in the business of buying and selling securities, either for one’s own account (as a “dealer”) or for the account of others (a “broker”) is a regulated activity. Securities brokers, dealers and their representatives must be licensed under federal and state securities laws.
Going through the process of selling securities can be a daunting, but it is important to make sure all of your bases are covered. The work put in now will ensure your greater success in the future.
ABOUT THE AUTHOR – shannon starr
Shannon Starr is an attorney at Gutwein Law. Prior to receiving his J.D. from the University of St. Louis, he earned a BS in from DePauw. He is a member of the Indiana Trial Lawyers Association and the District 5 Representative for the Indiana Bar Litigation Section Council. He focuses primarily on litigation.
