Classic Capital Raising Mistake #1: Seed Funds without Securities Law & Regulation Compliance

by / Sunday, 14 September 2014 / Published in Private Placement Memorandum

Early stage companies raising money have several core options to raise capital (e.g., crowdfunding). However, when raising money from funders who expect a return on investment (i.e., they are buying a security) those funders are essentially “investors” and the issuer company likely has triggered the securities laws. None of this should be cause for alarm for an early stage company looking to raise capital. Rather, if pursuing an early state offering (either through early stage equity or often, convertible debt), it should try to as much as possible do so according the rules. (Note: pursuing non-equity crowdfunding is in many instances a viable way to raise a “friends and family” round, provided the circle of contributors are closely related to the founders and have a clear and express understanding their contribution is not an investment and not made for return).

Why Should the Issuer Care About the Securities Laws?

There are many, many articles and cases on the legal consequences of failing to comply with the securities laws (e.g., investor rescission, criminal repercussions, and/or being subject to the SEC “Bad Actor” rules). However one *very* practical and often overlooked consequence is the negative impact a sloppy round will have on future rounds where more sophisticated or institutional investors seek to invest (e.g., VC’s, Angels, etc.). It is precisely these parties that will, during due diligence, determine whether or not the securities law were properly complied with in order to protect their own interests. No VC wants it invest in a company whose investors may have securities claims and/or unclear contractual rights in connection with their investments (what are the terms governing management, dilution, drag-along, preemption, etc.?)

Not only does this reflect poorly on the issuer’s management/founders, but on a more practical level a VC will not want to “hold the bag” if the initial investors seeks rescission or some other legal remedy.  Hence, the issuer should make a concerted effort to invest in the best practices for private placement offerings of securities (the following is not an exhaustive list but a good start):

  1. Properly defining the terms of the investment and having investment contracts that reflect these terms (e.g., subscription agreement);
  2. Having robust disclosure documents such as a private placement memorandum (PPM);
  3. Complying with applicable Blue Sky Regulations (e.g., filing a Form D);
  4. Having accredited investors invest to the greatest extent possible.


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