Inexperienced entrepreneurs usually enter the startup phase of their business with one goal in mind: to raise funding from anyone they possibly can.
At first glance, it makes sense—they want to make their product or service the best it can possibly be, and the extra money would be a big step in the right direction.
However, many entrepreneurs are unaware of the legal requirements behind accepting investor funding. Accepting money from anyone and everyone is rarely a good idea; in the worst case scenario, it may even be illegal.
Understanding Securities Regulations
The Securities Act of 1933 requires any company, including startups, to provide investors with full disclosure of all facts pertinent to the investors' ability to make an investment decision. Prior to 1933, no such law was in place, and most analysts believe this was a notable contributing factor to the stock market crash of 1929.
While securities legislation has been modernized and simplified in recent years, it's still exceedingly important for entrepreneurs to familiarize themselves with the law or they'll be at risk of subjecting themselves to civil and/or criminal liability.
The primary concept to understand is that anytime a startup offers stock, stock options, or any kind of equity award (securities)—the startup must comply with securities laws at the federal and state level.
Notable Securities Legislation for Startups
Startups should likely familiarize themselves with Rule 506 of Regulation D. This regulation allows startups and other companies to raise unlimited funding from accredited investors.
An accredited investor is usually a person or business entity with $1 million in net worth not including their primary residence, or a person or business with $200,000 in income for the preceding two years.
Additionally, startups who wish to provide compensatory equity issuances (such as a stock option for an employee), Rule 701 should also be closely studied. If the startup qualifies, Rule 701 can provide valuable exemptions and allow the startup to provide these kinds of securities.
To learn more about startup funding, you may contact us.
Julian Cordero is an Attorney, Business Strategist, and Music Producer. Oh and he blogs too! Julian is licensed to practice law in New York and is the Managing Attorney of Cordero Law LLC, a New York City based law firm focusing on Business Law, Entertainment Law, and Intellectual Property Law.