29 Mar Early Stage, Step 9: Raising capital in the securities landscape
Editor’s note: This is the ninth in a series of articles on developing start-up companies in the technology or biotechnology sectors. The most recent article focused on worker classification.
Madison, Wis. – The idea is developed. Lawyers and accountants are on board. The intellectual property has been protected. The entity is formed. The name has been chosen. Perhaps workers, other than founders, have been hired and independent contractors have been contracted with. Usually, simultaneously, this new company must raise money. This is one of the most difficult and legally challenging steps of the early stage.
Most new companies need money desperately. Without funds, they will die right away. Very few have too much money. New companies struggle to raise funds. They must understand the legal complexities of doing so.
Securities laws were really the first large-scale consumer protection laws in this country. These laws came out of the stock market collapses of the late 1920s. Most securities laws were enacted to provide sufficient information so that investors/buyers know what they are buying. The goal is a level playing field for all investors, no matter how rich or poor.
Federal and state securities blankets
Securities laws are broken down between federal and state laws. You have a federal securities law issue if you are selling securities to an investor outside Wisconsin. In addition, the securities laws of the state in which you are selling will also apply. If a company intends to sell securities to Wisconsin residents only, then the federal securities laws are avoided. This is called the “intra-state exemption.”
Initially, most new companies raise money from themselves, family, and friends. Assuming they all live in Wisconsin and number less than 25 people, then the new company qualifies for a state securities law exemption. This exemption means that the new company does not have to register with the state securities commissioner, now housed within the Department of Financial Institutions.
Notwithstanding the fact that you are raising money from family and friends, the new company must provide adequate disclosure. Adequate disclosure amounts to: financial statements for the new company, including past, current and future prospects; and information on the new company, such as the business plan and its management. Some description of the security that is being offered is necessary.
How much of the new company is being sold? What is the new company’s valuation? Is the security a preferred security? What voting rights does it have, or not have? Can investors/buyers sell the security and are transfers restricted in other ways? Disclosure of all of these details are critical as you proceed.
The potential investor needs to be fully informed. While there may be no formal federal or state registration requirements because it is an intra-state offering and the appropriate Wisconsin exemption is available, the investors are still entitled to be fully informed. This due diligence or anti-fraud compliance is consistent with the consumer-law nature of the securities laws.
Like reading the ingredients on food labels, you are entitled to know what you are getting. Securities laws, however, are not there to protect investors from foolish decisions. The securities laws do not ensure that the investment is a good one, they ensure only that you have enough information to make an intelligent choice if you actually read and study the information as a potential investor.
One final note here on state securities laws. Not only do the laws not indicate whether it is a good or bad investment, but there is no assurance you can resell the security to anyone. In other words, when individuals invest in small new companies, they better understand that their money is illiquid, that it is not going to be repaid anytime soon.
This is just the beginning on securities laws. Next time, I will delve further into them, including discussions on the federal laws.
Previous Early-Stage articles by Joe Boucher
• Early Stage, Step 8: Misclassifying workers brings risk
• Joe Boucher and Bonnie Wendorff: Early Stage 7, Part I: Just what is an employee?
• Joe Boucher: Early Stage: Step 6 – Taxes, taxes, taxes!
• Joe Boucher: Early Stage: Step 5 – Forming the entity
• Joe Boucher: Early Stage, Step 4: Cautionary trademark tales
• Joe Boucher: Early Stage, Step 3: Naming the entity
• Joe Boucher: Early Stage Step 2: Choosing a domain name
• Joe Boucher: Starting a tech business? Step 1 is minding the intellectual property
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