Raising Money - Legally
Raising Money - Legally
1. Basics of Private Placement and Direct Placement Offerings
1.1 Philosophy of the Securities Laws
The securities laws exist because of past (and current) fraud regarding the sale of securities. Whether you agree with their approach or not, these laws attempt to find a balance between protecting investors and allowing companies or investment funds to raise money.
The securities laws try to protect investors by placing requirements on the types of investors allowed, by limiting the public advertising of offerings, by sometimes limiting the amount of money that can be raised, by controlling where the investors are located and by mandating certain disclosures to investors. Each offering approach has its own combination of these factors.
People who do not comply with the securities laws can be sued by their investors for large amounts, can be banned from the securities industry by the securities regulators, and can face criminal prosecution. Unfortunately, one can always find companies who are violating the securities laws.
1.2 What Is a Security? Almost Everything .
As the securities laws - by their very name -- apply to securities, one fundamental question is what constitutes a security. The short answer is that virtually every type of investment is a security unless one can prove that one of the rare exceptions applies. In other words, an investment is guilty of being a security until proven innocent. The basic federal definition includes promissory notes, stocks and bonds; profit-sharing agreements and investment contracts; interests in oil, gas or other mineral deposits; puts, calls and options; certificates of deposit; and anything "commonly known as a 'security'," etc. (15 U.S.C.
77b(a).) (For the California definition, which is similar, see Corporations Code Section 25019.)
Very few investments are not securities. Investments in general partnerships usually are not because each partner has full rights to enter into contracts on behalf of the partnership and each partner is personally liable for all of the obligations of the partnership. (It is a rare situation where a general partnership would be appropriate, given the personal liability.) Still, if even one partner does not play a substantive role in management, the partnership interests could well be found to be securities.
The law in California and some other states provides an exclusion for a limited liability company that is member-managed (all owners being managers) where it can be proven that all of the members are actively engaged in the management of the limited liability company. It is not enough that the members vote, or have the right to information, or the right to participate in management: Each member must have the skills to participate in management of the LLC and take a substantive role in management. Clearly that's not a requirement that a passive investor could meet.
Tenancy-in-common (TIC) arrangements - where every investor is on title for a piece of real estate - are securities unless the organizer is willing to give up management control of the TIC, and most are not. Like member-managed LLC's, every investor would have to exercise true management power or at the very least have the power to choose and replace the manager. In addition, the arrangement among TIC members is that of general partners, so again investors have individual liability unless they invest through an LLC or corporation.
Most promissory notes are securities even if they are secured. Certainly any promissory note that in addition to interest has an equity or profit "kicker" or that is convertible to equity is a security.
Under federal law, the presumption is that every promissory note with a maturity date in excess of nine months is a security, but there are exceptions. The case law - which is based on a four-factor test -- is unce