Capital: The Life Blood of any Business

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Capital is the life blood of any business. A business needs capital to launch and later to grow its operations by hiring additional staff, developing new products or services and expanding its marketing efforts, among other things. This is the first of a series of posts we intend to publish that will provide an overview of the laws and regulations that govern the sale of stock or debt instruments in order to raise capital.

A business can obtain capital through borrowing, such as a bank loan, or it can issue securities. These securities could be equity securities, which provide an interest in the gains and losses of the business or debt securities, which provide a fixed or variable rate of interest upon a principal amount for a fixed term, or they could be instruments that combine features of debt and equity, such as preferred stock or convertible securities.

Most small businesses raise capital through what are called private offerings. Private offerings are exempt from the registration and complex disclosure requirements of public offerings. The regulations governing private offerings, however, place various restrictions on the offer and sale, which can include limitations on the amount that can be raised, restrictions on advertising or public solicitations and/or net worth and financial sophistication requirements prospective purchasers must meet. In the coming weeks we will focus on the following exemptions, and may address related topics in the future:

  • Part 1: Small offerings of up to $1 million; these offerings are exempt from most federal regulation, but are subject to state regulations on required filings and manner of conducting the offer and sale.
  • Part 2: Offerings up to $5 million made to no more than 35 investors; these offerings are subject to restrictions on the manner in which the offering can be advertised but are exempt from most state regulation.
  • Part 3: Offerings with no maximum amount made to “accredited investors” (meaning investors meeting certain sophistication and net worth requirements) and no more than 35 unaccredited investors; these offerings are subject to restrictions on the manner in which the offering can be advertised but are exempt from nearly all state requirements.

Although fund raising is an integral part of growing a business, it is heavily regulated by both state securities agencies and federal agencies such as the Securities and Exchange Commission (SEC). The discussion in the coming posts addressing offerings of securities are not intended as legal advice, and a business owner considering raising capital should consult with an attorney. The penalties for failing to comply with state and federal regulations in offering and selling securities can be severe. An offering that does not comply with applicable regulations can lead to a right of rescission on the part of the buyer (meaning a return of the invested amount) as well as monetary penalties for the offeror. In addition, any material false or misleading statements or omissions made in offering securities can give rise to liability for fraud under state and federal law, with penalties ranging from civil monetary penalties to imprisonment.

So, before you go looking for angels, find out everything you can about the devils.

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