No Friends or Family
A common misnomer for early stage companies is that they are raising funds through a “friends and family” round. What they typically mean is that they are seeking funds from close family members, or acquaintances, who might be easy touches for giving up their dollars, but the company is not going through the full documentation, disclosure and other compliance measures associated with private placement offerings. In other words, they seem to think that getting money from people they know really well is a short-cut to save time, effort and money in the fund-raising process. After all, these folks just want us to do well, and are low-risk investors.
Not so fast!
The securities law issues, under both federal and state securities laws, can be bewildering for the uninformed. Here is a resource published by Krause Law that tries to make some practical sense of those laws.
However, what cannot be found in this or any other credible resource, is a short-cut around securities law compliance. A “friends and family” exception simply does not exist. The most commonly used offering structure for an early stage company is an exemption under Rule 506(b) of Regulation D of the U.S. Securities and Exchange Commission, for an offering made only to an “accredited investor” without any kind of general solicitation or advertising to identify a prospective investor. If all the requirements of the rule are met, then the company is exempt from the requirement to register the offering with the U.S. Securities and Exchange Commission and state securities regulatory authorities.
Under this particular exemption, each investor must be an accredited investor by meeting either a net worth test or an income test. If the best friend or favorite aunt is not an accredited investor, then the offering structure does not work because the exemption requirements are not met. Those innocent investors, no matter how friendly and how much they want to give their money to a worthy cause, cannot simply look the other way and waive the company’s compliance.
The only feasible and legally defensible way to raise investor funding is to identify an applicable exemption from federal and state securities law registration requirements, make proper disclosure prior to taking funds from prospect investors, and enter into appropriate legal documents to evidence the investment transaction. To do otherwise is to expose the company and its controlling persons to very significant potential liability, and moreover is a great disservice to those who would seem so friendly.