Ask a Business Lawyer Blog

Legal Traps for the Unwary Entrepreneur, Part Three

 Email Article  

Tweet  

  

 delicious  

  

This is Part Three of the series, Legal Traps for Business Startups to Avoid. Previous and subsequent articles in this series can be found, at this Entrepreneurs' Blog page. 

The information on starting a business contained in this article, relates to funding issues commonly faced by entrepreneurs and means for dealing with them through proper prioritization.

No. 8:  Failing to properly prioritize the importance of full disclosure and good faith appraisal of goals, within the business plan and compliance with state and federal securities laws; and, failing to distinguish between funding source that is an active participating partner versus an “Investor.” 

Entrepreneurs can be sued for fraud by their Investors.  A business plan that sets forth promises or goals that the presenter knows are unattainable, will be considered fraudulent, if presented to an Investor or potential Investor.  Investors require real information, in order to make informed decisions.  If the deal goes-bad for any reason, an Investor who has provided funding will be looking for all means possible to recoup his/her losses, including legal action. 

If you make representations to an investor that are not completely truthful and/or if you have not complied with state and federal securities laws, you will diminish your credibility with Investors, and in addition, the company’s exposure to liability, as well as your personal exposure to liability, will be great.  Even if the first round of funding goes well, your ability to obtain second round funding will be seriously compromised, if it appears that your first round numbers were fabricated.  Applicable consequences for non-compliance with securities laws and regulations could include criminal charges.

State and federal laws and regulations strictly regulate offering of equity (stock/ownership interest) in businesses in exchange for something of value (e.g., funding) to an Investor. Where such an offering is made to someone who will not be "actively" involved in the business operations and who provides funds with the expectation of receiving a return, where such expectation of return, is based upon the performance of someone other than herself/himself, the funding source is an "Investor." Each person and company selling such equity/stock (or other securities) must comply with federal and state securities laws. 

There are only three types of such offerings, i.e., (a) registered; (b) exempt; or (c) illegal.  If your securities are not registered, and not exempt, then it is illegal to make such an offering or solicit an Investor.  Obtaining advice from a competent securities attorney is essential, to determining if, and how, your offering can meet the requirement of exemption from registration.  Even if your offer is exempt, additional steps will likely be necessary for compliance; for example, you may need to be registered (even if the securities do not need to be registered), before soliciting Investors. 

We have all heard the cliché, ignorance is no excuse.  With regard to a securities case where criminal penalties were applied, a judge stated, "No one with half a brain can offer 'an opportunity to invest in our company' without knowing that there is a regulatory jungle out there."  Courts do not accept “I didn’t know” as an excuse.   

Moral of this story is, to seek advice from a business lawyer earlier on, to identify the issues that put you and your business at risk; obtain the advice of a competent securities attorney and business lawyer, before you solicit any potential Investor; and determine, with the advice of legal counsel, whether the individual or business providing funding, is an “active” participant in the operations of the business or an Investor.

When you are ready to discuss the legal issues associated with your business, click here to contact Michelle L. Grenier, Esq.

Copyright (c) 2011-2012 Michelle L. Grenier, Esq. All rights reserved.