You know the story. A new business venture is getting off the ground. The founders of the business are scrambling to conduct research, product development, marketing, and/or sales. And then it happens. The business needs more money, and the founders are tapped out. So, where to get that much-needed capital?
The most common source of capital for a new business venture is from individuals with a preexisting relationship with the founders - relatives, friends, and business associates. Of course, it makes sense to seek out informal investors, because by knowing the founders, an informal investor is likely more willing to accept the high risk of an investment in a new business venture, and may be less aggressive and demanding in negotiating terms and conditions for whatever financing is being provided. As a result, founders may assume that informal financing with relatives, friends, or business associates doesn't require the full disclosure of the material facts and investment risks as would other financing sources. However, such an assumption is often the downfall of new businesses.
In Nevada, an effort to raise capital in exchange for equity in the business venture will involve the state securities laws as well as federal securities laws. Under Nevada law, a "security" includes a note, stock, bond, debenture, an interest in a limited partnership, an interest in a limited liability company, as well as other interests and instruments commonly known as a security. Thus, if a security is being sold, the nature of that security and transaction may require registration with the Nevada Securities Division and/or the Securities and Exchange Commission, unless an exemption to registration applies. So, what's the big deal? A failure to comply with the securities laws may lead to significant fines and penalties.
Moreover, even though the investors may be relatives, friends, or business associates of the founders, like anyone else unhappy after losing their money, they may claim misrepresentations were made by the founder and the new company to induce them to invest. Thus, it is vitally important to not only provide full and fair information to the investor, whoever that may be, but to document that disclosure.
At the end of the day, any new business venture planning to raise capital in exchange for some type of an interest in the company should seek legal advice to understand the possible application and requirements of the securities laws and avoid any unnecessary legal problems that may stop the business in its tracks.
Lance P. Maiss is an attorney with Armstrong Teasdale, LLP. in Reno.
