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Before Taking That Cash Infusion, Be Sure You Aren’t Violating Federal Securities Laws

For many startups and entrepreneurs, capital contributions are an essential part of starting and continuing to operate a business. However, capital contributions cannot always be funded by the business’ founders and many businesses rely on contributions from Venture Capitalists, Angel Investors, passive investors, and sometimes even family and friends.

These contributions—yes, even contributions from family members and friends—are governed by state and federal securities laws and businesses that do not adhere strictly to the registration, reporting, and filing requirements or comply with some sort of exemption put forth by the Securities Exchange Commission (SEC) could be subject to strict civil penalties and substantial fines. 

While the SEC has jurisdiction over all securities-related matters, determining what exactly qualifies as a security is not as easy as it may seem. When the 1933 Securities Act defines “security” it includes an extensive list of instruments that most people would normally consider a security such as a stock, bond, and debenture. 

However, the definition also includes a sort of “catchall” type of security, an investment contract, but does not further describe what an investment contract specifically is. Thankfully, the Supreme Court has provided some guidance concerning what an investment contract may be.

In SEC v. Howey the Supreme Court articulated the four-part Howey test to help define what exactly an investment contract is. The Howey test defines an investment contract as a contract, transaction, or scheme whereby (1) a person invests their money, (2) in a common enterprise, (3) with the expectation of profits, (4) whereby those profits are derived substantially from the efforts of others. Since the Howey test was first articulated, courts have found that a time share agreement, an investment scheme that involved pooling money together in order to purchase foreign bonds, and a scheme involving the pooling of money to fund an orange grove all constituted an investment contract. Even with these elements, ambiguities abound.

SEC regulations are a minefield ripe with civil penalties and substantial fines for even the slightest misstep. For this reason, it is important to ensure that any sort of contemplated cash infusion from passive investors, venture capitalist, angel investor, or even friends and family, is carefully analyzed and structured to comply with federal and state securities law and pertinent exemptions. 

For questions concerning Securities Laws, SEC enforcement, and potential seed and venture funding for your business contact OVB Law & Consulting, S.C. by phone at (414) 585-0588 or by email at info@ovblaw.com. Our offices are located at 839 N Jefferson Street, Suite 502, Milwaukee, WI 53202, on the west side of Cathedral Square.

Legal Disclaimer: The information contained in this post is provided for informational purposes only and should not be construed as legal advice on any subject matter. You should not act or refrain from acting on the basis of any content included in this post without seeking legal or other professional advice.

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by Emil Ovbiagele

Emil is an award-wining attorney and the founder of OVB Law & Consulting, S.C. He is known for his knack for creating customized legal and business solutions for his clients.