When does taking investor money become a securities question?

A friend wants in. A few investors want to pool money for your next property. A relative offers to fund the business in exchange for a share of the profits. None of it feels like Wall Street.

Securities law doesn't care how it feels.

What makes something a security. An interest in a business is generally a security when someone puts money into a common enterprise expecting profits mostly from the efforts of others. Stock almost always qualifies. An LLC interest held by an active member who helps run the business may not. An LLC interest held by a passive investor who writes a check and waits for distributions very often does. The same is true for profit-sharing arrangements and many promissory notes sold to investors.

The question isn't what the document calls it. It's what the investor is actually doing.

Why it matters. Every offer and sale of a security has to be registered with the government or fit within an exemption. Registration is expensive and built for public companies, so small businesses rely on exemptions. Those exemptions come with conditions: who can invest, how you can find them, what you have to tell them, and what notices have to be filed with the SEC and with each state where an investor lives.

Getting it wrong can give investors the right to demand their money back, sometimes with interest, regardless of how the business performs. It can bring regulators. And the people who sold the interests can face personal exposure, which is a liability your LLC doesn't shield.

Where small businesses walk into it.

Real estate groups. A few people pool money, one or two find and manage the deals, and the rest wait for returns. The passive members' interests may be securities. SPVs and waterfalls shows how these deals are structured.

Friends-and-family rounds. Telling a wider circle about the opportunity, posting it online, or accepting money from people who don't meet the exemption's investor standards can blow an exemption you didn't know you were relying on.

Paying someone to find investors. A finder paid per dollar raised may need to be a registered broker-dealer. If they aren't, the problem can attach to your offering.

Promises in a pitch. Projections and promises made to investors carry anti-fraud liability whether or not the offering is exempt.

What to do before you take the money. Before you accept a check from anyone who won't be running the business, talk to a securities attorney. That's someone whose practice is capital raising and securities exemptions, ideally with small-offering experience. The conversation is far cheaper before the money moves than after.

Securities compliance is outside my practice, so I don't handle it. What I do handle sits next to it: the entity structure and the agreement among the people running the deal. Do you have to convert your LLC to take on investors? and Co-founder equity: vesting, 83(b), and what happens when a founder leaves cover that side.

The rule of thumb: if someone is giving you money and expecting you to make it grow, stop and get the securities question answered first.

Book a consultation if you want help with the structure around a raise.

This is general information, not legal advice for your situation. If you want an answer for your situation, book a consultation.