If you own a business and need an infusion of cash, borrowing from banks has become increasingly difficult during these recessionary years. Most business owners logically look toward family and friends as sources of capital. On face value this may be just fine; however, the "devil is in the details."
Technically, whenever a business is raising money it's in exchange for shares of stock or membership units. Those shares or units are the evidence of ownership as a result of receiving the funds. These shares or units are securities, and as such, are governed by both state and federal laws. Granted, many small businesses taking money from friends and family fall within exemptions to state and federal securities laws; yet, it is critical to ensure that your company does in fact fall within and comply with those exemptions. Otherwise, penalties can be assessed, and depending on the circumstances, there can be other more serious consequences if any fraud or misrepresentation to the person or entity giving the money is proved (if a dispute happens down the road).
So if your business needs money and it can’t be obtained through traditional sources, what should you do?
• Most of the exemptions to securities registration prohibit advertising, so you should not advertise that you need money unless you talk to a lawyer knowledgeable in the area. There are limited "tombstone ads" that may be placed, but this shouldn't be done unless you have sought legal advice.
• Assuming you are just asking a family member or friend for the money, you should definitely have the necessary legal documents drafted. These documents will reflect what needs to be done from the company's perspective in terms of complying with your Bylaws or Operating Agreement. Other related documents will address the sale of the share or units in exchange for the funds, and still more documents will address appropriate disclosures to protect your company. Overall, you will generate some paper, but the "bark" here is bigger than the "bite."
• Your company will need to file appropriate documentation with the state Department of Corporations. This is done online and is to be done within 15 days of the company issuing any stock in order to avoid penalties.
While all of this may seem a bit burdensome, in the end, doing this will position your company to reduce risk with respect to regulatory compliance and an investor who was your family member or friend, but is now your plaintiff.
This information is intended for general educational purposes and not specific legal advice.