Preventing legal issues while raising capital Featured

8:00pm EDT May 24, 2004
Owners of small and mid-sized businesses have plenty on their minds. While few ask themselves, "Gee, I wonder how I can avoid violating the securities laws today," they may wonder how they will fund their next advertising campaign or new product line, and how they will survive the next recession.

The solution to many of these problems is, of course, more capital. Capital can take many forms, such as equity -- common or preferred stock -- or long-term debt. A well-capitalized business can expand faster, and a business with capital reserves has a better chance in a bad economy.

Knowing they need capital, and armed with do-it-yourself enthusiasm, business owners spring into action, contacting family, friends and business contacts. This is a challenge, and they will meet it just like any other business challenge.

Many business owners are not aware, however, that raising capital involves selling "securities." Not only are there federal securities laws, each state also regulates securities. But the sale of stock or promissory notes to a few investors can't be regulated like an IPO, right?

Sure, but there are still hoops to jump through, and serious risks if you don't. Charges of securities fraud can ruin a business, and no business owner wants personal liability to investors.

First, a basic principle: the securities laws require every offer and sale of securities to either be registered or to qualify for a registration exemption. Registration is feasible, however, only for large financings. Small financings usually can qualify for both federal and state registration exemptions. Sometimes, but not always, these involve pre- or post-sale government filings and specific disclosure requirements.

A second basic principle is full and accurate disclosure. Whether the offering is registered or exempt, potential investors must receive all material information about the investment, and none of the information they receive can be materially false or misleading. Violating this principle amounts to securities fraud, even if the securities are fully registered or clearly exempt.

And if the self-reliant business owner disregards these principles?

That is where the risk comes in. The Securities and Exchange Commission, which oversees federal securities laws and agencies that administer state securities laws, can bring civil enforcement actions. The Department of Justice and state attorneys general can bring criminal actions. Usually, these are prompted by complaints from unhappy investors.

Even without government action, if an investor purchases unregistered securities without an exemption or if there is less than full and accurate disclosure, that investor can demand his money back. Unlike most claims against a corporation or limited liability company, the business owners may have personal financial exposure to these claims.

The do-it-yourself business owner runs another kind of risk as well. When a homeowner builds his own deck, he will have a problem selling his house if that deck is starting to sag. Similarly, when a business succeeds after raising capital, and the business then is for sale or needs to raise more capital, an inspection of its records will reveal any defects in the capital-raising process. Those defects can slow down a desirable transaction, reduce the selling price or kill the transaction entirely.

So where does this leave business owners who need capital?

Fortunately, help is available, and it need not cost an arm and a leg. Attorneys experienced in private financings and sensitive to the needs of smaller businesses can help structure the transaction, guide the business owner through the regulations and create a common-sense disclosure package. What's more, they can bring peace of mind, all without much delay and for a reasonable fee.

Henry B. Levi is a shareholder at Baker, Donelson, Bearman, Caldwell & Berkowitz, PC. Reach him at (404) 221-6508 or hlevi@bakerdonelson.com.