📄 Securities Law Basics for Startups

🎉 Happy Friday, funds family!

Every time a startup issues equity, a 📄 SAFE, or a 📄 convertible note (as examples) to an investor/stakeholder, it is conducting a “securities offering”, and that offering must either be registered with the SEC or fall within an exemption. It’s an important topic for the companies and the investors involved, because a company that raises money without a valid exemption has violated securities laws (even if foot faults) that can give investors rescission rights and create liability for the company and its officers, regardless of how well the business itself is doing.

The short answer is: startups most commonly raise capital under an exemption from SEC registration (e.g., Regulation D) rather than through a registered public offering. That means restricting sales to accredited (and limited non-accredited) investors, filing a Form D within 15 days of the first sale, and making corresponding state filings. Skipping these steps is not a paperwork nicety; it is a securities law violation that can have practical consequences.

➡️ Why does securities law apply to a startup financing at all?

📄 The Securities Act of 1933 requires that any offer or sale of a security be registered with the SEC unless an exemption applies. For instance, a SAFE, a convertible note, and common or preferred stock are all securities. Registration (the process behind a public offering) is prohibitively expensive and impractical for a startup, so virtually all startup financings rely on an exemption from registration rather than registering the offering itself.

➡️ What is the most common exemption startups use?

The overwhelming majority of startup financings rely on Regulation D, specifically Rule 506(b) or Rule 506(c) of Regulation D:

• 📄 Rule 506(b): allows the company to raise an unlimited amount from an unlimited number of accredited investors, plus up to 35 non-accredited but sophisticated investors, but prohibits general solicitation or public advertising of the offering.

• 📄 Rule 506(c): allows general solicitation and public advertising of the offering, but requires that all purchasers be accredited investors and that the company take reasonable steps to verify accredited investor status (not merely rely on self-certification).

• Most startup financings use 506(b) because it is simpler (no advertising, no independent verification burden) and because most institutional and angel investors are comfortable self-certifying as accredited.

➡️ What does it mean to be an “accredited investor”?

An accredited investor is a person or entity that meets specific income, net worth, or professional criteria set by the SEC, on the theory that such investors can either bear the financial risk or evaluate the investment sophisticatedly enough not to need the protections of a registered offering. Common (but not all) qualifying categories include:

• Individuals with income exceeding $200,000 ($300,000 household) in each of the prior two years, with a reasonable expectation of the same in the current year.

• Individuals with net worth exceeding $1 million, excluding the value of their primary residence.

• Certain professional certifications, including holders of Series 7, 65, or 82 licenses.

• Entities such as registered investment advisers, banks, and entities with total investments exceeding $5 million.

Companies may collect a signed accredited investor questionnaire from each investor as part of the closing documents (and as representations and warranties), both to comply with the exemption and to create a documentary record if the company’s compliance is ever questioned.

➡️ What other filings and requirements come with a Regulation D offering?

Relying on Regulation D is not simply a matter of restricting who can invest. Companies must also:

• File a Form D with the SEC within 15 days after the first sale in the offering, disclosing basic information about the company and the offering.

• Make corresponding 📄 blue sky filings in each state where investors are located, since state securities regulators retain their own notice filing requirements even though Regulation D preempts substantive state review.

• Avoid “bad actor” disqualification. Regulation D is unavailable if the company or certain covered persons (such as officers, directors, and 20%+ owners) have specified disciplinary or securities law history, which is why financing documents typically include bad-actor representations and questionnaires.

➡️ What happens if a company raises money without a valid exemption?

A financing conducted without a valid registration or exemption is a securities law violation, even if unintentional. The consequences can include a right of rescission for investors (meaning they can demand their money back, sometimes with interest, well after the investment was made) along with potential liability for the company and, in some cases, its officers and directors personally. This is why proper securities counsel and disciplined closing documentation (subscription agreements, accredited investor questionnaires, Form D filings) are not optional formalities; they are the company’s evidence that the offering was conducted lawfully.

➡️ The practical takeaway

For the company:

1. Confirm which Regulation D exemption applies to each raise: 506(b) or 506(c), before beginning to solicit investors, since the rules on general solicitation differ materially between them.

2. Collect a signed accredited investor questionnaire from every investor / make sure each investor makes the accredited investor representation and warranty; and retain it as part of the permanent deal file.

3. File Form D within 15 days of the first sale, and make the required state blue sky filings; missing these deadlines is a common and avoidable compliance gap.

4. Run bad-actor disqualification checks on officers, directors, and significant owners before relying on Regulation D. In a financing round, for instance, companies can have covered persons execute and submit signed certifications regarding bad-actor disqualifications.

For the investor:

1. Complete accredited investor questionnaires accurately and/or make sure the representation is accurate and up to date; misrepresenting accredited status creates risk for both the investor and the company.

2. As part of diligence on a company’s prior financings, confirm that Form D filings and state notice filings were made for each round.

3. Understand that a company’s failure to maintain a valid exemption on a prior round is a real diligence issue.

4. For larger or more sophisticated deals, confirm bad-actor certifications have been collected from company officers, directors, and significant owners.

Thanks for reading, everyone!

Have a great weekend! 🙌

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This may be considered attorney advertising.