Jackson Kelly PLLC

The Legal Brief


August 29, 2022

By: Elizabeth Osenton Lord

There are three types of securities offerings: registered, exempt, and illegal.  When raising capital for a start-up business, many entrepreneurs are very surprised to learn that there is no “friends and family” exemption under the securities laws. Often, entrepreneurs speak of raising money from a “friends and family” offering.  “Friends and family” only identifies to whom the offering is made.  It does not identify an exemption from Securities and Exchange Commission or state registration.

Regardless of whether a company or  entrepreneur calls an offering a “friends and family round,” an “angel round,” a “seed round,” or a “Series A round,” the company or entrepreneur must structure the deal to fit within one of the regulatory exemptions from registration.  Otherwise, the offering must be registered. 

Registering an offering with the SEC and state regulators is very time consuming and expensive.  Therefore, companies and entrepreneurs may want to structure the offering so that it is exempt from registration.  The most commonly used exemption is the Regulation D exemption under the Securities Act of 1933 (the “Securities Act”).  This is a convenient exemption so long as the company meets the regulation’s requirements.  Meeting those requirements adds certainty that the company has a valid exemption from registration.  Another often incorrect assumption is that if an offering is made to less than 35 persons, the offering is exempt.  There is no 35-person exemption under the Securities Act.  This 35-person limitation is only one of the several requirements for a valid Regulation D offering.

Sometimes, the Section 4(a)(2) private offering exemption is available for a company if it cannot meet the Regulation D requirements. However, unlike a Regulation D exemption, the pure Section 4(a)(2) exemption is subject to a facts-and-circumstances test, and no clear guidance exists as to whether an offering complies with this exemption unless it meets the requirements of Regulation D.  Federal and state securities laws provide other exemptions in addition to the Regulation D and Section 4(a)(2) exemptions, but the Regulation D and Section 4(a)(2) exemptions are often easier from a compliance standpoint and tend to be more flexible. 

Accordingly, companies (and their management), should keep in mind that when a company offers securities to friends and family, and those folks do not actively participate in the company’s business, then the same securities laws apply as they would as if the offering were being made to strangers.  To avoid SEC and state regulatory scrutiny, companies must either register their securities with the SEC and various state regulatory authorities or find and qualify for an exemption from registration.  Companies should consider these issues and fashion an exemption prior to any offering activities as it is very difficult to correct these issues after the fact or to “reverse engineer” compliance with federal and state securities laws after an offering has begun.


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