Today, I want to talk about what you need to know when you fund your company with the help of your friends and family. People advise against taking money from friends and family for various reasons, including that it’s something that can ruin a good relationship, but we’re not talking about that today. We’re talking about what you have to think about from a legal perspective when you raise money from friends and family.
A potential rift in your relationship with your friends and family is a factor to keep in mind when raising money from them--you want to be on the right side of the law if your company fails or if you can’t pay back the money that your friends or family put into your company.
You Have to Consider the Securities Laws
In the United States, there are laws called the securities laws that you must comply with if you’re raising money by selling securities. For example, if you’re selling shares of your company, you are selling securities. In addition, if you borrow money from your friends and family, you also may be subject to the securities laws.
If you don’t comply with securities laws, you can be sued by regulators and by your own friends and family. Because of this, you want to be on the right side of the law when it comes to complying with securities laws.
There is No “Friends and Family Exemption” from the Securities Laws
There’s a misconception that when you raise money from friends and family, you do not have to comply with securities laws or that you can use a so-called, “friends and family exemption.” There is no such thing as a “friends and family exemption.”
If you are selling a security, you have to register with a federal regulator called the Securities and Exchange Commission (SEC) or you have to rely upon an exemption that applies to your situation.
The Wealth of Your Investors Determines Which Laws You Can Use
There are exemptions you can use to raise money from wealthy people, called accredited investors. There are also exemptions you can use to raise money from not-so-wealthy people, called “non-accredited investors.”
Wealthy or Accredited Investors
Whether someone is an accredited investor is based exclusively on their income and net worth.
A single person has a net income of $200,000 during the last two fiscal years and expects to continue making the same income, qualifies as an accredited investor.
For a married couple, the income required to qualify is $300,000 per year.
Someone with a net worth of $1,000,000, excluding his or her primary residence is also considered accredited.
Anyone who does not qualify as an accredited investor under the income or net worth test described above is a non-accredited investor.
There are rules that allow you to raise money from accredited investors, non-accredited investors, or both.
If your friends and family are all accredited investors, you can rely on the exemptions that allow you to raise money from accredited investors.
If your friends and family are non-accredited investors, you have to rely on the exemptions that allow you to raise money from non-accredited investors.
If you have a mix of accredited and non-accredited investors, you have to rely on the exemptions that allow both groups to invest.
The rule you choose will be based on which applies to your situation.
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This article is provided for informational purposes only and should not be construed as legal advice. Read our disclaimer here.