Expanding your business is an exciting prospect. You may have received orders for more than you can produce, or see a market opportunity to exploit. Whether you want to buy more or newer equipment, rent more space, or hire more employees, the key to expansion is money. There are several ways to raise capital: bootstrapping (finding the means within your company by reducing costs and/or increasing production), tapping private sources (personal savings, personal loans, etc.), applying for commercial loans, or—if you’re willing to share ownership of your business—finding investors.
Oftentimes, you don’t have the necessary capital yourself or within the business, or don’t want to risk your savings. Banks typically won’t fund a risky expansion, and will demand a steady stream of payments, regardless of the success of your expansion. Private investors, on the other hand, typically are willing to take more risk, i.e., delay receiving a prompt return on their investment in exchange for a larger pay-out later if and when your expansion succeeds.
If you choose this latter option, it is important to consider the various regulatory and other burdens imposed upon you when you seek capital from investors. Here are five tips to consider as you traverse this process:
- Be Secure When Selling Securities
Once you ask anyone to invest in your business, via either a loan (debt) or ownership interest (equity), you are subject to securities laws and regulations, and it’s imperative that you retain an attorney familiar with these requirements. This area of fundraising is highly regulated by both state and federal law and there are very specific criteria regarding how and from whom you can receive investment funds. Not complying means being held liable for even innocent mistakes.
- When Accepting Investment Capital From Friends and Family, Securities Laws Still Apply
You can, without much bureaucratic oversight and red tape, sell equity to friends and family, i.e., people with whom you have a pre-existing relationship but who may not be sophisticated investors. However, you are still subject to securities laws even when dealing with people you know well. Thus, you should provide your friends and family full access to information about your business, including your financial books and records and a written list of risk factors, before asking them to invest in your business. If you are concerned about confidentiality, you should ask any prospective investor to sign a non-disclosure agreement before sharing with them sensitive information about your business.
- When Offering to Sell an Equity Interest in Your Company to Anyone Other Than Your Friends and Family, the Need for Formality and Disclosure Increases Dramatically
Not everyone has friends and family willing and able to invest in their business. If you are one of those people, you will need to look primarily to “accredited investors” for your fundraising needs. An “accredited investor” is someone who meets very specific criteria of assets and/or income, and experience investing, as defined under federal securities law. To sell equity in your business to these prospective investors, whom you might have never met before, you will need to disclose detailed information about your company in a private placement memorandum (“PPM”). A PPM is a highly detailed document that describes your company, its finances, the investment terms you are proposing, and discloses any risk factors for prospective investors to consider. It is a much more formal document than you would typically provide your friends and family, and thus should be prepared by a competent attorney experienced in securities law.
- Strictly Adhere to Basic Corporate Governance Procedures
If your business is owned by just you or small group of co-founders, you might have performed only minimal corporate formalities, e.g., holding annual meetings, drafting and approving minutes and resolutions, etc. While this might not have caused you problems yet, when you add outside investors as equity owners, the need to strictly follow the basic governance procedures that apply to your business increases substantially. You will likely have to give your investors a voice in how the company is run, either by operation of law or the terms of your agreement. Corporate governance procedures allow them to exercise that voice. Strictly following these procedures is not just a duty you owe to your investors, but is necessary to maintain the protections of the corporate form and shield yourself from personal liability.
- Be Prepared to Change Your Mindset
When you accept new equity owners into your company – whether from outside investors, employee stock option plans, etc. – both the dynamics of your business operations and your legal obligations change significantly. No longer can you run your business for your sole benefit. You will owe each and every person that has purchased or earned an equity interest in your company their due financial reward as well as your loyalty. Your investors expect to be paid their fair share for risking their hard-earned cash with you. Moreover, while you can still ultimately run the company, you have to consider the financial interests of all equity owners, generally called your “fiduciary duties.”
Expanding your business is an exciting time in the life of your company. Before you take this leap, it’s important to understand the additional laws and regulations that apply when you seek, and after you accept, investment capital from outside investors.
This guest post is courtesy of Benjamin Pugh. He is a Shareholder of Enterprise Counsel Group specializing in business litigation. A graduate of UCLA, Mr. Pugh received a Juris Doctor degree from Notre Dame Law School. He has been a guest lecturer at Pepperdine Law School, is a member of the Orange County Bar Association and serves on the board of director for the Federalist Society, Orange County Chapter. In addition, Mr. Pugh is a board member of the Atlas Political Action Committee and chairman of the Endorsements Committee.
About Enterprise Counsel Group: Enterprise Counsel Group ALC (ECG) is a prominent West Coast law firm providing impeccable representation including litigation, mediation, arbitration and transactional services for a wide range of businesses and industry leaders. Driven by the values of professional competence, enthusiasm, intensity of effort and an unwavering dedication to clients' best interests, ECG discovers and implements the most innovative, practical and cost-effective solutions in and out of the courtroom. For more information visit www.EnterpriseCounsel.com and follow ECG on LinkedIn, Facebook and Twitter.