5 Legal Mistakes Startups Make When Seeking Investors
If you’re a founder raising capital, you’ve probably got a pitch deck, a valuation in mind (maybe pulled from thin air—no judgment), and a list of people (friends and family, angel investors or VCs) to target. But what most founders don’t have…A clear understanding of the legal minefield that surrounds offering securities—i.e., selling pieces of your company to investors.
Let’s be clear: whenever you offer equity or convertible instruments (like SAFEs or convertible notes) and in MANY other transactions, you’re dealing in securities. That means you’re subject to federal and state securities laws—even if your company is two people and a dog in a coworking space!
In my experience, startups tend to make the same five legal mistakes when raising money. Let’s break them down.
1. Assuming Private = Unregulated
One of the biggest misconceptions I’ve seen is that if you’re not going public or advertising your offering, you don’t need to worry about securities law. Wrong.
Every offer or sale of securities—public or private—must be either registered with the SEC or exempt from registration. This applies even if you are just getting money from friends and family. Startups almost always rely on exemptions, typically under Regulation D (e.g., Rule 506(b) or 506(c)). These rules have specific requirements around who you can take money from, what kind of disclosures you need to give, and whether you can publicly talk about your raise.
If you skip these steps you could face serious consequences, including having to return the money you raised or being barred from fundraising in the future.
Tip: Know which exemption you're relying on before you start raising. It should be part of your game plan, not an afterthought.
2. Taking Money From Unaccredited Investors (Without a Plan)
This one’s a trap for a lot of early-stage founders. You start talking to friends, family, and maybe that dentist your cofounder knows from high school. One of them wants to invest $25K. Great, right?
Not always. Under Rule 506(b), you can accept money from up to 35 unaccredited investors—but there’s a catch. You’ll need to provide extensive disclosure documents (think mini-prospectus) if any non-accredited investors are involved. There are also considerations you have to make regarding how and when you and the investor learned about each other.
Rule 506(c), on the other hand, allows you to advertise your offering (say, on your website or LinkedIn), but only if all your investors are accredited and you verify their status with documentation (tax returns, W-2s, etc.).
Tip: If you’re going to take money from ANYONE, talk to a securities lawyer first. If you don’t follow the rules properly you can have huge problems.
3. Not Filing Form D
Here’s a sneaky one. You’ve successfully raised money under Rule 506(b) or 506(c). Congrats! But did you file your Form D?
Form D is a notice filing with the SEC that’s required within 15 days of your first sale. Also, virtually every state requires their own filings and payment of a fee if you have an investor who resides in their states.
If you skip this step, you’re technically out of compliance—even if the rest of your raise was squeaky clean. That could come back to bite you in due diligence during a later financing or acquisition. Don’t let that happen – at a minimum it can delay the deal and in a worst case scenario it kills it.
4. Using SAFEs Without Understanding the Consequences
SAFEs (Simple Agreements for Future Equity) are startup-friendly instruments that delay pricing your company and avoid immediate dilution. But don’t let the “simple” in the name fool you—there’s real legal complexity under the hood.
Here’s what founders often miss:
SAFEs are still securities. So everything I’ve said about exemptions and filings still applies.
Too many SAFEs with big discounts or aggressive valuation caps can create a cap table nightmare when you raise your priced round.
Investors may have very different interpretations of how SAFEs convert, especially if you’ve used multiple versions (post-money vs pre-money SAFEs, for example).
Tip: Use SAFEs strategically, and make sure you understand how they’ll convert. Model your cap table before and after conversion, not just during the raise.
5. Failing to Keep Proper Records
It’s shocking how many startups don’t keep track of what they’ve sold, to whom, and under what terms. We’ve seen everything from missing SAFE agreements to convertible notes that were never signed. Not only is this sloppy—it’s risky.
When you go to raise your next round or get acquired, investors and acquirers will expect a clean, accurate record of your securities history. Just like I mentioned above, if your documentation is a mess, it can delay the deal—or kill it entirely.
Tip: Maintain a well-organized data room from Day One. Use digital signature tools. Track investor details, dates of issuance, and legal docs. Future-you will be grateful.
Final Thoughts
Founders are masters of wearing many hats—but when it comes to raising money, don’t DIY your way into securities violations. The legal risks are real, but manageable if you go in informed.
Understand your obligations and treat your raise like what it is: a regulated transaction involving the sale of securities. You don’t have to become a securities lawyer—but you do need to know when to call one.
Need help navigating your next raise? Make sure your foundation is solid before you take that term sheet. It’s easier—and cheaper—to do it right the first time. Contact me today for a consult.