Securities Law Compliance for Private Companies: What Founders Get Wrong
The phrase "securities law" tends to conjure images of Wall Street enforcement actions and publicly traded corporations. But the reality is that securities law applies to nearly every company that has ever accepted money from an outside investor — including the startup that raised $50,000 from a family friend, the real estate company that formed a joint venture with a passive investor, and the growing business that brought on an angel investor in exchange for equity.
Private companies are subject to federal and state securities laws every time they issue equity, convertible notes, SAFEs, or any other instrument that qualifies as a "security." Getting those transactions right — and maintaining ongoing compliance — is one of the most important and most frequently neglected areas of legal risk for privately held businesses.
Why Private Companies Are Not Exempt
Many founders believe that securities laws only apply when you "go public" or when your company reaches a certain size. This is one of the most dangerous misconceptions in business law. The Securities Act of 1933 makes it unlawful to sell any security unless the offering is either registered with the SEC or qualifies for a valid exemption from registration.
Registration is the exception for private companies, not the rule. Nearly all private capital raises rely on an exemption — most commonly under Regulation D, Regulation A, or Regulation Crowdfunding. The existence of an exemption does not mean you can ignore the law; it means you need to comply with the specific requirements of the exemption you are relying on.
The Most Common Compliance Failures
Failure to File Form D
Regulation D requires companies to file a Form D with the SEC within 15 calendar days of the first sale of securities in the offering. Form D is a brief notice filing — it is not a registration — but failing to file it (or filing it late) can jeopardize the availability of the Regulation D exemption, trigger state enforcement actions, and, in some states, bar the company from relying on certain state-law exemptions.
Many founders learn about this requirement only after it has already been missed. If you have already sold securities without filing a Form D, work with a securities attorney immediately to assess your options — in many cases, retroactive or late filings can mitigate the damage.
Inadequate Investor Suitability and Verification
Under Rule 506(b), you must have reasonable grounds to believe that each non-accredited investor (up to 35 are permitted) is a sophisticated investor capable of evaluating the investment. Under Rule 506(c), you must take affirmative steps to verify that every investor is accredited. Under any exemption, you should be maintaining documentation of the investor questionnaires, verification steps, and communications that support your compliance.
In an investor dispute or SEC inquiry, your ability to demonstrate that you undertook appropriate investor qualification procedures can be the difference between a manageable situation and a serious liability exposure.
General Solicitation Without 506(c) Compliance
As discussed in our post on Rule 506(b) vs. 506(c), engaging in general solicitation while purporting to rely on 506(b) is a fundamental offering violation. This includes not just obvious advertising but also posts on investor networks, mass emails to non-existing relationships, and certain demo day or pitch competition presentations. If you are uncertain whether a particular communication constitutes general solicitation, ask a securities attorney before you send it.
Inadequate Disclosure
Even in a validly structured Regulation D offering, failing to provide material information to investors can give rise to both civil liability (under the antifraud provisions of the securities laws) and regulatory exposure. A well-drafted Private Placement Memorandum is the primary vehicle for providing that disclosure, and it should be updated to reflect material developments in the business as the offering progresses.
State Blue Sky Compliance
The federal Regulation D exemption preempts state law registration requirements for most offerings, but states retain authority to require notice filings and to pursue fraud claims. Many states require a Form D notice filing within a specified period (which varies by state and can be as short as 15 days after the first sale in that state). States typically also impose filing fees that must be remitted with the notice. Failing to make required state filings can result in fines, disgorgement orders, and, in severe cases, rescission rights for investors.
Building a Compliance Framework
If your company has raised, or plans to raise, outside capital, the following practices should be in place:
Maintain a capitalization table that accurately reflects all outstanding equity and rights. This includes common shares, preferred shares, options, warrants, convertible notes, SAFEs, and any other instruments that can convert to equity. Inaccurate cap tables are a frequent source of disputes and a red flag in due diligence.
Document every offering. For each capital raise, you should be able to produce the offering documents (PPM or term sheet), investor questionnaires, subscription agreements, state filings, and correspondence related to investor solicitation. These records should be maintained for at least five years and preferably longer.
Know when your exemption expires or changes. A Regulation D offering under Rule 506(b) that continues past the point where you begin general solicitation is no longer eligible for the 506(b) exemption. A company that crosses certain assets under management or investor thresholds may lose access to exemptions it previously relied upon. Working with securities counsel on an ongoing basis, not just at the moment of the offering, is the most reliable way to stay compliant as your company evolves.
Respond to changes in the regulatory environment. Securities law is not static. The SEC regularly issues guidance, modifies exemption rules, and brings enforcement actions that illuminate how existing rules are being interpreted. A securities attorney who actively follows these developments can help you adapt your practices before you encounter a problem rather than after.
The Cost of Getting It Wrong
The consequences of securities law non-compliance can be severe. At the civil level, investors have the right to rescind their investment and recover their purchase price plus interest if you sold them securities in violation of applicable law. They can do this even if the investment performed well and even if the investor suffered no financial harm. At the regulatory level, SEC enforcement actions can result in injunctions, disgorgement of profits, civil monetary penalties, and bars from serving as an officer or director of a public company. At the criminal level, willful violations of the securities laws can be prosecuted as federal crimes.
None of these outcomes is inevitable for a company that takes compliance seriously and works with experienced counsel. But ignoring compliance, at any time but particularly in the early stages of a company's life, when the founder's attention is naturally focused elsewhere, is a risk that can compound over time and become vastly more expensive to address after the fact.
The Law Offices of James G. Dodrill, P.A. advises founders, entrepreneurs, and growing businesses on securities law compliance at every stage of their growth. Contact us to schedule a consultation.
Disclaimer: This blog post is provided for general informational purposes only and does not constitute legal, tax, or financial advice. Reading this post does not create an attorney-client relationship with me or my law firm. Reach out for a consultation and to obtain advice specific to your individual legal needs.