When you seek professional investors, whether organized angels or venture capitalists, one of the early questions you are asked is \u201cHow have you financed the business so far?\u201d\u00a0 Investors love to see entrepreneurs who have used their own money to ignite their businesses.\u00a0 But often, entrepreneurs turn to others for initial capital. Describing that capital using the phrase \u201cfriends, family and fools,\u201d or \u201cFFF,\u201d\u00a0 \u00a0has become as common as to be trite.\u00a0 And even more recently, \u201ccrowd sourcing\u201d has been enabled by the Internet \u2013 seeking many investors at a small amount per investment.<\/p>\n
The problem in taking such money rests in the legality of taking money from non-accredited investors, people who do not meet the SEC standard for making non-public company investments.\u00a0 Currently that standard requires a minimum of $200,000 in annual income or over one million in net assets, including the value of the investor\u2019s principal residence. \u00a0Since many small investors in a young business do not meet that standard, there is a chance that the company has taken money that it should not have taken, according to SEC rules.\u00a0 There is an exemption for members of the entrepreneur\u2019s family and in some cases for close friends with intimate knowledge of the entrepreneur and of the plan and, of course, for employees of the company.\u00a0 It is worth checking with an attorney to see if such investors are truly exempt.<\/p>\n
[Email readers, continue here…]<\/span><\/em> Some small companies work to create \u201cprivate placement memorandums,\u201d attempting to protect themselves against this problem, couching the proposed investment in legal language stating the risks involved in making the investment.\u00a0 The PPM does nothing to mitigate that problem when the investor is not accredited.<\/p>\n To compound the problem, often stock is issued by the entrepreneur without filing any report of such issuance with the state of issue.<\/p>\n The sum of these problems is that a disaffected investor can sue the entrepreneur or the entrepreneur\u2019s company for a rescission of the investment and return of the money invested if the money was taken improperly, especially when the business has failed and the investment lost, putting the entrepreneur at risk for the loss of additional personal assets.<\/p>\n The cure for this, when professional investors enter the picture, is for the company to craft a \u201crescission offering\u201d to those shareholders who invested illegally, offering to repurchase their shares at full value invested.\u00a0 This is sometimes difficult since it often happens just at the time a company needs new money most and is in the process of seeking that money for growth.\u00a0 If a previous investor does not accept a rescission offer, there is some insulation provided to the company against a future lawsuit by that investor.<\/p>\n So, plan to take money only from qualified investors. Check with your attorney if there is any doubt.\u00a0 The risks of a problem rise with unmet investor expectations, and fade with success.\u00a0 But sometimes, such behavior will cause a subsequent angel or venture capitalist to pass on an otherwise good opportunity, and that would be a shame, one that could have been avoided by diligent process in the early investment cycle.<\/p>\n","protected":false},"excerpt":{"rendered":" When you seek professional investors, whether organized angels or venture capitalists, one of the early questions you are asked is \u201cHow have you financed the business so far?\u201d\u00a0 Investors love to see entrepreneurs who have used their own money to … Continue reading