Law News and Tips
Fred L. Vilbig © 2018
One of my sons texted me the other day. He needs money. Not the way you’re thinking. He’s getting into the real estate business – multifamily units. He was renting an apartment but got tired of that, so he bought a 4-family, lives in one unit, and rents the other three. I wish I would’ve been that smart.
He’s going into business with one of his grade school buddies to buy more properties. But they want to get bigger properties. The problem is that that requires more money than the two of them have.
That seems to be a perennial problem for businesses – money. It happens all the time where a business needs to buy more equipment or expand facilities in order to grow and make more money. But the question is how.
Owners can borrow money, but banks can be stingy. They don’t like lending money when there’s a chance they won’t get it back. It has to be a pretty certain business opportunity for them to lend a bunch of money. Just to make sure, they will usually put some kind of a lien against the assets, and they’ll impose a bunch of financial covenants or promises on the business. Those covenants can be kind of a pain, but it is their money that they are lending you.
Instead of a bank loan, business owners can go to friends and family to get private loans. Those can get messy. It’s important to have a clear understanding about what’s going on. If things go well, your “lender” will want to treat it as an investment so that they get to share in the growth of the business. If things go badly, your “investor” will want to be treated as a lender so they can get paid back before the shareholders. And the understanding needs to be in writing – people are funny about remembering things the way they want to.
My son knew that he wanted to sell interests in the business. He also knew that this would raise securities law issues. He thought that meant he had to register with the federal Securities and Exchange Commission. That is a horrendous effort, so you try to avoid it at all costs… that is, short of prison. So small business owners need to fit into a federal exemption.
Generally, small (under $5 million with less than 35 investors) or purely intrastate security sales are exempted, though the devil is in the details. If you have investors in more than one state, you’ll probably need to file a Reg. D registration which is a simplified (although not simple) process. But even if you have all of your investors in one state (and intrastate offering), you may still be subject to that state’s securities law, so you need to look for a state exemption. In Missouri, you’re pretty safe if you have fewer than 25 investors.
But even if you’re exempt from state registration, you probably still are subject to the disclosure requirements. If you’re offering securities to people who will not be directly involved in the business, you cannot make a material misstatement (that is, tell a lie) and you cannot fail to disclose some material information about the business. And again, this kind of disclosure needs to be in writing because of that memory issue I mentioned earlier.
If you’re thinking about raising money to expand your business, give us a call. It’s important to everyone to get it right.
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