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All businesses need capital at some point. Newly formed businesses frequently rely on funds provided by the business owners themselves and/or their friends and families. More mature businesses require capital to either fund internal growth, or growth by acquisition (buying another company).

Obtaining Business Capital - Debt or Equity

Companies can obtain capital in two different ways – by borrowing or by selling a portion of the ownership of the company to an investor.

A company that obtains funds through borrowing will be required to sign (among other things) and issue a promissory note to the lender to evidence the loan. If a company obtains money from the sale of ownership interests (stock in a corporation; membership interests or units in a limited liability company, etc.) the company will likely issue an ownership certificate to the investor.

A promissory note issued by a company, and an ownership interest in a company, each constitute “securities” under federal and state law. Securities laws apply to all capital raising transactions, including small isolated transactions. Securities laws apply to public and private companies.

Securities Laws

Securities laws require that the party seeking capital provide comprehensive written disclosure about the company’s business and financial condition, the background of the persons controlling the company, what the proceeds will be used by the company for, and the risks associated with the investment. This disclosure is often provided through a private placement memorandum with the terms of the investment and the investor’s status documented in a subscription agreement.

Securities laws include harsh penalties on companies raising capital and their officers and directors (personally) for failure to comply with the disclosure and other requirements. To be clear, officers and directors of any company raising capital can be personally liable to investors. Fortunately, federal and state securities laws provide exemptions for certain capital raising transactions (or offerings) and certain issuers. These exemptions give smaller companies an opportunity to abbreviate disclosure without incurring liability.

A company should not solicit or accept capital, though a loan or the sale of ownership interests, without consulting with a securities attorney.