What To Watch Out For

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​danger​ A few important pitfalls when it comes to securities law and fundraising:

• Make sure the company is complying with the law in regard to its fundraising. When you are evaluating a company, you should make sure the company is following the rules of whichever securities law compliance path it chose.

  For example, if the company is telling you that it is conducting a Rule 506(b) offering, but it is advertising its securities offerings on its website, that is a red flag. It means that the company is not complying with the law. The company may not be getting good legal advice, which is a signal that other things might be amiss as well.

• While you’re investigating the company’s fundraising history, note that many angel investors are leery of companies that have crowdfunded or taken money from friends and family, partly because there may be a large number of non-accredited and potentially naïve investors on the cap table, which can complicate future fundraising.

• If you run across a company with a large number of non-accredited investor shareholders, this may make it more difficult for the company to receive venture capital funding. The presence of a large number of non-accredited investors on the cap table can also indicate the company has not received good legal advice, and other things in the company’s corporate records are not correctly done either.

• Sometimes companies are not careful in how they conduct their securities offerings. You want to make sure that the company you are investing in is well advised and scrupulous about its securities law practices. If a company violates the rules, your money may well be used to clean up the mess. You don’t want your funds used in this way.

• Don’t inadvertently become a VC. Unless you are in the business of investing other people’s money, and you have all of the required licenses and credentials, complied with all legal requirements, and have insurance, do not invest other people’s money, charge other investors a fee for investing in your deals, or take a carry on other investor’s investments.

  • It is not uncommon for angel investors to want to follow a well-known investor who has access to deals that they might not have access to, because of their reputation or prior experience. You might run into someone who asks you to start investing their money in your deals. This might be alluring to you if you would like to have more negotiating power.

  • The problem is, the law in this area is onerous and easy to run afoul of. For example, if you charge other investors a fee to invest in your deals, you might have to be registered as a broker-dealer or an investment advisor. If you form a fund, even if you don’t charge any fees, you have to worry about compliance with the Investment Company Act.

  • You never want to be sued by another investor in a deal based on the claim that you advised that person to make the investment. Each investor in any deal should make their own independent decision whether to invest.

• In general, securities regulators are hostile to non-registered broker-dealers (so-called “finders”) receiving a commission on the sale of securities. In general, if someone is receiving a commission on the sale of a security, the securities regulators will take the view that the person should be registered as a broker-dealer. Some states, such as California, provide investors with a statutory rescission right if a company paid a commission to a non-registered broker-dealer. You should be aware that finders and broker-dealers must be disclosed on the Form D that the company is required to file with the SEC, which is a public filing anyone can access.

  • The key advice here is: don’t act as a finder for a fee. Meaning, don’t help raise money for a startup in a way that provides you any kind of payment or commission or other remuneration such as additional stock.