You probably already know that the sale of “securities” triggers legal risks and compliance obligations, but many entrepreneurs and business owners are a little fuzzy on the precise definition of a “security.” Most know that any sale of corporate stock counts as the sale of securities, but the statutory definition is actually much broader.
The SEC definition provides the following examples:
- Note (includes promissory notes and convertible notes)
- Evidence of indebtedness
- Participation in any profit-sharing agreement
- Investment contract
- Option or warrant
Over time, our courts have interpreted the definition of a security even more broadly (based on the definition of “investment contract”) to include any investment with an expectation of profits based primarily on the work or efforts of others. The investment need not even be monetary but could include time or resources
At first blush, the breadth of the definition seems contrary to daily reality. When we think about personal debt, car loans, or credit cards, we do not consider these securities, yet technically they fit within the SEC definition. Numerous exemptions and exclusions reduce or eliminate compliance obligations under many circumstances, including personal loans and consumer debt scenarios.
Even in business transactions, applicable exemptions frequently can be found. However, failure to comply with filing or disclosure obligations can result in a securities violation, a costly mistake for a growing company. Fortunately, in most circumstances there are cost-effective solutions which enable entrepreneurs and small business owners to raise capital without breaking the bank or violating the law.