Guidance on Handling Disclosures When Selling Private Securities

Raising money and selling securities (e.g., stock, membership interests, convertible notes, certain types of debt or notes, etc.) is a challenging feat for most entrepreneurs.  But, in addition to the challenge of actually raising the money, selling securities is a high risk activity that can have disastrous consequences to the entrepreneurs and principals…personally.  That’s right, promoters of securities (think: founders/principals) cannot shield themselves with the corporate or LLC veil of limited liability.  Instead, they can be personally liable for their acts and omissions in the context of selling securities.  So, it shouldn’t be done without thought and care for complying with the law and mitigating your risks.  


Generally, the securities laws of United States and each of the various states provide for three options when it comes to selling securities:

  1. Register the securities with the SEC or one or more states (think IPO, listing your shares on an exchange, etc.);
  2. Seek an exemption from registration (e.g., 4(a)(2), 506(b), 506(c), 504); or
  3. Do neither and run the risk that your offering is illegal.  


If a company pursues a registration process, then the registration process will dictate what and how a company and its promoters must disclose information to prospective investors.  Thus, for purposes of this article, we won’t focus on disclosures in registered offerings.   And, since our firm doesn’t get involved with companies that risk conducting an illegal offering, the focus of this article will be disclosure in private and exempt offerings. Of course, even in exempt offerings, there are some mandated rules on disclosure (for example, in a 506(b) offering with unaccredited investors, the company must provide audited financials and disclosures that are similar to registered offerings).  But, in many common contexts (e.g., a 506(b) offering with only accredited investors, or a 504 offering), the form and manner in which information is disclosed is not prescribed by statute.  The company and promoters have some options.  This article will discuss some of those options.  


What is the law on disclosure?  


In short, the law states that anyone involved in the sale of securities cannot “make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.”


Ok… But how do we do that?  


Our firm looks at the disclosure issue as one that falls on a spectrum that runs from minimum compliance to full written disclosure.  Here 3 examples along that spectrum.


Minimum Compliance


Again, under many exemptions, there is no prescribed manner for disclosures.  Disclosures can occur through meetings, emails, phone calls, presentations, pitch decks, sharing of documents, or creation of a “data room”.  So long as the information isn’t untrue or is omitting material information, then, this complies with securities laws.  


The downside, however, to this approach is that, in a case where a disgruntled investor sues on the grounds of securities fraud or misrepresentation, then the issue becomes one of evidence.  The emails and memories of the individuals will be the crux of the case.  To us, that seems like a risky proposition.  Can anyone really remember exactly what was said in that meeting years ago?  Was something misinterpreted or taken out of context?  


Middle of the Road


One of the middle-of-the-road approaches to disclosure is to include “Risk Factors” with the agreement to buy securities.  Risk factors are cautionary statements to the investors to advise them of risks that the company will face (internally and externally) in the execution of its business plan and the risks the investors are taking by participating in the offering.  Frankly, risk factors read like doom and gloom because they list out scores of ways in which an investor can lose their money.  But, all the doom and gloom descriptions provide for great protection against disgruntled investors. 


The fact that risk factors are written and dated (i.e., “time-stamped”) are a clear added benefit over the minimum compliance approach because of its evidentiary value.  Again, assuming that nothing is presented in a misleading manner, the disclosure of information is evidenced in writing and will serve as “Exhibit A” to the company and promoters’ defense to a claim of misrepresentation.  


Robust Written Disclosure:  Private Placement Memorandums or Offering Circulars


The next major step up from risk factors is providing a full Private Placement Memo (“PPM”) or other offering memorandum to investors.  In addition to providing risk factors, a PPM will go further and provide the following categories of information:

  • Cover page and summary of the offering
  • Investor and SEC / blue sky required disclaimers
  • Cautionary notices about forward-looking statements 
  • Offering summary or summary of the terms
  • Executive summary of the business plan
  • Industry and transaction specific risk factors
  • Summary of the business opportunity or business plan 
  • Description of securities sold
  • Summary of management (bios, background, and experience)
  • Disclosure of management compensation
  • Disclosure of beneficial ownership by principals and insiders
  • Disclosure of related-party transactions
  • Disclosure of plan of distribution and sale of securities
  • Description of qualifications of who may invest and how to invest
  • Summary of charter documents (e.g., operating agreements, shareholder agreements, certificate of incorporation, etc.)
  • Qualifiers and disclaimers related to projections 


When it’s all said and done, there’s a lot that is covered in a PPM.  As you can see, this provides an even greater level of written disclosure to investors at the time of the investment than what is accomplished through risk factors alone.  


These are all significantly varying scopes of work for a law firm.  Thus, oftentimes, a promoter needs to value the services and work product compared to the value of risk mitigation.  Some clients, for example, highly value risk mitigation and will undertake a PPM in each instance.  Others will not.  I also think that, to a certain degree, the size of the offering comes into play.  The larger the offering, the more advisable the PPM will be.  


Contact Us

Selling securities comes with a myriad of complex rules and guidelines to follow.  Don’t try to do it alone.  Our team can help you find the right solution for your offering and help you protect, not only your business, but also your personal assets.  Set something up with our team today.



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