Early stage companies frequently want to raise money from friends and family. There is a common misconception that somehow the U.S. securities laws do not apply to these transactions, and that there is a “friends and family” exemption from the U.S. securities law registration requirements.
Unfortunately, under the U.S. securities laws, there is no such thing as a “friends and family” exemption from registration. To sell shares of stock or securities in a company, the company either has to register the securities with the SEC (an expensive and onerous process), or issue the securities pursuant to a securities law exemption. The most common exemption relied upon by early stage companies is the exemption for securities issued pursuant to the all “accredited investor” offering exemption under Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended.
You can find the definition of accredited investor here. Please be advised, however, that the individual net worth definition has changed, as explained here. Also, be aware that there are a number of conditions that must be met in a Rule 506 offering, including not running afoul of the general solicitation prohibition (for an interesting blog post on this condition, see Bill Carleton’s piece of the other day).
If you raise money from friends and family members who are not “accredited investors,” this can complicate future offerings that otherwise would have qualified as all “accredited investor” offerings. For example, under Rule 502 of Regulation D, a friends and family offering might be considered part of a subsequent offering that would have otherwise qualified as an all “accredited investor” offering, causing the subsequent offering to not qualify as exempt as a Rule 506 offering. Non-exempt, non-registered offerings can also upset strategic transactions, or give rise to government investigations and expensive rescission offerings.
Always consult with counsel before selling securities in your startup company.