Raising Capital For Your Business & The SEC (Toby Mathis PODCAST)
Hey guys you're listening to the anderson, advisors, podcast. And today we have a really, cool guest, uh christopher myers, first off welcome, christopher. Thank you thanks for having me, yeah and uh, chris is a, like. He's. First off he's my personal counsel. When it comes to working, on, uh, on. Scc, matters oversight. Uh fundraising. Just because he's an expert in the area we'll kind of go over that, um. But he's gonna go over the the basics, of what you should know if you're thinking about raising money for a project. Whether it be for your business or for, an, apartment complex, that you've got your eye on or if you have other investors, that you want to work with and so. He's absolutely fantastic. So again welcome christopher. Uh i'll just call you chris welcome chris. And uh thanks for being with us. Thank you. Yeah, so um. Let's kind of go over some of your background, like i know the background. Uh and it's pretty, darn impressive, chris has actually worked for like finra. Uh, way back when right how long ago ago was, yeah i i worked there and i was getting uh basically a master of laws. In business law with a focus on securities, regulation. Spen, spent a a year there one semester, no he. Um, interned. There during the uh masters, program, it was great. Um. Some tremendously, smart, um. Caring people there. And it was just a unique insight into into, the finra world into the, their great mission. Yeah so he's been on that side and then and then he just kind of coupled it up. By, going in and working with the nevada, secretary of state securities, division right. Yeah that was that was my first job out of law school, um, uh i i practiced law here in the great state of nevada. Um, and you know my first entree, into the full-time working world was with the securities, division. Uh i served in the capacity, as a securities, examiner. And essentially, what that was is i i reviewed. All securities, offerings, that were being qualified. And oversaw, licensing, of investment, advisors. Uh broker dealers. Uh and uniquely enough athletes, agents. Which was a fun, uh change every once in a while. I could imagine that you saw a few things there. Yeah you know it's, uh there are rules here in nevada, contrary to popular belief, uh. Not everything goes maybe down on the strip but in in the in the securities, world, uh, there's certainly a state dedicated, to protecting your investors. Yeah and then uh and then you went right over to probably one, i look at as one of the most aggressive. Uh states, uh california. And you worked with what the department, of oversight, than the securities, division. Yeah yeah, essentially, my, wife and i were both from southern california. And uh. We were expecting our first child, and a desire to be a bit closer to family. Uh took us back to california, and i worked for the, securities, regulation, division within the uh. What's now the department of business oversight. Um much larger, much larger, organization. Um obviously much larger state one of the largest economies, in the world. And, it was it was fun i i spent about, a year there working with some some very smart people. Um again sort of was in a role where i oversaw, securities, offerings. Um and then was sort of council de facto council to our broker dealer. An investment, advisor, regulation. Unit. Um, gotta help out on some unique stuff but, again a tremendously. Um, you know passionate, group of folks that you know looking to, make sure they protect. The residents of the state of california. Yeah so when you say security like we're throwing around some some uh phrases, but anybody who has a, corporation, an llc. You're dealing with securities, the interest, there is a security, right so. When you're talking about offerings, and things like that, these are the people that are actually putting together, both public, and private offerings, right, correct yeah, they're they're unfortunately. There there is a tremendous. Uh, knowledge, gap, um. And i think understandably. So. With folks trying to. Raise money start a business, grow their business.
And Say hey stock is what i see in the new york stock exchange. Right when i'm i'm just raising money for my business. Um. Debt or equity, and i think what's crucial to understand, and sort of put it into the most easily understandable, terms is. If someone gives you money. Um, and you're going to take that money, and build your business, expand your business, acquire, an asset. Do anything, where that person expects that money back. Plus. Some. Uh or expects their money back or hopes they get anything back. Um, you may be involved, in a securities, transaction. And importantly, there is a there are, a wide range of laws both at the federal, and at the state level that apply to anybody engaged in that activity. And it's crucial, before anybody, takes money from another, person. To understand, compliance. Is going to be necessary, both at the federal, and at the at the state level. And, some folks say well i'm based in california. I only have to worry about california. And i tell folks if it's actually, patchwork, is a little bit broader. It's going to be. California. And any state that you offer into, in any state where you have an investor, based. So it's very important for folks to understand. Um, there is a price. Associated. With uh, helping to raise money to grow your business. With with you know confident, counsel. A helping. Law can absolutely. Be complied, with. Um it's just you want to do it beforehand. Um, and have a plan versus, get to the end and go i hope i didn't step out of bounds because. It's easy to do. Yeah so, there's a few things i want to unpack there uh before i jump into that, you're now in private practice you work with uh it's hauling in heart right. Correct yeah i spent two years. As a securities, regulator. And after that really had a desire to help small business owners entrepreneurs. Um. Raise money and and i i saw, a lot of the pitfalls, that folks stepped into. And i think, something crucial for a lot of folks to understand, is i think a securities, regulators, are only out there to, get the bernie madoff's. Of the world right people intentionally. Committing, fraud. And unfortunately, that's that's not really, um the majority of the of the issues that i saw as a securities, regulator. A lot a lot of times it's entrepreneurs, that just have unknowingly. Uh engage in a securities, transaction, without an exemption. They say hey you know i'm raising money from a handful of rich people. Um, how is that a securities, offering right they invested in my llc. Or, they helped me you know go buy that apartment building over there. Um, and and. Or, unit. How is that a securities, transaction. Yeah. And that's not just that's not just raising i don't mean to interrupt you but that's not just. Them putting money in for equity that's also, if you're borrowing, from them correct. Correct yeah there are certain types of, debt instruments that can be considered, a security, and i think the safest, place to start, uh from from an assumption, on, a, entrepreneur, business owners standpoint, is, assume. Anytime, you take money debt or equity that you're. Considered to be engaged in a securities, transaction. From there we can look for exemptions. Or exclusions. And exclusion, is, what i'm doing the nature of it how it's structured. Is not considered to be a security, which is great. The second is hey what i'm selling. Debtor equity, is in fact a security. But maybe there's an exemption that applies to me, and there's both what are called transactional. Exemptions. Which is based on, the fcc, and state regulators, saying based on the nature of the people involved in this transaction. We don't need to regulate, it, either because the offering, is is small, and localized. To a, group of very sophisticated.
Wealthy, Investors. Um. And there's also. Certain things that, securities, that are exempt but usually that's applies to like bank stocks, and certain things, just the average, entrepreneur, is not going to be selling. Why don't you uh kind of go over some of those like, what would be an example of an exclusion, something that's not. Um. That that that may, contrary, to popular belief not be a security, transaction. So there so there are there are some things where. It technically. You know can be a security, with this the but the sec, says listen this is just going to be excluded from us regulating, it based on the nature of the offering and they're usually things like bank stocks. Um, or. Things that the average entrepreneur, is just not going to be engaged in doing. Okay. By and large the most for the most part the focus, for, entrepreneurs, or anyone raising money, is going to be focused on what are called transactional. Exemptions. Which are, hey i'm selling a security. But based on the nature of the people i'm going to let participate, in this offering. Investment. I don't need. Securities, oversight. Um. I don't need to register it with the sec, or a state, i can be, exempt. Can you give me some example of some exemptions. That, that, people would have. So so a starting point, at the federal level is something called um, section 482, of the securities, act of 1933.. Um section 482. Essentially, is is an exemption that says. Uh, you don't have to qualify. A non-public. Offering. What that's def, how that's defined, is through. A variety of case law and interpretive, letters from from the sec. It's you know it's a very broad exemption, however in practice it can be a little bit narrower than people think. And so folks said hey can you provide me any real guidance on this and the sec. Long time ago came out with something called regulation, d. D is a safe harbor, underneath, 482. That says hey if you can comply. With these specific, set of rules. Your transaction. Will be exempt. And, traditionally. The primary. Regula, exemption, under reg d was, rule 506. And rule 506. Allowed you to, through, non-general. Solicitation. Raise money from no more than 35. Non-accredited. Investors. An unlimited, number of accredited investors, in theory but there's, a point where you have to become a reporting company. But allow you to raise money from accredited, non-accredited, folks as long as you comply, with. A laundry, list of. Of requirements. When. Um, you look back you say wow. I had to jump through all these hoops. I've certainly, done enough to sort of either. Add value to the company, audit financials. Disclosure. Items. Things that will inform, an investor. The. Uh however, traditionally, that was done, through non-general, solicitation. Um. During president obama's administration. He passed uh or with congress's help passed something called the jobs act which is an acronym for jumpstarter, businesses, startups, act, it was a response, to one of the worst recessions, this country, has ever seen. It, did was it passed, a tremendously, powerful, exemption, for um, entrepreneurs, and business owners. And that's something called what's now known as 506. C. And 506. C, is a transaction, exemption, that allows you to rely on on this regulation, d exemption. But raise, but generally solicit, your offering. Um. To. Anyone. So long as your investors, prove, they're accredited. Which makes people with, um, you know net worth over a million dollars. Exclusive, of their primary, residence. And anything. And. It's tremendously, powerful, because, there was a lot of entrepreneurs. And business owners that said. Hey i'm willing to only have, accredited, investors, and, invest in my offering.
I Just don't know any rich people. What class allows them to go out so when you say general solicitation, this is really important for people to understand. If you have a pre-existing, relationship. With somebody. Is that an ex is that an exemption, from the general solicitation. Rules. Yes, yes so, so, uh general solicitation. Is is, not something that's been specifically, defined by the sec, but through, uh, guidance. Case law interpretive, letters. There's, some, some general parameters, regard rails. And yeah the focus in general solicitation. Is do you have a substantive, pre-existing. Relationship, with this person. And more than just i know their name i know their address. Is i know their background. I you know i. You know know their middle name. I know they're financially, sophisticated. You know they're a cpa, they're, you know a doctor. Um, an architect. They have, you know a level of sophistication. That you know bypasses. The average american, that you know. Can understand, stocks generally, but they're a person that. Understands, investments, and you know private deals. As an income that's, relatively, substantial. Um. But you know all of that about a person, you're getting to the realm of, i have a substantive, pre-existing, relationship, with this person. Fortunately. That sort of limited your ability to raise money, to the people that you knew. Know enough people that could finance, your venture. You were in a realm of well what exemption, can i rely, on, um. Raise the rest of this money. The jumpstarter, business the startup, act when it was when it went into effect said, well you know what, you don't have to have that level of knowledge of all the people you offer to. You can go out and as long as all the people that actually, give you money. Are accredited, and they have to there's certain things they have to provide as proof that they're accredited. The fcc, will now exempt that transaction, and let entrepreneurs, raise money from folks that they may not have a pre-existing, relationship, with, other dollar limits to that like how much you can raise. No so so 506, c is, unlimited, in the amount of money that can be raised. Um there are certain, uh thresholds, where if you have more than a certain number of stockholders, you can eventually become a reporting company but that's not a concern for usually the average, business owner. One of the things though that i counsel, folks on is. Yes you may have an exemption that allows you to solicit. An unlimited, number of people. But you don't necessarily, want an unlimited number of people to come into your business. Um, particularly, if you're selling equity. Because there's the. Exemption, but there's also the practicalities. Of having these people, own equity in your business. And have expectations. They're going to want reports. And particularly, sophisticated. Investors, or wealthy investors. Will oftentimes, demand, things that sort of match almost. Having a registered, offering. And to be candid, i i tell a lot of folks. Um, you know having, 50 investors, that you've never met before, that you're now essentially, your boss because you have to report to them. It can be a big burden for a startup business. So, 506c. I think is a tool. Um. To be in a founders, or our entrepreneur's. Tool chest, but i think, and it has to be used, in connection, with practicalities. Of, do i really want investors, i've never met to own a part of my business. What about, um. So you're discussing, this is for accredited investors, what if it's just family members, or my friend across the street and we decide to do something together. Yeah so so reg d rule 506. Is a federal exemption, and that's sort of the starting point, if you do a 506.
Offering. Um you can offer in states, and you file you make a notice filing. Along let's look at reg d for when they're going to be raising money from either people they don't know, or a larger offering. There are however. State exemptions, that people can rely on. In addition to, the, large federal exemption which is section 482. And. For example we have an exemption, that. Is if you offer to a limited number of people. And you raise, less than a certain dollar amount. That offering can be exempt, from registration. At the state level. You still have to look at the applicable, federal, exemptions. But second, grade two is oftentimes. An exemption, people rely, on, in connection, with what's you know usually, a small localized, offering, friends they call it friends and family right so correct. And what's the typical is it like 15, people, or. 10 people. So it depends on the state you're in there's a lot of states that have adopted, something called the uniform, limited, offering, exemption. And depending, on what state you're in that number can range from, you raise no more, money from no more than 15 people, some states it's no more than 25. And, there's usually a dollar amount associated, with that in some states it can be you know. As little as a million, i've seen it as at five million in some jurisdictions. But the crucial, thing to understand, in the friends and family around is, yes they're friends and family. But they. May be buying a security, from you, and whether they're friends, family or not. That transaction. Must be. Um. Exempt, if it's not registered. And. A lot of folks come to me and say well what's the you know, i don't care, you know what do i need to document, this for. And for a lot of entrepreneurs. The big thing is, corporate diligence, down the line, is going to pick up a, non-compliant. Securities, offering. And a lot of folks are worried about. You know the sec. Or state securities, regulator, they think well they're not gonna they're not gonna know. But even if a regulator, doesn't come in and identify, your offering is non-compliant. You still run the risk of, later stage investors, saying. Hey you did a non-exempt. Transaction. Where you didn't pay for this transaction, appropriately. I don't want to invest, into a deal that has risk, unrelated, to the project. Business. And that's just something that entrepreneurs. Um. You know it can be difficult to clean up after the fact if, it in fact can be, and it's just something that i think entrepreneurs. You want to be in a position where you're either explaining, your project, you're explaining, your business. Not trying to clean up, you know, missed paperwork. Yeah this is one of the hardest parts for people to really get, around, you know get their minds around.
You Set up an llc, even if it's with, your buddy, and your partner, and you're going to buy this you know you're it's the person you buy real estate with and you're buying houses. Or apartments, or you're filling the blank. That's still a security, it's just. Because you guys are both partners, in it you're probably, going to be exempt you're under you're it's a small, amount. You're both the principal's, in it you're both running it, the second you start going out saying hey we need extra money. And you start reaching out to people hey let me talk to my uncle or let me talk to my. This guy i know in town who's who's, pretty wealthy. And you're just asking even for a loan you're you're still under the securities, realm, and you got to make sure you don't step on a land mine is that essentially, uh, yeah correct and and i and i've you know friends and family are great, until, you know a dispute, arises, and i have seen, clients, that have you know gone out and taken money from immediate, family. Um but not done it in a you know compliant, way. And unfortunately. Sometimes, they're falling out with family, there's you know. Uh, a business venture doesn't turn out the way everybody, thought, and. Slighted. Um, you know they can they can report they can call their local securities, division they can try and call the sec. But they can call someone and say hey you know what i put money into this deal. I don't think it was done right. Is there anything you can do. And, that's just not something that you want to have to deal with in addition to you know. Business venture. Is a call from a regulator, trying to find out hey have you done something nefarious, here. And again with with proper planning. It could easily be addressed, up front. It's just crucial, for a lot of business owners to understand that these laws, do apply. Even if you have an exemption. The laws still apply. You just need to make sure you either pay for that exemption. Or tailor your offering in a way that that qualifies, for an exemption.
Do You remember any cases that you ran across, where you were like oh man this is so the guy didn't. Or the person did not mean, to step on any land mines but when they do step on it, you know that where you were like i feel kind of bad. Yeah there's, you know a handful, of examples, that i that i see, or or cases i hear about. One is engaging, in general solicitation. Without. A proper, exemption. And folks will say well. You know i only sold, to like 10 people, well if you offered, to people you didn't know. That's general or didn't have a substantive, pre-existing, relationship, with, you in fact engaged in general solicitation. And there's folks sometimes, go well i didn't offer, a security. I just said i was raising money. Well. Anything, that primes the markets, for, securities, transaction, can be considered. An offer of a security. And, i've been at you know start-up events, where i hear entrepreneurs. Say you know hey i'm, i'm raising. You know. Stop, i'm selling stock at this price and at this valuation. And they don't know it but they've just generally solicited, an entire room full, full of people. Yeah what's the random occasion. What's the random image if they do it, correct, and sometimes those folks will have exemptions, in place and they say hey no i'm allowed to do this i'm relying on 506, c i'm only going to take money from people that prove they're accredited. And sometimes, i see it, in the context, of. Hey all i did was. You know i i engaged in general solicitation. That's fine. I was going to rely on rule 506. But they didn't take proper steps to verify, that investors, were accredited. He has come out and said. Even if people, ultimately, wind up to be accredited, right assume, a person raises money, they generally, solicit. Um, you know send out a blast, email. Um, you know something to that effect. But they only take money from from you know 10 people. Those people. Wind up being accredited. The sc, the sec, has come out and said, even if those folks, are in fact. Ultimately, determined, to be accredited. If you didn't take the proper steps to to verify, that those folks were in fact accredited, at the time. Their money. That's, that's a non-compliant. 506. Offering. And because you engaged in general solicitation. Now you don't have an exemption. And those folks are in a very tough spot where. You know. Not asking for one or two more pieces of documentation. Could have exempted their offering. Now they're in a, non-client. Space. Now if you're non-compliant. Do you end up is it disgorgement. Is it penalties. Is it jail time what is it if if you're non-compliant. So, so non-compliance. Could the the penalties, for non-compliance. Can. Range. Broadly, depending, upon, the the regulator, you're dealing with. Um, whether you're dealing with an investor, that's suing you. Um the sec. Uh the penalties, can be brought. Um, and there's, you know. A lot of folks think well i didn't take their money and you know, keep it or you know this wasn't a ponzi scheme the business just went down or hey the business actually made money and everybody's, really happy. A baseline. Remedy will be a securities, regulator, saying hey you need to register, this transaction. Folks, that's just. That's not going to be possible. So in those moments regulators. Sometimes, will say okay well then you need to offer everybody their money back in what's called the recision, offer. And for a lot of folks, that are startup. Business owners or they you know, are trying to you know, buy, a real estate asset and they're in the they're in the early years of either rehabbing, the project, or it's not stabilized, it's not rented out. Um coming back to an investor, and saying. Hey do you want all your money back. Can be a very enticing, person that says well, what's the company worth what's the project.
You're Sitting there saying well. We're in that sort of down period where we raise the money all the cash is out, um. It's you know technically if you got all your money back right now as of today it'd be a better return. You know. It could really kill a business to have to go through that whether through. They have a regulator, involved i mean somebody probably blew the whistle on it right like somebody. Probably bad stuff's going on and you're in a precarious. Position, and all of a sudden they come in and say, you got to give everybody back their money they're like we don't have their money. Correct and, and that can be so reg so regulators, can get tip, can can learn of a busted offering in a handful of ways. One can be someone's, told, right sometimes, it's an investor that's frustrated. Um sometimes, it's you know, a securities, broker, or or to be often sometimes a competitor. Says hey i i, learned that this person was raising money you should go check it out because i don't think they're doing it in a compliant, way. Another can be. Folks just you know. Again not knowing what they're doing as a securities, transaction. Can sometimes, send out flyers, i've seen advertisements. In newspapers. That are securities, offerings, and. You know sometimes, there again there can be exemptions, for some of that activity. But, quite often, um when i was a regulator, and we would reach out to people and say hey we saw that you're doing this activity. Um can you please confirm what exemption you're relying on and oftentimes, people are like, you would say you know i, had a lawyer. I didn't know what i was doing was a securities, transaction. What do you recommend, that i do. So. If you're asking for securities, advice from a securities, regulator, you've probably done something wrong. The, securities, regulator, it's not their job to help you. Comply, or plan your offering it's their job to protect. Uh their citizens, right and. If. You're raising money in a non-compliant. Way. You've violated, a law that they're sworn to to enforce. And, and if you get to that point with the regulator, it's not because, they're nefarious. It's not because. Um they're out to get anybody, it's because they have a set of laws they have to enforce, and if you violated, it and they know about it they have to take action against you, can they throw you in jail for doing stuff like that. Depending, on the nature of the of the of the violation, there are certain securities, crimes that are punishable, by. Imprisonment. Uh you look at mr mr madoff. Who's you know currently, a resident of the federal correctional, system. Um, you know that's certainly very egregious, activity. Um, lesser activity, that can get folks in, in. In in trouble, uh criminally, as well. And, sometimes. What can, make taken action from civil to criminal. Is. Either repeated. Offenses. Uh. An intent to defraud, investors. Um. Or or, actions, that can only be, interpreted, as an intent to. Defraud, investors. So assuming, assuming, that all of our people listening. They just want to do things right in fact a lot of them are just scared to death of even going out and raising money because they know these rules exist but they don't know. What they are, how do you do it right let's say that i want to i hey i have a great apartment, building that i got my eye on. And i know that. We could run it and make a good a good chunk of money leverage it up fix it up, and possibly, sell it in two or three years and really make a killing. And i'm and i'm, thinking boy i would really love to go see if there's somebody that wants to do this with me what would be my steps. So i think step one is looking at the process, of raising money like a road trip. You need where you want to end up and you need to know where you're starting. And, i often tell folks do you plug in the mapquest. Directions. Before you get in the car or do you do it when you're already on the freeway hoping you're going in the right direction. What i recommend to folks is. Using the mapquest, example is plug in the destination. Before you before you get in the car. No. One, know where you want to be. And. Really just look at the road map of how you're going to have to get there, and i, strongly, encourage. Investors, or anybody trying to raise money, don't do that on your own, right, don't try and take out the map and think you know the best route.
Contact, A securities, attorney. Contact, someone that um, can help you through that entire process. And i think the, the key is, making sure you know betting the person a bit making sure you truly believe that they have the skills set to assist you. Unfortunately, i run into folks that have gone out and they've engaged. Either legal counsel or someone that purported to be an expert. And the advice they've gotten is either incorrect. Um. Not complete. Or just you know completely, wrong. And you know you have an entrepreneur, that's sort of. Gone the route of, trying to get advice and they just didn't get it correctly. Starting, point is, knowing where you want to wind up. And identifying, someone to help you get there. And, so assume that i i'm going to raise. Two million dollars to do this apartment. And, i sit down with you and i say you know what, these are people that i actually, know exactly, who i'm going to talk to it's a bunch of investors, that i work with. What's typically, i'm going to do a 506. C. Or something along those lines. So, any number of facts can sort of diff can can differ the the, advice, that an attorney would give in in a situation, like that but i think the crucial analysis, is for, is for the um. That the person trying to raise the money. To look at vote with their counsel both a federal exemption, and a state exemption. People to understand. Okay do i know these people, have i done business with them before. Are they sophisticated. What's their net worth. And i think, the answer, helps to answer the federal, and state securities, law questions. From a state standpoint, it's crucial to understand, where are these folks where do they actually, live, because. I've dealt with entrepreneurs, before that'll say well hey this person is in is in washington, state. And we'll look at the you know securities, laws in washington. Because it's crucial to understand that all offers. And sales must be exempt. So, you can even approach that person about investing, you need to have a securities. Exemption, identified. To even approach them about the offering. And i've had instances, where. You know a person comes back and says well i moved i'm not in washington anymore i'm now in illinois. And now you're in a moment where you go uh-oh. What's the law of illinois. Right so. Depending, on, the nature, of. The the prospective, investors. If you know that in advance, identifying. The federal and state laws that you can rely on. If an investor if a person raising money says hey i don't know who the investors, are going to be. Then we're looking at exemptions, where we can what's called preempt, state law. And that's, that's a moment where rule 506. Which is a federal exemption, that preempts the application. Of registration, requirements, not the fraud requirements, or notice filing requirements. 506, can say hey as long as you comply with this federal, rule. You can file notice with these state securities, regulators. And that location. You're still subject to prosecution, for things like fraud.
But You can now focus on one set of laws. From a from a, upfront compliance, standpoint. That sounds pretty tasty, for somebody who's going to raise money and you might have. 20 people all across the country that sounds like. This is secret, yeah regulation, d rule 506, is a very popular, exemption with with with entrepreneurs, and again one of the big things there is hey i don't know who all my investors are going to be, and then you get into analysis. Into an analysis, of well do i do a 506, b offering. Or do i do a 506. C offering. And how do they differ, and what are the pluses and minuses, associated, with each one. Encourage, entrepreneurs. If they are in a position where, they truly do not know who their investors, are going to be, they're going to have to have. A, lot of conversations. They're going to have conversations, with people that they don't know, they're going to ask their friends and family for repeat for referrals, of people that, you know, you're starting to get one or two concentric, circles, outside of your direct contact, base. Really encourage, folks to look at rule 506. C. Because again. It is an exemption. From, registration. That allows, you to engage in general solicitation. Without having to be look over your shoulder. And then you're actually. Registering. Your offering, as a reg d offering you're letting the sec, and the states, know. Hey i'm out here raising, money. So so regulation, d the the. It's not registration. It is it's it's a notice filing that you've engaged in an exempt transaction. And. The weeds and what an entrepreneur needs to know, but yes you you file something, you file what's called a form d with the u.s, securities, and exchange commission. And then you will provide, that same filing, to the states in which you sell securities, in. So a person that you know, is getting ready to conduct. A securities, offering. Uh says you know what here's the nature of my investors here's the nature people i'm targeting, they, ultimately, determined, their council to rely on rule 506.. That person would then look at the, 506, notice filing requirements. And that's in in the the states they want to sell into. And then they would with their council, file a form d with the sec. And then file, a form d in the states where they have investors. Other people that just skipped that that say hey i'm going to deal with the credit investors. I know that i'm going to be, that i'm that i'm meeting all the requirements. And if if a regulator, ever comes in i'll just file it then. Are the people that do that, there there are absolutely, people that do that that's never something that i recommend, because unfortunately.
Uh There are some states that say. Um. Or in the sec, a willful, fail, failure to file, a form d, can, initiate, your ability to claim that exemption. Yep then all of a sudden you're in hot water again, so we'll do it right. You're back to it right from there you're sort of scrambling, to see do i have a securities, exemption. That i can fall back onto. And what i tell folks is. You always want to have a fallback, point where you can say if i somehow, didn't qualify, with this exemption. I have another, one, that i can probably, rely on, because. It's a very, is a very narrow focused, exemption, with a lot of requirements, to comply with it. There are some large, some, broader. Uh, more lacks, exemptions. Around, red d. However, the ability to rely on those really goes out the window with things like general solicitation. Taking money from people you don't know. Or raising over a certain, dollar amount, or raising money from more than a certain number of people. All right so. Let's assume, that we're going to do it right we've gone we, we actually file our notice. Our form d. Then we always hear about hey accredited, investors how do i verify. And do i have to verify, that they're accredited. And then what about the this whole thing called, an offering memorandum, what are all these things that what are the next steps that i have to worry about. Yeah so so there are folks that say okay well i know i want to comply with securities, laws. What do i do. So, if people engaging in rule 5 if they're going to rely on rule 506, as an example rule 506, has two avenues, there's the 506, b avenue which is no general solicitation. And there's the 506, c avenue which is general solicitation. 6b. Approach. Folks are not required, to have, definitive, proof, that a person is in fact accredited. They can rely on what's called. Self-certification. And that will. Be. In the form of an accredited, investor, questionnaire. Where the the issuer, or the entrepreneur, whoever's raising money, will send out a questionnaire, that says, check on this box. How you're accredited. You have a net worth over a million dollars, you have a household, income of uh over three hundred thousand dollars, annually. Tell me how your, tell me how you're accredited, and that person will just check a box. Sign it and say i promise that i'm accredited, this way. In contrast, rule 506, c offerings, because you're engaging, in general solicitation. And your offering is being you know. Sent out to sort of you know people you don't know.
There's A higher threshold, there, and in those situations, the sec, is going to make you have proof, that you now improved, these people were accredited. There's a handful of ways that the sec, has come out and presented. As methods that you can use to verify, a person is accredited. One is getting a letter from their accountant. Or. A cpa. An attorney. I'm saying this person is in fact accredited. Another, is to see, um. Start asking things like w2s. Tax returns. But they have to be current right a w-2, from adjustment. Is no longer at is not sufficient. Um. There and there's a handful of other approaches, the sec, has said if you rely on one of these methods to prove people are accredited. Uh we'll deem that to be you you. Proving, that they're accredited, there's some online, services, too though you can go and they plug it in and then. Correct there's, there's a variety, of these certification. Firms, that have popped up i i say you always want to vet those. I think you want to have, what i could what i call the quarterback, on the on the transaction, someone that's going to help, is going to focus, helping you comply. With all securities, laws making you making, sure you select, proper vendors to help with certification. Compliance. And then. Really focus on um. If the business. The interaction, with investors, explaining, their pro, their concept, their proposal, to folks. And letting, people that, specialize. In securities, compliance. Take over that approach. I kind of look at it as. If i'm going to go do surgery. Or i need surgery on my knee. I'm not going to go down to the home depot and buy, an exacto, knife and try and figure it out right. That's what they just gross. Yeah okay. Add some screws put them on in there get a drill. Correct you know maybe you poke around long enough, you hit, you find the acl, maybe you duct tape it but the. Security, space. You're because you are. Yeah i apologize, for the for the for the. For for folks though in the security space what they need to understand though is that, they are not taking a risk, their investors, taking a risk. Because. People are giving you money, it must be done in a compliant, way. And if you can go out and you can you know, comply, with the requirements, under 506b. 506c. Or some other exemption you're relying on. Now you can just focus on the core business. And then it gets to this thing and we see this all the time and it drives me absolutely crazy. They do the, the offering memorandum. And that's almost where everybody, starts, we're, we're, we're into this conversation. Now. And we're finally to the point where we actually have the offering memorandum. And, most people, that's where they start. When the offering memorandum, is where you're like oh i'm gonna go, entice, all these people it's gonna be so great and. You know and it's. Basically, you're putting the, you could lose all your money together. Uh or you could lose all your money. Statement, right at the beginning, of like hey this is for. I think you know sophisticated. Investors, is for credit investors, and all that good good stuff yeah, and the offering, memorandum, can be can be tough and there, are some folks that say hey i'm raising money from you know friends and family immediate, people that i know. What, what do i really have to tell them and and i think disclosure, of certain key risk factors in a moment where it's friends of, a very limited, offering. I've seen folks say do i really need a full-blown, 60-page, offering memorandum. When i'm taking a limited amount of money from people that i that i. Have more than a substance appreciation, relationship, with these are these, this is my tribe right i i know them. I know everything about. Them. That's a moment where working with securities, council. Folks may be able to say you know what i'm going to take a different approach. I'm going to disclose, risk factors a certain way i'm going to have, a. Reduced set of subscription, documents, but i'm still going to, pay for the transaction. Disclose, material, risks. When folks go out to people they they either don't know or they start to go out to a larger, group of investors. Um. An offering memoranda, becomes crucial.
Um. Both for purposes, of qualifying, for certain exemptions, some examples. Certain exemptions, require, investors, receive. A certain set of disclosures. Risk factors. Summary, of management. What they're up to. Really importantly, use of proceeds what's money going to be spent on. And, you know who's going to get what fees, or conflicts, of interest. Really explaining, an investment, to. To your investors. And. It is a lot of folks look at it it's just an expense i don't need. And i really look at it as just costing, doing business. Um if you want to build out. You know, you want to flip it up you want to buy an apartment complex, you're going to have to pull permits, you're going to have to have the city come inspect. Different phases of construction. And an offer memorandum. For folks that are looking to, invest in real estate. I look at to the entrepreneurs. This is just one more permit you have to pull. It's a defense, where. Maybe you don't do it, um. Maybe. Nothing, comes of it, but if it does, it's something you wish you you wish you would have done, nine out of ten times, it's a complete cover your back side it's disclosing, everything so somebody cannot come to you and say. You made me and you enticed, me and you misrepresented. It it's almost like the the fraud defense, just kind of throws them right like you know this was all disclosed to you right at the very beginning so you put all the horrible stuff that could happen in there right, correct yeah, and. Unfortunately. A lot of um disputes, that i see both in private practice and when i was a securities, regulator. Um were based around a sort of misunderstanding. Of the offering. Um. Either people not understanding. The nature of their investment. Um which is which is sort of a red flag from the beginning of is this person really as sophisticated. As i think they are. Is not understanding, use of proceeds. Appropriately. There are certain folks that will say well you know what i'm gonna go buy a four plex. And, i'm gonna fix it up and i'm gonna flip it it's gonna take me, six to nine months to do that. Um, and obviously, i'm gonna be compensated, for my time in the form of a development, fee a management, fee. Um. A salary, some kind of expense, like that. However an investor. Sometimes will come back and say hey you never told me you were going to take a management fee or development. You know, you just said that you were going to go buy the apartment building and flip it. Had i known you were going to take a development, fee or some type of, a, fee. I wouldn't have invested. It's, crucial, for folks to explain. Basically. As much as they can about the project, as much as they can about use of proceeds. Because, if you can sort of, cut off at the beginning. Um. Any argument that a person can have of i didn't know. X y or z. You're in a much better position, to, hopefully. You know, yes defend, any type of claim that may come. More importantly, hopefully cut off the desire of a person to bring a claim. And. That's, both for information. And for making sure that your investors, are right for the product. I. I have folks that will say well i complied with all the exemptions. Um i have a ppm. Or offer memorandum. I'm doing a 506. I filed it with the sec, i filed in, the state where these investors, are. Um, i'm free and clear. And. I think there's, you know, compliance, with the rule, but there's also really understanding, the practical, nature of taking money from people. A big rule of thumb that i have and that some states will actually impose. Finra has rules like this for their brokers. Is. Don't take more, than a certain percentage, of a person's. Liquid net worth. If a person, writes you a check and says, i'm all in. And i i like the investment i like the product. If you say. What do you mean all in, you know and sometimes. No i gave you all the money in my bank account, and if this doesn't pay off. Right. I'm i'm bankrupt. In my. Opinion. That is that is never, an investor that you want. As a rule of thumb that i have for folks and again this is my rule of thumb um, not my firms or any of my colleagues. Is. A 10, test. If you're going to take more, than 10, of a person's. Net worth. I think you really need to evaluate, is this the appropriate. Person, for me, or do i want to sort of, count them against being two in, because. It happens.
After Investments, are made. People. Jobs, recessions, hit, people need cash for unexpected. You know emergencies. Health issues come up, and. You're sitting there and you've taken, half their half their savings account. Um or, a large portion of their net worth. That person. Notwithstanding, the project performing, well, not withstanding, that person set to receive a large return on the back end. Is going to become difficult because they just need the cash now. And. The entity, is either, you know not able to make that distribution. Not able to give that investor, money back. You could have an issue where a person, is. Starting to either make claims. Uh call regulators, do something. Um just because they're desperate to get cash back. Yeah and, i i, just show you one one, interesting, scenario, was it was a private placement, back in 2000. It was year 2000, early 2001. And. It involved. Some banking it was some. Money transfer. Technology. And 911, happened. And it made it virtually, worth it uh worthless. At the time. But the technology, the intellectual, property ended up, still being somewhat valuable, and the company ended up, doing a merger with another company. Um. And literally. Uh, you fast forward, 19, years. And the investment. Gr you know bore fruit it actually a company went public and the, the initial investors, ended up with shares in that company ended up, with restricted, shares but they ended up doing quite well. Uh after the case. Because, they were able to weather that storm. During that same period of time, the original. Folks that, uh, that, had started, the uh the money raise. Were settling, out. Uh, disputes. I don't think they they went to lawsuits, but the people that were hurting for cash. A lost the opportunity, to participate. In that growth. And b were the ones that, squawked, the loudest. And so, i always just kind of keep that in the back my head is that it's not good for them it's not good for you it's not good for the the person who comes in, is you want to be dealing with adults that understand. This is a risk, and are able to weather that storm that this isn't the money that they need to. Live off of in two years. And they're not banking on you. Returning, their investment, plus this so that they can make their living or they can retire, or something. You need to make it to where this is actually an investment. And uh you know that's just my from my standpoint i'm not a securities, attorney, i don't pretend to be, i always look at this and say uh like i'd like to kick him over to you chris because. You're you're very uh, your non-promotion. About it some of these folks they go and they sell the uh. The ppm, and, and they're saying hey we can go out raise money and they skip the whole, you know registration. Part and they skip the whole, here's who you can solicit, and and. Here's the rules, they go right to the, let's do this enticing. Salesy. Business, plan, private, placement memorandum, that we can go pitch to people and you can be, you can raise a whole bunch of money and i just think that that's buying people a lot of trouble. Yeah i i call it the furniture, without the instructions. Right i i, recently, bought a an, end table, from a retail, outlet here and you know i, dropped all the pieces out and i said oh my gosh i don't have the instructions, what am i gonna do i gotta. Was it swedish. It may be i don't know i don't know i don't wanna, i don't wanna get violate any copyrighted trademark. But i i i look at your lawyer. I got a 160. Pile of wood here. And uh, lucky for me i just missed the instructions. Inside of the box but. Um. Yeah the the the product without the instructions, can be difficult, i think entrepreneurs, need to really make sure, that they they understand, both. You know. Not only the rules but the spirit behind them again, having been a securities, regulator, i can assure you that folks are not out to, make. Entrepreneurs, difficult, they are not out to. Have a gotcha, moment with folks. They are really at they are really out to help preserve the integrity. Of this uh, securities, marketplace. Entrepreneurs. Can continue to raise money. If you look at the integrity. Of our of our financial, system here in the united states. We have one of the more transparent, securities, markets. People. Are comfortable putting their their money to work in the united states. And that's because, we have securities, regulators. That ensure folks are not doing nefarious. Things. And we have to have rules to help them do that. And absolutely, words that can sort of come to understand. Regulators, or people to to. Work with, be prepared, for. And understand where they're coming from, are going to be in a much better position, that folks that sort of take the ostrich, in the sand approach.
I'm Just not going to worry about it because you know everybody else i know doesn't get caught. When it's sunny you don't need a roof you know so it corrects, you know so you. But you you you don't want to build your house without a roof because ultimately, it's going to rain and you know you just want to be prepared for that, this is how you prepare it you know this is your roof and it sucks that you have to, go through the expense, i know we'd all love to be able to. Ignore that aspect, of it and say we don't have to worry about uh, you know, it's we're not going to be in that scenario, we're not going to lose money or we're not going to have rough times, or, there's there's never going to be a situation, where somebody's, cash poor and needs their money back and we're not able to provide it. But it happens, all. The, time, i'm sure you've seen it. Correct, it happens all the time and you never want to be in a position, where something you could have. An ounce of preventative. Preventative, maintenance, now. And businesses, fail all the time ventures fail all the time. Um, you know real estate markets. Securities, markets go up and down. But if you can be in the position where you say hey i fully complied, with both federal and state securities, laws. I did exactly, what i said i was going to do with your money. I told you about the risks inherent in investment, like this, i didn't take too much of your money so you shouldn't be upset. If you can do all those things, all of which are 100. In the control of the entrepreneur. If the unexpected. Happens with respect to the marketplace. The project the investment. That happens. But if you can have, controlled, everything you can you're going to be in a much better, deal that with that. Potential, downside. Well i really appreciate, it we went way over but i love talking with you so it's like, i don't care. Uh. Here's the uh here's the thing could you give him a phone number, where if somebody, wanted to reach out to you somebody's a little bit worried or somebody is in a situation, where they're trying to raise money that they could actually get a hold of you.
Uh Yeah so so my so my number is uh. 702-669-4621. I'm an attorney at the law firm of, holland and heart. Um and and. I'll put your information, up as well but i just, some of these folks listen to it on a podcast, where they don't see and they're not they're not looking at uh, they're not looking at it on the internet they're just listening but i would like, this is one of the most important phone calls you can make and i'm sitting here as a tax guy. As a i am a licensed attorney but i don't pretend to be a securities, attorney by any extent. And i'm just saying. The second somebody, says. I'm raising money or i'm getting money from from other people. Is when i usually say hey you really need a securities, lawyer to look at it make sure you don't step on a land mine and i always send them to chris. Absolutely, and whether it's me or someone else as long as it's someone, that knows what they're doing and can be able to. That's, absolutely, a tremendously, important call to make, and, and vice versa that the once you get past, the securities, piece unfortunately, there's all kinds of others. Tax. The whole nine yards and again when you're dealing with other people's money it's important to make sure you're shepherding, it well, well i really appreciate, it chris thanks for joining us uh, this round. And. Thank. You. You.