Does Securities Compliance Matter?

We know it sounds boring and useless.  To most people, the notion of having to make securities filings in order to report private financings seems like an unnecessary task one can ignore and clean up later, right?

Wrong.  Don’t ignore it.

While it’s true many companies choose to disregard securities filings when fundraising, the other truth is any business hoping to raise capital from a more sophisticated investor will learn that, for several reasons, failure to comply is problematic.  Future investors want to know they are putting money into a clean company with no potential litigation, administrative actions, or hidden fines and penalties.  No investor wants to buy into a problem and the easy solution for avoiding said problem is to not invest.  So why jeopardize the future of your company by skipping the simple step of complying with the law?

Simple?  Yep—that’s correct.  The beauty of securities regulation in the U.S. is that, for the most part, if you comply with federal regulations, state compliance is a snap.  In many states, you may even be exempt from making a filing for the sole reason that you’ve already completed your federal filing.  And how hard is it to make the federal filing?  Well, we here at Main Street Exchange (MSE) have automated the process for you, so your finalized forms are finished in about four seconds flat.  You can then log into the federal filing site (the U.S. Securities and Exchange Commission’s [SEC’s] Electronic Data Gathering, Analysis, and Retrieval [EDGAR] portal) directly from our system, fill in the information from what was generated (or download the form from us and upload it straight to the SEC), and your filing is done.  No fees and no hassles, with perfect records being the result.  We will also tell you whether exemptions are available so you don’t have to make state-by-state filings.  Further we’ll pre-populate all of your required state filings, all the while providing clear and easy-to-follow instructions so you can easily make said filings.

And what happens if you don’t do your federal filing?  Many states have a safe-harbor provision that relies on the federal filing, and no further filings are required.   In the absence of a safe-harbor exemption, each state (plus Washington, DC and the various U.S. territories) has its own laws that govern how securities can be sold to investors who reside within its boundaries.  Those regulations cover everything from who you can talk to, what information you have to present to them, when you can do all of this, and what individual filings you need.  In each state where there’s an investor (or, in some cases, any state in which you even spoke to a resident who may or may not have invested), you would be required to prove you’ve satisfied all of the requirements under that state’s securities laws.  In many instances, the safe-harbor exemption made available simply by completing a federal filing is enough to satisfy a state’s requirements (a self-executing exemption).  In other states, you merely need to provide a copy of the federal filing to establish and confirm a safe-harbor exemption.  We have seen companies that, upon deciding not to make federal filings, didn’t even realize state filings were required.  In each case, these companies became subject to years-long investigations, hearings, and, ultimately, penalties.  We even know a founder who had to close his company and move out of state to avoid huge fines and potential criminal liability—all because of failure to make required filings and associated, subsequent investigations.

Any investment that doesn’t comply with federal and state regulations is subject to potential rescission by unhappy investors.  If an investor is, for any reason, displeased and determines you didn’t comply with mandatory filing requirements, he or she can request a rescission (or undoing) of his or her investment—you could be required to pay back the entire investment.  You could potentially then have to pay back every investment to every investor in the same round, as well as for every subsequent round.

Even if your investors opt not to seek rescission, you don’t have the government after you, and you succeed in getting additional investments in the future, your ultimate exit could be significantly complicated and compromised due to prior compliance failures.  Due to an inability to prove prior compliance, we’ve seen companies lose millions of dollars in valuation during potential mergers and acquisitions [M&A].  We’ve witnessed companies spend tens (and sometimes hundreds) of thousands of dollars to pay legal counsel for the purpose of fixing prior mistakes in order to make a future deal happen.  We once saw a $60 million acquisition fail because of the company’s lack of early securities compliance.  It’s real and it can hurt.

Although it sounds boring and seems to be more of an annoyance than anything else, making sure your fundraising is compliant is critical to your company’s success.