“Friends and Family” NOT a legal category

“Friends and Family” NOT a legal category

Don KonipolBusiness Member
Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes

This is from a blog post PPM Law

A friends and family round is still a sale of securities, which means securities law applies to it exactly the way it applies to a raise from strangers. The relationship does not create an exemption. To raise from people you know legally, you sell under a real exemption (most often Regulation D Rule 506(b)), give every investor honest written disclosure, file a Form D and any required state notices, and keep general solicitation out of it. Done right, the same documents that keep you compliant also protect the relationships you care about most.

This is one of the few moments in a capital raise where the legal stakes and the personal stakes point in the same direction. For the founder, syndicator, or fund manager, getting the structure right is what prevents a soured deal from becoming a lawsuit. For the friend or family member writing the check, the documents are what turn a favor into an informed decision. Both sides are served by the same thing: doing the early raise the way you would do a professional one.

Is a friends and family round a legal category? No.

“Friends and family round” is a phrase from the startup and syndication world, not a section of the securities laws. There is no rule that says money from people you know is exempt, lightly regulated, or off the regulators’ radar. When you give someone equity, a promissory note, or an interest in your fund in exchange for their money, you are selling a security, and that triggers the same federal and state rules that govern any private offering.

Read full article: https://ppmlawyers.com/friends-and-family-rounds/

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Chris SeveneyBusiness Member
Moderator
Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
2mo
Agree 100% as people think they can just raise money from friends and families and it’s cool Then people will say I will just do a 506(b), but An area where I think people make a big mistake on 506b is the moment you bring in non accredited investors there are additional reporting requirements under rule 502(b) which could include audited financial statements which can be very costly as you not only need a third party auditor but you need an excellent accountant who does you books knowing the financials wil be audited. So that is a big question to ask your attorney when preparing the docs
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  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    2mo
    Agree 100% as people think they can just raise money from friends and families and it’s cool Then people will say I will just do a 506(b), but An area where I think people make a big mistake on 506b is the moment you bring in non accredited investors there are additional reporting requirements under rule 502(b) which could include audited financial statements which can be very costly as you not only need a third party auditor but you need an excellent accountant who does you books knowing the financials wil be audited. So that is a big question to ask your attorney when preparing the docs
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    • Don KonipolBusiness Member
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      Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
      2mo
      Quote from @Chris Seveney:
      Agree 100% as people think they can just raise money from friends and families and it’s cool Then people will say I will just do a 506(b), but An area where I think people make a big mistake on 506b is the moment you bring in non accredited investors there are additional reporting requirements under rule 502(b) which could include audited financial statements which can be very costly as you not only need a third party auditor but you need an excellent accountant who does you books knowing the financials wil be audited. So that is a big question to ask your attorney when preparing the docs
      I almost think that the smaller investor going family and friends route would be better served to utilize the general exemption for private placements rather than any part of Reg D.  The reason is that although Reg D is a “safe harbor”, used incorrectly by violating any of the many provisions leaves a “trail” that can be used by the SEC, DA’s office, or more likely disgruntled investors in a civil lawsuit. The general exemption requires no “paperwork”, and as long as the sponsor doesn’t do something dumb (like advertise the investment on BP, etc.) “non compliance” is hard to establish and hard to prove. 

      As I’ve spoken about in the past, the reason to go to the expense and trouble of doing a Reg D rather than relying on the general exemption for private placements are (1) complying with Reg D is a definitive defense against lawsuits initiated by investors (absence fraud) so investors will not be able to get any attorney to take their case on contingency and in fact won’t be able to get any attorney”honest” attorney to take their case at all, (2) compliance with Reg D eliminates post capital raise “review” of private placements legitimacy by the SEC and (3) all investors I know with any significant capital to invest would only consider fully compliant Reg D offerings and eliminate any offerings relying on the general exemption. 


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  • Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    2mo

    @Chris Seveney, I am 1000000% not a securities attorney or SEC attorney, or tax attorney or anything of the like.  But, I have worked for some 506(b) and 506(c) offerings, including those that seemingly had very conservative compliance attorneys on staff.  

    From my quick search, 502(b) only comes into play if the offering is $7.5mm or more.  Given most syndications I see these days, and particularly those under 506(b) do not cross that threshold.  

    But more directly, EVERY syndication I have seen or worked on is a completely new issuer.  From my quick google search, it appear 502(b) only requires audited financials for the last two years of the issuer, and most every PPM I have read clearly states: this is a newly formed entity with no operating history, yada yada yada.  

    So, while I respect you bringing that up, and I am happy to be proven wrong here, but I would assume this is more of an exception in our industry than an actual need.  Even though me saying that goes against our general alignment that too many people with no experience or know-how syndicate deals.

    • Chris SeveneyBusiness Member
      Moderator
      Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
      2mo

      @Evan Polaski - 

      I am not an attorney, either, but more of my point is that people need to understand all the ramifications. For example, I know people who do a 506B, who raise $10 million, and it's an evergreen fund. Do they need audited financials? I do not know because I don't do 506B offerings, so I am not an expert at it. When I looked at one in the past, this issue did come up as something to flag and do more research on. Since I never moved forward with it, I did not research it

      The moral of the story is that just because you have somebody write a PPM is very different than also maintaining ongoing compliance. 

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