I’ve found that while entrepreneurs have an excellent sense of the law when it comes to term sheets and venture deals, they have a much more limited understanding of securities laws. What’s worse, many lawyers I’ve talked to aren’t aware of the details of Colorado’s securities laws, either. Most competent attorneys know about the basics of federal securities compliance, but I’ve had to bite my tongue on a few occasions when attorneys have given shoddy advice because they failed to take into consideration Colorado law.
What’s a Blue Sky Law?
Blue sky laws are just another name for state securities laws. Most of them were initially passed before the Federal Securities Acts of 1933 and 1934, which now serve as the basis for most securities laws today. But there are still discrepancies between federal and state laws that apply today and in Colorado in particular.
The Basics of Federal Securities Law
Without going into too much depth, here is the gist of the situation: If you want to sell securities (stock or an equity interest) in a company, you must either 1) make a formal registration with the Securities and Exchange Commission or 2) qualify for an exemption. There are a number of exemptions, but generally, to qualify, you must limit both the number of people buying the securities, the type of people buying it (based upon the finances, knowledge, and company relationship of the buyers), and the amount you sell.
What About Colorado Law?
Even where federal law provides an exemption to a formal registration (and all the time, expense, and requirements a formal registration entails), that doesn’t end your obligations under Colorado law. Similar to federal law, Colorado law requires that either you formally register the offering with Colorado unless you qualify for an exemption.
Now, just because a federal exemption applies to your offering does not mean, in all cases, that there is a corresponding Colorado exemption that will fit your offering. And if there isn’t, you’re looking at very extensive, and expensive, registration requirements. You’re also looking at delays in registration prior to being able to take investment money. It is important to explore the ramifications and requirements of the securities laws in the states you are raising money early in the process and prior to needing the money to operate your business.
Even if there is a corresponding Colorado exemption for your offering, an exemption doesn’t mean you have no obligations. Exemptions under Colorado Revised Statute 11-51-308 still require you to file a “Form D” (used in the federal filing) with the state of Colorado.
“Friends and Family” is Not a Legally-Recognized Phrase
I’ve heard entrepreneurs tell me that they’ve sold stock, sometimes in large numbers, claiming there was no need to register anything since it was a “friends and family” offering. Unfortunately, the words “friends and family” don’t have actual weight in securities law. There is no “friends and family” exemption in federal or Colorado law. In fact, because “friends and family” often do not qualify as “accredited investors” (a legal term identifying investors of certain experience, company relationship, or specific financial means), these “friends and family” rounds often require more restrictions under securities law than an offering to experienced and established investors.
If you’ve made a mistake, it’s imperative to follow the law and correct those mistakes as soon as possible. Unaddressed violations of securities laws not only risk fines and audits, but impose risks on your company that can restrict your growth, including your access to subsequent offerings, down the road.