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Sweet marketing music

Tanner Montague came to town from Seattle having never owned his own music venue before. He’s a musician himself, so he has a pretty good sense of good music, but he also wandered into a crowded music scene filled with concert venues large and small.But the owner of Green Room thinks he found a void in the market. It’s lacking, he says, in places serving between 200 and 500 people, a sweet spot he thinks could be a draw for both some national acts not quite big enough yet for arena gigs and local acts looking for a launching pad.“I felt that size would do well in the city to offer more options,” he says. “My goal was to A, bring another option for national acts but then, B, have a great spot for local bands to start.”Right or wrong, something seems to be working, he says. He’s got a full calendar of concerts booked out several months. How did he, as a newcomer to the market in an industry filled with competition, get the attention of the local concertgoer?

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by Todd Taylor
April 2005

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Careful: Laws apply when raising money from friends, family

Unfortunately, you are not independently wealthy, so you need some help. You ask your family to invest. They do.

You tell all your friends about this great idea and they invest. You talk about it at your kid’s hockey practice, church and the PTA and get other people to invest. All this new money helps you start your business.

Unless you were very careful, or more likely lucky, you might have joined the ranks of Kenneth Lay and Martha Stewart and gotten accused of violating securities laws. Most business owners understand that raising money from venture capitalists or in an initial public offering (an IPO) requires some level of legal involvement.

What most do not understand is that raising money from friends and family, or so-called founders stock, is governed by many of the same laws. Considering that 10 times as much money is raised from friends and family than from venture capitalists, this is a sobering thought.

Unfortunately, there is no distinction between your neighbor or brother-in-law and larger institutional investors when it comes to complying with the securities laws. There is also no such thing as founders stock that makes it immune from the securities law or different from any other sale of securities, whether the sale is to the people that start the business or the friends that give some money to help get it going.

Any offer and sale of stock, LLC units, LLP interests and so on must either be registered with the Securities and Exchange Commission and the applicable state regulators or exempt from such registration. Even borrowing money from your friends and family might count as a sale of a security.

Complicated rules
The first and most important rule for a business owner to remember when raising money is securities laws are designed to protect investors, not help business owners.

Remember this whenever you are thinking of asking people for money to help your business. The securities laws are complicated and it is easy to misunderstand what is required. The two-tier system of federal and state regulation and the fact that every state has its own rules, many of which are unique to that state, makes this even worse.

Selling securities in violation of these laws can result in penalties that range from being required to refund investors money, with interest, to payment of fines, and even potential criminal penalties for serious offenses.

You will need to make sure that you provide enough information to your potential investors so that they can make an informed investment decision about your company. People need to understand the nature of your business, what their money will be used for, the risks involved in the business and most importantly, that they will lose their money if the business fails.

Failing to tell your potential investors, even your brother-in-law, about all the important aspects and risks related to your business is fraud. The best way to avoid this risk is to prepare some kind of disclosure document, or private placement memorandum.

You also must be careful when deciding who you will let invest in your business. Rich Uncle Sebastian is a better investor than your 82-year-old mother-in-law on Social Security. People with wealth or high incomes can more often afford to lose money in a risky venture than those with little wealth or meager incomes.

Remember, the law protects the investors, especially those who cannot protect themselves. Also, you should favor investors that have good business judgment and avoid those with little or no business experience.

State exemptions
In Minnesota, there are a number of exemptions from registration that a start-up or small-business owner can use to raise money. As a general rule, Minnesota allows sales of securities to up to 10 investors who are not “accredited” in a 12-month time frame. Sales to more than 10 non-accredited investors require a filing and the limit is 35 non-accredited investors.

An accredited investor, generally speaking, is a person with an income of at least $200,000 or net worth of at least $1 million. Minnesota allows unlimited sales to accredited investors. The federal rules permit companies to raise up to $1 million in a 12-month time frame and make sales to an unlimited number of investors.

Combined, in Minnesota a company can sell up to $1 million of securities to no more than 35 non-accredited investors. The rules are actually more complicated than described above, and there are also a variety of other exemptions and requirements that may work better for a specific situation. Remember, there are no exemptions from the anti-fraud rules.

If your business does fail, your one-time friends and even family may start asking for their money back. If you did not follow the proper procedures, you could be held personally liable to refund their money.

If you failed to give them enough information about the business before they invested, you could be facing a securities law fraud claim. Since approximately 95 percent of all businesses fail within five years, this risk is real and needs to be addressed.

Hire an attorney and prepare written disclosures to give to your investors. Prepare written agreements for your investors to sign and treat the process as if your friends and family were strangers. This should help avoid disputes in the future.

Greatest danger
A final note goes beyond legalities: For all the legal requirements described above, the greatest danger I counsel my clients on when they wish to raise money from their friends and family involves their relationships with these people.

Their friends and family are likely not wealthy and are risking what is likely a significant amount of money on a business venture about which they know little.

If the business fails, they lose their money. This makes for an uncomfortable Thanksgiving dinner across the table from your Aunt Mildred who just lost $10,000 because of you.