Securities law is a complex minefield that terrifies even the most seasoned lawyers. As a small business owner, you must comply with all the federal and state securities laws that may apply to your business. Most people think that only corporate stock qualifies as securities, but did you know that LLC ownership interests might be considered securities, too? You must know whether your LLC interests might be securities, resulting in onerous federal and state securities law implications.
Simply put, a security arises from a transaction in which someone invests money in a company expecting to receive profits from someone else's efforts. In other words, if someone buys shares of a company primarily as an investment vehicle, and that investor will not participate in the business's day-to-day operations, the shares would likely qualify as a security. All securities must be registered with the U.S. Securities and Exchange Commission (SEC) and appropriate state agencies unless they fall into an exemption. But even if they are exempt, you may still have to file documentation showing that you're exempt.
For instance, in California, shares of an LLC in which any member is not continuously and actively involved in the management would qualify as securities. This usually happens if the LLC is manager-managed and at least one member does not participate in the business's day-to-day operations. Therefore, if you have an LLC where certain members have bought in as investors, but any of them will not manage the company daily, your LLC ownership shares may qualify as securities. Likewise, even if all members intended to participate, but at least one does not participate continuously, your shares may be considered securities.
Alternatively, if all of the LLC owners also manage the day-to-day operations, your membership interests would not likely be considered securities, depriving you of the obligation for additional filings.
If your LLC interests qualify as securities, you are required to register your securities with the SEC and the appropriate state agency. However, most small businesses are exempt from having to register.
In California, for example, you may sell your securities without registration if the following criteria are met:
The purchaser's competence to buy the shares is satisfied by a showing of any of the following:
If you are exempt, you must file a notice of exemption, although you avoid the more burdensome registration filing. The required notice form in California is called a Notice of Transaction (commonly referred to as a 25102(f) Notice) and must be filed with the California Department of Business Oversight. This notice informs the state of California that you are exempt for the allowed reasons listed above. You must file this notice within 15 days of issuing your securities, and the filing fee fluctuates based on the value of the interests to be sold.
Most small businesses will not be required to file an exemption notice with the SEC.
But, let's now briefly compare Texas with the California rules.
In Texas, the Texas Securities Act and Board rules govern the selling of securities without registration. Here's how the laws in Texas parallel with the specified California laws:
In California, sales are permitted to 35 or fewer members. Similarly, Texas law, under Section 5.I(a) of the Texas Securities Act, allows sales by an issuer without public solicitation or advertisements as long as the total number of security holders does not exceed 351.
California law mentions purchaser competence as a criterion for exemption. In Texas, purchasers must be either "sophisticated" and "well-informed," or "well-informed" with a relationship to the issuer, as defined in Rule 109.13(a)1.
The California law specifies that each purchaser should buy the securities for their account and not for sale in connection with any distribution. The Texas law doesn't provide a direct equivalent but does mandate that the sales are made without public solicitation or advertisements12.
California and Texas laws require no public advertisement for the sale of securities12.
In California, a Notice of Transaction (25102(f) Notice) is required, whereas in Texas, specific forms like Form 133.29 or Form D are required depending on the nature of the exemption. Form 133.29 is needed if sales are made to natural persons other than through a registered dealer in Texas, and Form D should be filed no later than 15 calendar days after the first sale of securities in Texas13.
In California, the filing fee fluctuates based on the value of the interests to be sold, whereas in Texas, a filing fee of 1/10 of 1% of the aggregate amount of the securities offered for sale, up to a maximum fee of $500, must be paid if sales are made to natural persons other than through a registered dealer in Texas1.
Texas also has exemptions under Rule 109.13(l) for intrastate offerings and under Rule 109.13(k) for interstate offerings as per SEC Rule 506 of Regulation D, allowing for different kinds of sales and exemptions not explicitly mentioned in the California law example1.
In Texas, the exemption under Rule 109.13(l) is unavailable if the issuer or its registered dealer was the subject of specific regulatory or legal action1.
If your LLC interests count as securities and don't qualify for an exemption, you will have to register your securities with the SEC and the appropriate state agency. Security registration is an involved process subject to a complex web of securities laws. You will need the assistance of a skilled securities lawyer to make sure you're in full compliance.
Even if your business entity is an LLC, your membership interests may be considered securities, potentially requiring state and federal filings. As always, check your local, state, and federal laws to ensure you comply. Book a call if you need assistance determining what steps you need to take.
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