Securities law is a complex minefield that terrifies even the most seasoned lawyers. As a small business owner, it is your responsibility to make sure you’re complying with all the securities laws, both federal and state, 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 qualify, too? Here’s what you need to know about whether your LLC interests might count as securities, and what steps might be required so you can avoid some serious consequences.
To put it simply, a security is a transaction in which someone invests money in a company with the expectation of receiving profits from the efforts of someone else. In other words, if someone is buying shares of a company primarily as an investment vehicle, and that investor is not going to be participating in the day-to-day operations of the business, the shares would likely qualify as a security. All securities must be registered with the government, unless they fall into an exemption. But even if exempt, you may still have to file documentation showing that you’re exempt.
In California, shares of an LLC in which any member is not continuously actively involved in the management of the LLC would qualify as securities. The most common scenario where this would happen is if the LLC is manager-managed and at least one member does not participate in the day to day operations of the business. In other words, if you have an LLC where there are certain members who buy in as investors, but any of those investors will not manage the company on a day to day basis, your LLC ownership shares would qualify as securities. Likewise, even if all members intended to participate but at least one does not participate on a continuous basis, your shares may be considered securities.
If all of the LLC owners are also managing the day to day operations, your membership interests would not be considered securities. Therefore, you will not have to file any securities registration or notice of exemption.
If your LLC interests qualify as securities, you are required to register your securities with the government. However, most small businesses are exempt from having to register.
In California, you may sell your securities without registration if the following criteria are met: 1) you are selling to 35 or fewer members; 2) each purchaser is competent to purchase the securities for reasons discussed below; 3) each purchaser is buying the securities for their own account and “not with a view to or for sale in connection with any distribution of the security”; and 4) there was no public advertisement for the sale. The purchaser’s competence to buy the shares is satisfied by a showing of any of the following: the purchaser has a preexisting personal relationship with the seller (like a family member or friend); they have the capacity to protect their own interests due to their own business or financial experience; or their interests will be protected because they have retained qualified professional advisors to assist. If your securities satisfy this test, you do not need to register your securities, but you do need to file a notice of exemption.
In California, the required notice form is called a Notice of Transaction, and must be filed with the California Department of Business Oversight. This notice is commonly referred to as a 25102(f) Notice. 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 federal government. However, it’s always best to check with your business lawyer about whether any notice or registration is required for your individual business, and in your particular state.
If your LLC interests count as securities, and those securities don’t qualify for an exemption, you will have to register your securities with the government. This is something a skilled securities lawyer should assist you with in order to make sure you’re in full compliance with the complex web of securities laws.
Even if you’re an LLC, your membership interests may be considered securities, and you therefore may have to file a notice of exemption. In California, if you have a manager-managed LLC with certain members who do not participate in the day-to-day management of the company, you must file a 25102(f) notice with the Department of Business Oversight to notify them that you are selling securities but that your securities are exempt from registration. As always, make sure to check your local and state laws to ensure you’re always in compliance. And when it comes to complex issues like securities, it’s always best to double check with a lawyer to make sure you’re not setting yourself up for expensive trouble down the road.