Startups and Securities Laws

Cite this article as:"Startups and Securities Laws," in The Business Professor, updated December 4, 2014, last accessed August 3, 2020,


Startups and Security Laws

Small businesses need capital to startup, operate, and grow. Seeking capital from outside investors is instrumental when the entrepreneur lacks the ability or desire to fund the venture from personal assets. Obtaining a loan from an outside institution is one manner of seeking funds; however, the ability to borrow substantial amounts of money is often limited for startups. Entrepreneurs must turn to alternative methods of financing, such as selling an ownership interest (equity) in their business venture.

If a business entity (Issuer) offers or sells securities it must comply with and meet the procedural requirements of the ’33 Act.   Specifically, Section 5 of the ’33 Act prohibits persons from using any method of interstate commerce to buy, sell, deliver, or offer to buy, sell, or delivery any security, except in accordance with the provisions stated therein. Violating Section 5 carries potential civil and criminal penalties. Most notably among the securities laws is the requirement to “register” with the SEC any sale of securities. Registering a securities issuance is a detailed and burdensome information-filing process.

Congress recognizes the importance of balancing investor protection with the need to foster economic activity by promoting the growth and development of startup ventures. Few people deny the significant impact that startup ventures have on the economy.  In light of the above-stated objectives, Congress and the SEC promulgated several exemptions, both statutory and rule-based, to the extremely burdensome registration requirements.

The exemptions allow non-public companies (companies not registered with the SEC as publicly traded) to raise capital through a non-public sale or private placement of equity. The exemptions, however, can be difficult for entrepreneurs to navigate. Entrepreneurs must understand the requirements to register a security, the applicable registration exemptions, the types of investors the entrepreneur can solicit, the amount of funds available under any exemption.  These considerations play an important role in the entrepreneur’s decision on how, if at all, to pursue startup financing.

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