A: There are strict legal requirements for raising money, even for small companies. If the individual contributing the money gains an interest in your company, their interest is called a “security” and is subject to regulation under The Securities Act of 1933 (the “Act”) which is administered by the Securities and Exchange Commission (the “SEC”). The Act requires the registration, with the SEC, of all securities offered for sale and requires significant disclosure of information about your company for the protection of prospective investors. Public solicitation of purchasers for unregistered securities is prohibited and failure to register or properly disclose information can result in federal or state government investigation, private law suits, or other penalties. In other words, you can’t simply post on your website or send out a mass e-mail to everyone you know asking for funds!
Luckily, some securities are exempt from the burdens of registration. The most helpful exemptions for small business are the ones covered under Section 4(2) Act and Section 3(b) – Regulation D, which depend on how much is being raised or to whom the securities are sold. But be aware, that although they may be exempt from registration, the sale of these securities must still be disclosed to the SEC on Form D.
Section 4(2) of the Act provides an exemption for “transactions by an issuer not involving any public offering” aka private offerings. In the series of cases, the Court outlined the main factors for whether an offering is private: the sophistication of the investors, the accessibility of relevant investment information, and the number of people offered the ability to invest. Other relevant factors include: the size of the offering, whether it appears to be public, and the manner of the offering. Because this is a somewhat vague standard, in order to facilitate the capital needs of small businesses, the SEC created Regulation D.
Two key items of Regulation D are the definitions of “accredited” and “sophisticated” investors. Some examples of “Accredited” investors are individuals with a net worth over $1,000,000 or an annual income over $200,000 in the last two years and businesses in which all the equity owners are accredited investors. “Sophisticated” investors are those that are knowledgeable and experienced enough in financial and business matters to appreciate the risk and make an intelligent investment decision. Under Regulation D, you may not use public solicitation or advertising to market the securities and the securities are “restricted”, meaning that they are not freely transferable.
The logic is that if you are wealthy or sophisticated enough, you can take care of yourself.
Regulation D is comprised of three sections:
Rule 504 which provides a limited offering exemption for offers and sales to anyone not exceeding $1 million during any 12-month period.
Rule 505 which allows you to offer and sell up to $5 million in any 12-month period to an unlimited number of accredited investors and up to 35 non-accredited purchasers; and
Rule 506 which is a “safe harbor” under 4(2) for offers and sales of any dollar amount to an unlimited number of accredited investors and a maximum of 35 unaccredited, but sophisticated investors.
Generally speaking, formal disclosures must also be made to unaccredited investors and in every case, your disclosures must not be fraudulent.
Obviously, the first step for your company is to determine how much you need to raise. This might knock out Rule 504, if the amount is over $1 million. Then, the next step is to determine who your potential investors are and where they reside. One way to do this is to have them fill out a questionnaire which requests information to answer these questions. If you will have relatively few investors and they are all accredited, you’re in a good position. If you do intend to sell securities to non-accredited investors then you must furnish certain required information prior to the sale, which is similar to that required for a registered offering.
In addition to the federal requirements, each state has its own securities laws that may impose filing requirements over and above those required by the federal securities laws, which are commonly known as Blue Sky Laws.
In conclusion, raising funds legally is a fairly complicated process and anyone who seeks to raise money should consult with counsel before beginning, even for a very small offering.
 Regulation A can also be useful if you are raising less than 5 million and you want to solicit the general public. It provides for an abbreviated registration process. Regulation 4(6) can also be useful if you are raising less than 5 million and you want to solicit only accredited investors.
 This is just a summary of the requirements. See http://sec.gov/info/smallbus/qasbsec.htm#eod6 for more details.