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Published:February 5th, 2009 17:18 EST
Business Advice

Business Advice on LLCs and Securities Law

By Joel G. Block (Mentor/Columnist)

This is the second article in a series by my good friend and attorney colleague, Steven A. O`Rourke He is a very sharp corporate and business lawyer and he is a guy that other attorneys go to when they want to debate the law. But he is also a guy that entrepreneurs and business owners should go to when they are concerned that they are thorough and accurate because Steve strives to be both. We often kick around concepts that affect the entrepreneurial community and below, I want to share another piece of work that Steve produced as a result of a recent conversation that we had.

Business AdviceBeginning of Contributor Comments:

Business people are often puzzled that securities laws might apply to their funding efforts. They often believe that, because they are not selling stock " or advertising beyond word on mouth (or word of internet), or are selling only to 5 or 6 people, theirs is somehow under the radar of the Wall Street " laws and regulations. This article alerts you that securities law is unclear, but expansive, in scope and effect, even to the small business ". A director, officer, finder ", promoter, or professional advisor to a company, might well be personally, even criminally, liable in ways he`d never imagined possible.

As with explaining football, anything I write here will have some exceptions but you need to understand the overall game. This is not the world of typical business negotiation or caveat emptor. The promoting side owes fiduciary duties to the investing side. Under federal law, although investors bear the entire risk of business failure, they ought not bear the risk of fraud in connection with the offer and sale of securities. Fraud " can mean any merely reckless statement or omission, however innocent.

For example, under SEC Rule 10b-5, as interpreted by courts, statements to a prospective investor in connection with the offer of a security ought not be false or misleading, nor should they omit to disclose any fact that would be important to the offeree`s decision to invest. Failure to register a security when required, or to meet the anti-fraud disclosure rules, can mean that all the investors can force a return of their money and/or have legal rights against various participants to recover damages. Any business, no matter how large or small, needs to assess and control that risk.

OK, but what is a security "? Federal law attempts to differentiate a security " from other types of business contracts. Certainly, shares of stock are securities "; the Securities Act says so. For non-corporate interests, courts have focused on the statutes having specified as securities investment contracts ". Courts define investment contract " generally as a transaction in which a person contributes money in a common enterprise with the expectation of profits solely from the efforts of others.

A partner in a general partnership usually has an effective right to participate in management and so is not relying on others and does not own a security ". A limited partner in a limited partnership usually has no right to participate in day to day management and so does own a security ", according to SEC Rule 405 and most courts. LLCs are a hybrid entity because members have limited liability, as in corporations, yet can be treated as partnerships for tax purposes. Another complicating attribute is that LLCs can variably structure the rights of members to participate in management " from all " to nothing ".

So, having an expert draft or examine the LLC operating agreement, and examine the factors influencing control, and examine the applicable state law, will help you better determine whether you are selling a security that must be registered with the SEC, or find a registration exemption. Even with an exemption, the anti-fraud " rules I mentioned above apply. State laws must always be examined; securities offerings can be by the state of residence of the offerees (yes, all of them), and/or by the state of formation or even principal office.

NOTE: This article is designed to provide accurate and authoritative information about the subject matter covered. It is published with the understanding that neither the author nor the publisher is thereby engaged in rendering legal or other professional services. If legal advice is required, the services of a competent professional should be sought.

* * * End of Contributor Comments * * *

Joel`s thoughts:

1. Don`t get caught in the no man`s land " where even small contributions of capital trigger big legal problems. Look into these issues before entering into the transaction. This is one of my most important concepts ( Get good business advice and legal advice as well.

2. Don`t assume anything. Errors in this area are punishable with civil and sometimes criminal penalties. That should get your attention. And,

3. If you have any questions on these complex issues call a securities attorney. And try to become friends with a guy like Steve O`Rourke. He would be a good guy to call and get to know.

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About Joel G. Block, President of Growth-Logic, Inc.
Often dubbed a "Growth Architect" by his clients, Joel Block advises companies on explosive growth strategies by driving revenue and sales. Well known in the capital markets, Joel is a successful entrepreneur, speaker, advisor and faculty member of the iLearningGlobal community. To bring Joel into your company, please visit or Also, be sure to check out our newest project: a blog to organize the blogs that cover entrepreneurship - And finally, for film makers: - our newest project.