Part of our regulatory series: This article covers the Securities Act. Also read about the Investment Company Act (fund structure) and Investment Advisers Act (adviser regulation).
The Simple Question
Sarah's Cupcake Business
Sarah needs $50,000 to expand her cupcake business. She plans to ask 10 friends to invest $5,000 each in exchange for a 5% ownership stake in her company.
Is this legal? What paperwork does she need?
If friends aren't accredited, Rule 506(b) requires specific disclosures to any non-accredited purchasers under Rule 502(b). Those disclosures can be substantial relative to a small raise.
The moment Sarah offers ownership stakes in exchange for money, she's dealing with securities. The Securities Act of 1933 governs exactly how she can do this legally.
The same law applies whether you're raising $50,000 for cupcakes or $50 million for a tech startup. Let's break down what you need to know.
What is a Security?
The Supreme Court's "Howey Test" helps determine if something is a security. All four criteria must be met:
Investment of Money
Someone pays money (or other valuable consideration)
Common Enterprise
Multiple investors' fortunes are tied together
Expectation of Profit
Investors expect to make money from the investment
Efforts of Others
Profits come from the promoter's or management's efforts
Sarah's cupcake business meets all four criteria:
- Friends are investing money ($5,000 each)
- All investors share in the business success or failure
- They expect to profit from the business growth
- Profits will come from Sarah's work running the bakery
Result:
Sarah's ownership stakes are securities and must comply with federal securities law.
Key Securities Act Requirements
The Securities Act of 1933 was created after the stock market crash of 1929 to protect investors and restore confidence in capital markets. The Act imposes several requirements on securities offerings:
Registration or Exemption
All securities offerings must either be registered with the SEC or qualify for a specific exemption. Registration typically involves extensive disclosure, audited financials, and significant costs.
Common Exemptions: Regulation D (private placements), Regulation A (mini-IPO), Regulation CF (crowdfunding)
Disclosure Requirements
The level of required disclosure varies by exemption and investor type.
For Accredited-Only 506(b): No prescribed Reg D disclosure, but anti-fraud rules still apply
Anti-Fraud: All offerings are subject to federal and state anti-fraud provisions regardless of exemption
Most private businesses, including many private funds, rely on exemptions rather than full registration due to cost and complexity. The most commonly used exemption is Regulation D.
Regulation D - The Most Common Solution
Many issuers use Regulation D exemptions because they're much faster and cheaper than full SEC registration. Here are the two main options:
Rule 506(b) - Private Placement
Rule 506(c) - General Solicitation
What's an Accredited Investor?
An individual qualifies if they meet any of the following:
- $1,000,000+ net worth (excluding primary residence)
- $200,000+ annual income individually (or $300,000+ with spouse/domestic partner) for the last two years with an expectation of the same
- SEC-designated professional credentials (currently FINRA Series 7, 65, or 82)
Two Real Examples
Sarah's Cupcake Empire
Raising $50,000 from 10 friends and family members
The Challenge
Each friend is investing $5,000 for equity. Most are not accredited.
The Solution
Use 506(b) and either (a) accept only accredited investors (simplest), or (b) include some non-accredited investors but provide the required Rule 502(b) disclosures.
Required Steps:
- For 506(b) accredited-only: maintain a reasonable belief investors are accredited
- If any non-accredited participate: provide Rule 502(b) disclosures
- File Form D within 15 days after the first sale
TechFlow Startup
Seed round of $2M from angels and VCs
The Challenge
Wants to advertise the offering and reach new investors
The Solution
Use 506(c) — general solicitation permitted — but sell only to verified accredited investors.
Required Steps:
- Form D filing (within 15 days after first sale)
- Offering materials with all material information (anti-fraud compliance)
- Third-party or documented internal accredited-status verification
Simple Compliance Steps
Here's what every business should do to stay compliant with securities laws:
Choose Your Exemption
Understand how 506(b) compares to 506(c). Most private companies choose 506(b) for its flexibility with non-accredited investors and simpler compliance requirements.
Timeline: Before fundraising begins
Prepare Disclosure Documents
Create offering materials with all material information. If any non-accredited purchasers will participate in a 506(b) offering, prepare the Rule 502(b) disclosures.
Timeline: 2–4 weeks before launch (varies)
Handle Accredited Status Correctly
506(c): Take reasonable steps to verify accredited status. 506(b): Maintain a reasonable belief investors are accredited if you choose accredited-only.
Timeline: Before accepting funds
File Form D
File a notice with the SEC within 15 days after your first sale of securities.
Timeline: Within 15 days of first investment
State "Blue Sky" Notices
Rule 506 offerings are federally preempted from state registration, but most states require notice filings and fees where investors reside. Check each state's timing (often shortly after the first sale in that state).
Timeline: As required by each state
What Could Go Wrong?
Securities violations can result in significant penalties. Common mistakes include:
✗ General Solicitation Without Permission
Wrong: Posting on social media: "Investment opportunity! 20% returns! DM for details."
Right: Consider Rule 506(c) if you need to advertise and can verify all investors are accredited, or use Rule 506(b) for private placements without advertising.
✗ Accepting Non-Accredited Money Without Proper Disclosures
Wrong: Taking $5,000 from non-accredited friends with just a handshake agreement.
Right: If any non-accredited purchasers participate in a 506(b) offering, provide the required Rule 502(b) disclosures.
✗ Forgetting Form D Filing
Wrong: Starting to raise money and never filing Form D.
Right: File within 15 days after the first sale.
The Bottom Line
Key Takeaways
- Securities laws apply to any business raising money in exchange for ownership or investment contracts.
- Reg D (especially Rule 506) is the most common path for private offerings.
- If any non-accredited purchasers are included in 506(b), Rule 502(b) disclosures are required.
With the right structure and processes, you can raise money legally while protecting both yourself and your investors.
Important Notice
This content is educational and not legal, financial, or investment advice. Regulations change; verify requirements for your situation.