Selling 5% of a cupcake shop is a securities offering
Sarah needs $50,000 to expand her cupcake business. Her plan is simple: ten friends put in $5,000 each, and each gets a 5% ownership stake. No bankers, no term sheets, just people who believe in her. She assumes a spreadsheet and a handshake will cover it. Federal law sees it differently. The moment she offers ownership in exchange for money, she is selling securities, and the Securities Act of 1933 governs exactly how she can do it.
Congress passed the Act after the 1929 crash on a blunt premise: people who sell investments must tell buyers the truth, and regulators get notice of the sale. It scales all the way down. The same statute that governs a $50 million public offering governs Sarah's $50,000 raise from friends. What changes is the path you take through it, and picking the right path early is cheap. Fixing the wrong one is not.
The Howey test decides what counts as a security
The Supreme Court drew the line in SEC v. W.J. Howey Co., 328 U.S. 293 (1946), a case about plots in a Florida orange grove sold with a service contract. The Court held that an arrangement is an investment contract, and therefore a security, when four things are true at once.
Investment of money
Someone pays money, or other value, into the deal.
Common enterprise
The investors' fortunes rise and fall together.
Expectation of profit
The buyers are in it for a return, not for the product.
Efforts of others
That return depends on someone else's work, not the investor's.
Sarah's raise goes four for four. Her friends are paying in $5,000 each. Every investor shares in the same outcome. They expect the stakes to be worth more as the business grows. And the growth comes from Sarah's work running the bakery, not theirs.
Result
The stakes are securities. Every offer and sale must comply with federal securities law, no matter what the paperwork calls them.
The label never controls. LLC units, revenue shares, profit participation agreements: if it passes Howey, it is a security.
Register with the SEC or fit inside an exemption
Section 5 of the Act makes it unlawful to offer or sell a security unless the offering is registered with the SEC or exempt. Registration means a registration statement on Form S-1, a prospectus, audited financials, and a legal bill that only makes sense for a company going public. Nobody registers a $50,000 raise. Private issuers use exemptions instead:
- Regulation D: private placements, the workhorse for startups and private funds
- Regulation A: a lighter path to a public style offering, with reduced disclosure and dollar caps
- Regulation CF: crowdfunding in small amounts through registered online portals
One thing no exemption removes is antifraud liability. Section 17(a) of the Act reaches every offer and sale, registered or not. An exemption excuses you from registration paperwork; it never excuses an untrue statement or a missing material fact.
If you are pooling money into a fund rather than a single operating business, the Securities Act is only the first statute you deal with. The fund vehicle itself must also fit an exclusion under the Investment Company Act, usually Section 3(c)(1).
Rule 506(b) or Rule 506(c): decide before you talk to anyone
Regulation D's Rule 506 is the route most private raises take, and it splits into two branches. The choice controls who you may pitch, what you must hand them, and what you must prove.
Rule 506(b): the quiet raise
- Advertising
- None. General solicitation is prohibited.
- Investors
- Unlimited accredited investors, plus up to 35 sophisticated purchasers who are not accredited.
- Your burden
- A reasonable belief that each investor qualifies.
- The catch
- If even one purchaser is not accredited, Rule 502(b) disclosure documents are required, and they are substantial.
Rule 506(c): the advertised raise
- Advertising
- Permitted anywhere, publicly.
- Investors
- Accredited investors only, no exceptions.
- Your burden
- Reasonable steps to verify accreditation. Documents, not assurances.
- The catch
- Verification means tax returns, brokerage statements, or a letter from a CPA or attorney.
Who counts as accredited under Rule 501(a)
An individual qualifies by meeting any one of these:
- Net worth above $1,000,000, excluding the primary residence
- Income above $200,000 (or $300,000 with a spouse or domestic partner) in each of the last two years, with the same expected this year
- A professional credential the SEC has designated, currently the FINRA Series 7, 65, or 82 licenses
The $50,000 raise
Most of Sarah's friends are not accredited. Her cleanest path is 506(b) limited to accredited investors only. If she includes friends who are not accredited, she owes each of them Rule 502(b) disclosures, which can cost more to produce than a $50,000 raise justifies.
Filing: Form D within 15 days of the first sale.
The $2 million raise
TechFlow, a startup raising a $2 million seed round from angels and VCs it has not met yet, needs to advertise. That points to 506(c): promote the round publicly, sell only to accredited investors, and verify every one of them with documentation.
Filing: Form D within 15 days of the first sale, plus offering materials that hold up under the antifraud rules.
Five steps from decision to compliant close
Pick the exemption before fundraising begins
The choice between 506(b) and 506(c) cannot be reversed midstream. Publish one advertisement and 506(b) is gone for that offering.
Before any outreach
Prepare the offering materials
Include every material fact and get the numbers right. If purchasers who are not accredited will participate in a 506(b) offering, build the Rule 502(b) disclosure package.
Two to four weeks before launch
Confirm investor status before accepting money
Under 506(b), form a reasonable belief that each investor is accredited, or sophisticated within the limit of 35 purchasers. Under 506(c), collect verification documents first.
Before funds move
File Form D
A notice filing with the SEC under Rule 503. It is not an application, and the SEC does not approve or reject it. It is simply due.
Within 15 days of the first sale
Make the state Blue Sky notice filings
Rule 506 securities are covered securities under Section 18 of the Act, so states cannot require registration. Most still require a notice filing and a fee in each state where an investor lives.
Often shortly after the first sale in each state
The Form D step has its own traps, including amendment duties and what happens if you miss the deadline. Our Form D filing guide covers the mechanics in full.
This is also the part of a raise that platforms have absorbed. For funds launched on Hedgia, the fund documents, the Form D, and the state Blue Sky notice filings are prepared inside the launch flow, so the deadlines are handled rather than remembered.
Three mistakes that end offerings
Advertising a 506(b) offering
A public post reading "Open investment opportunity, 20% target returns, DM for details" is general solicitation. Once it is published, the offering can no longer rely on 506(b). If you need to advertise, run a 506(c) and verify every purchaser.
Taking unaccredited money with nothing in writing
A $5,000 wire from a friend who is not accredited, with no disclosures and no subscription agreement, takes the sale outside the exemption. Section 12(a)(1) then gives that investor a rescission claim: the right to demand the money back with interest, with the violation on your record.
Never filing Form D
The deadline is 15 days after the first sale, and nobody reminds you. Missing it also complicates the state notice filings, which key off the same date.
Two questions before you offer anyone a stake
First: does the deal pass the Howey test? If people are handing you money expecting a return from your work, it does, and everything above applies. Second: is every dollar coming from an accredited investor? If yes and you keep the raise private, Rule 506(b) is the path of least resistance. If you need strangers or advertising, run a 506(c) and verify. Either way the mechanics are fixed: Form D within 15 days of the first sale, a notice filing in each investor's state, and not a single untrue statement anywhere in your materials.
And if the money you raise will be pooled and managed rather than put into one operating business, there is a separate question with its own answer: whether you can legally manage other people's money at all.