By: Ralph Longo
When starting a business, many founders turn to the people they know best—close friends, family members, longtime colleagues—for early capital. These relationships often carry a sense of informality and trust, which can create a dangerous misconception: that securities laws don’t apply when the investors are personal connections.
That belief is false. And following it can create serious legal and financial exposure.
Under federal and state securities laws, any offer or sale of a security is presumed to require registration with the SEC unless it qualifies for an exemption. There is no special carveout for friends and family. If you’re offering equity, a membership interest, a convertible note, or any other instrument that falls within the (very broad) definition of a security, you are conducting a securities offering, regardless of who the investor is or how close your relationship may be.
Despite what some founders may assume, the term “friends and family” is not a legal term, and it does not come with any built-in regulatory leeway. The fact that an investor trusts you or is personally connected to you does not relieve you of your legal obligations. Without proper structuring and compliance, a friends and family round may result in rescission claims, liability for founders, complications in future financing, and even regulatory enforcement.
The most common path for compliance in these types of early-stage raises is through Regulation D of the Securities Act, particularly under Rule 506(b). This exemption allows a company to raise an unlimited amount of money through a private placement without registering the offering, so long as certain conditions are met. Most notably, Rule 506(b) prohibits general solicitation, but it allows investments from both accredited and, in limited circumstances, non-accredited but sophisticated investors. The company must still file a Form D notice with the SEC and make any required state-level filings within fifteen days of the first sale.
The availability of the Reg D exemption does not mean that documentation and disclosures are optional. Even when raising money from friends and family, a company should provide a private placement memorandum or investor disclosure document that outlines the business, the terms of the offering, the intended use of proceeds, and the risks involved. This may not need to be as elaborate as a venture-backed Series A PPM, but it must be complete and accurate. Accompanying this should be a subscription agreement that includes representations from the investor and documents the purchase of the security in writing.
If your investor is not accredited, the disclosure burden is even higher. Federal regulations require detailed financial and risk-related information to be provided to non-accredited investors, and failing to meet those standards could eliminate the exemption entirely.
Some founders are reluctant to formalize these arrangements out of fear that it will offend or alienate their personal connections. But the opposite is true. Providing clear, written disclosures and formal agreements protects both sides. It ensures that expectations are set, that risks are acknowledged, and that future misunderstandings are less likely to turn into legal problems. It also makes your business more attractive to future institutional investors, who will conduct due diligence and closely examine your past fundraising practices.
If you’re raising capital from people close to you, you owe them the same level of legal professionalism you would owe to a stranger. There is no legal exemption based on trust. If you are raising capital, you must either register the offering or comply with an exemption. Friends and family investments are no exception. The law does not care whether the person writing the check shares your last name or your childhood memories. It cares whether you followed the rules.
And if you want your business to grow, you should care too.