Is it a security?
To put it simply, a security arises from a transaction in which someone invests money in a company with the expectation of receiving profits from the efforts of someone else. In other words, if someone is buying shares of a company primarily as an investment vehicle, and that investor is not going to be participating in the day-to-day operations of the business, the shares would likely qualify as a security. All securities must be registered with the U.S. Securities and Exchange Commission (SEC) and appropriate state agency, unless they fall into an exemption. But even if they are exempt, you may still have to file documentation showing that you’re exempt.
For instance, in California, shares of an LLC in which any member is not continuously and actively involved in the management would qualify as securities. This would usually happen if the LLC is manager-managed and at least one member does not participate in the day-to-day operations of the business. Therefore, if you have an LLC where there are certain members who have bought in as investors, but any one of them will not manage the company on a day-to-day basis, your LLC ownership shares may qualify as securities. Likewise, even if all members intended to participate, but at least one does not participate on a continuous basis, your shares may be considered securities.
Alternatively, if all of the LLC owners are also managing the day-to-day operations, your membership interests would not likely be considered securities, alieving you of the obligation for any additional filings.
Is it exempt?
If your LLC interests qualify as securities, you are required to register your securities with the SEC and the appropriate state agency. However, most small businesses are exempt from having to register.
In California, for example, you may sell your securities without registration if the following criteria are met:
1. You are selling to 35 or fewer members;
2. Each purchaser is competent to purchase the securities;
3. Each purchaser is buying the securities for their own account and “not with a view to or for sale in connection with any distribution of the security”; and
4. There was no public advertisement for the sale.
The purchaser’s competence to buy the shares is satisfied by a showing of any of the following:
● Purchaser has a preexisting personal relationship with the seller (like a family member or friend);
● Purchaser has the capacity to protect their own interests due to their own business or financial experience; or
● Purchaser’s interests will be protected because they have retained qualified professional advisors to assist.
If you are exempt, you must file a notice of exemption, although you avoid the more burdensome registration filing. In California, the required notice form is called a Notice of Transaction (commonly referred to as a 25102(f) Notice) and must be filed with the California Department of Business Oversight. This notice informs the state of California that you are exempt for the allowed reasons listed above. You must file this notice within 15 days of issuing your securities, and the filing fee fluctuates based on the value of the interests to be sold.
Most small businesses will not be required to file an exemption notice with the SEC. However, it’s always best to check with your business lawyer about whether any notice or registration is required for your individual business, and in your particular state.
Do you need to register?
If your LLC interests count as securities, and those securities don’t qualify for an exemption, you will have to register your securities with the SEC and appropriate state agency. Registration of a security is an involved process subject to a complex web of securities laws. You will need the assistance of a skilled securities lawyer to make sure you’re in full compliance.
Even if your business entity is an LLC, your membership interests may be considered securities, potentially requiring state and federal filings. As always, make sure to check your local, state, and federal laws to ensure you’re in compliance. If you need any assistance determining what steps you need to take, give us a call.