Raising Money for a New Mexico Business: When Securities Laws Apply

A founder decides to raise $200,000. A former colleague will put in $75,000. Two family friends will contribute the rest. In exchange, they will receive minority interests in the company.

It feels like a private business transaction. Legally, it may also be a securities offering.

That distinction matters because federal and New Mexico securities laws generally require an offer or sale of securities either to be registered or to qualify for an exemption from registration. Being a small company, privately held, or financed by people you know does not by itself create an exemption.

For most small businesses, the practical question is not whether to conduct an IPO. It is how to structure a private capital raise so that an available exemption actually applies.

WHEN DOES SELLING PART OF A BUSINESS BECOME A SECURITIES TRANSACTION?

Stock is a security. So are many other instruments used to raise capital, including investment contracts and certain debt instruments.

For a New Mexico business, the state rule is particularly important: the New Mexico Uniform Securities Act expressly defines a “security” to include any interest in a limited liability company, in addition to stock, notes, investment contracts and numerous other instruments. NMSA 1978, § 58-13C-102(DD).

That means forming an LLC instead of a corporation does not take the transaction outside New Mexico securities law.

The issue can arise before money changes hands. Securities laws regulate offers as well as completed sales. A founder therefore should think about securities compliance before circulating investment terms, advertising an opportunity, or publicly asking people to invest—not after the checks arrive.

PRIVATE COMPANY DOES NOT MEAN EXEMPT COMPANY

There is a persistent misconception that securities laws apply mainly to public companies.

They do not.

Under federal law, every offer and sale of securities must either be registered under the Securities Act of 1933 or fit within an exemption from registration. New Mexico follows the same basic structure: a security generally cannot be offered or sold in New Mexico unless it is a federal covered security, the transaction or security is exempt, or the security has been registered under state law. NMSA 1978, § 58-13C-301.

Most ordinary small-business financings therefore depend on an exemption, not on avoiding securities law altogether.

REGULATION D: THE MOST COMMON PRIVATE-OFFERING ROUTE

One of the most frequently used federal frameworks is Regulation D. For many private companies, the two provisions that matter most are Rules 506(b) and 506(c).

Both allow an issuer to raise an unlimited dollar amount. They differ principally in whom the company may sell to and how the company may find those investors.

Rule 506(b): Private Fundraising Without General Solicitation

Rule 506(b) is the traditional private-placement safe harbor.

A company may sell to an unlimited number of accredited investors. It may also sell to up to 35 non-accredited investors within the applicable 90-day period, but those non-accredited investors must have sufficient financial and business sophistication to evaluate the investment, either themselves or through a purchaser representative. Additional disclosure requirements apply when non-accredited investors participate.

The important restriction is that the company cannot use general solicitation or general advertising.

An unrestricted website, public advertisement, or similar broad communication promoting an investment opportunity can constitute general solicitation. One established way to avoid the problem is to limit the offering to potential investors with whom the company or its qualifying intermediary has a pre-existing, substantive relationship. Whether a particular communication crosses the line is fact-specific.

For a founder raising money quietly from an established network, Rule 506(b) is often the first exemption worth examining.

Rule 506(c): Public Solicitation, but Accredited Investors Only

Rule 506(c) changes the tradeoff.

The company may publicly advertise or broadly solicit the offering. But every purchaser must be an accredited investor, and the issuer must take reasonable steps to verify accredited-investor status.

That verification requirement matters. Under Rule 506(c), simply asking an investor to check a box saying “I am accredited” ordinarily is not enough. Verification may instead involve financial documentation or written confirmation from certain professionals, including a licensed attorney, CPA, registered broker-dealer, or SEC-registered investment adviser. Other verification methods may also satisfy the rule depending on the facts.

Rule 506(c) can therefore make sense when a company wants to advertise an investment opportunity publicly, but it comes with a narrower investor pool and a more demanding verification process.

WHAT IS AN ACCREDITED INVESTOR?

For individuals, the most familiar financial tests are:

• net worth exceeding $1 million, individually or jointly with a spouse or spousal equivalent, excluding the value of the person's primary residence; or

• individual income exceeding $200,000, or joint income exceeding $300,000, in each of the previous two years, with a reasonable expectation of reaching the same level in the current year.

Other categories can also qualify, including individuals holding certain professional credentials and various qualifying entities.

Accreditation should therefore be determined under the actual Rule 501 criteria rather than

by assuming that someone who appears wealthy or financially sophisticated qualifies.

“FRIENDS AND FAMILY” IS NOT A SECURITIES EXEMPTION

A founder may be more comfortable accepting $50,000 from an uncle than from a venture fund. Securities law does not draw the same distinction.

The SEC specifically cautions that labels such as “friends and family round,” “seed round,” or “angel round” do not themselves create exemptions. The offering still must be registered or structured to satisfy an available exemption.

Friends-and-family rounds can actually require particular care because those investors are often not accredited investors. That may affect which exemption is available and what disclosures must be provided.

New Mexico also has its own transaction exemptions, including limited private-offering provisions. For example, NMSA 1978, § 58-13C-202(N) contains an exemption applicable to certain offerings involving no more than ten New Mexico purchasers during a twelve-month period, subject to additional conditions including restrictions on general solicitation.

Another state exemption applies where the issuer will have no more than twenty-five security holders and satisfies specified conditions.

Those provisions can be useful, but satisfying a New Mexico exemption does not by itself answer the federal securities-law question. The transaction has to work under both regimes.

FORM D AND NEW MEXICO NOTICE FILINGS

A Rule 506 offering is exempt from federal registration, but it is not paperwork-free.

An issuer relying on Regulation D generally must file Form D electronically with the SEC within 15 calendar days after the first sale. Form D is a notice filing—not an SEC approval of the offering—and it becomes publicly available through EDGAR.

A late Form D does not, by itself, destroy the Regulation D exemption, but the filing obligation remains and noncompliance can have consequences.

Rule 506 securities are also “federal covered securities,” which generally prevents states from requiring substantive state registration of the offering. That does not eliminate state securities regulation altogether. States may still require notice filings and fees and retain authority over securities fraud.

New Mexico currently requires Rule 506(b) and 506(c) notice filings through the Electronic Filing Depository within 15 days after the first sale in New Mexico. The current timely filing fee is $350, with higher fees for late filings.

This is one reason a founder should identify where the investors live before completing the offering: state notice obligations may arise in multiple jurisdictions.

SAFES AND CONVERTIBLE NOTES DO NOT AVOID THE ISSUE

Early-stage companies increasingly raise money through SAFEs—Simple Agreements for Future Equity—or convertible notes rather than immediately issuing stock.

Those instruments may simplify valuation and financing negotiations. They do not provide a way around securities compliance.

A SAFE gives an investor contractual rights to future equity upon specified triggering events. Convertible notes combine debt with a potential conversion into equity. Both are commonly used as startup financing instruments, and securities-law compliance should be addressed when they are issued, rather than deferred until conversion.

Changing the document does not change the fundamental question: the company is taking investment capital in exchange for an investment instrument.

WHAT HAPPENS IF THE OFFERING WAS DONE WRONG?

The problem with a defective private offering often appears later.

An unhappy investor may argue that the company sold an unregistered security without a valid exemption. Federal securities law provides potential remedies to purchasers of securities sold in violation of registration requirements, including recovery of the purchase price in appropriate circumstances. Exempt offerings also remain subject to federal antifraud rules.

New Mexico law creates its own substantial civil exposure. Under NMSA 1978, § 58-13C-509, a purchaser of a security sold in violation of the state's registration requirement may, subject to the statute's requirements, seek recovery of the consideration paid, interest, costs, and reasonable attorney fees upon tender of the security. The statute also creates remedies for material misrepresentations and omissions.

That is why rescission exposure matters. A financing that seemed successful when the business was growing can become considerably more expensive if investors later acquire a statutory claim to unwind their purchases.

An exemption also does not permit a company to make misleading statements. Federal and state antifraud provisions remain applicable even when the offering itself is properly exempt from registration.

WHEN IS SECURITIES COUNSEL WORTHWHILE?

Not every business transaction requires a fifty-page private placement memorandum.

But legal review becomes increasingly worthwhile when a business is:

• accepting investment money from more than one or two people;

• issuing stock or LLC interests for cash;

• taking money from non-accredited investors;

• raising money from friends or relatives;

• using SAFEs or convertible notes;

• approaching investors in multiple states;

• advertising or discussing the offering publicly;

• paying someone to locate investors;

• raising enough capital that rescission would materially threaten the company; or

• expecting later institutional or venture-capital financing.

The earlier the review occurs, the more useful it tends to be. Securities exemptions are generally easiest to structure before the first offer is made and before the first investment is accepted.

THE BOTTOM LINE

Selling ten percent of a private company may feel very different from selling shares on Wall Street. Securities law begins much earlier than the public markets.

For a New Mexico founder, stock, LLC membership interests, SAFEs, convertible instruments and other investment arrangements can all raise securities-law issues. The company generally needs to identify an available federal exemption, comply with its conditions, address New Mexico and any other applicable state requirements, make appropriate disclosures, and preserve records showing why the exemption applies.

The question is rarely, “Are we too small for securities law?”

The better question is: “Which exemption are we relying on, and have we actually satisfied it?”

REFERENCES

• Securities Act of 1933, 15 U.S.C. §§ 77a et seq.

• SEC, Exempt Offerings.

• SEC, Private Placements — Rule 506(b).

• SEC, General Solicitation — Rule 506(c).

• SEC, Accredited Investors.

• SEC, Assessing Accredited Investors Under Regulation D.

• SEC, General Solicitation.

• SEC, What Is Form D?

• SEC, Early-Stage Investors.

• SEC, Common Startup Securities.

• New Mexico Uniform Securities Act, NMSA 1978, §§ 58-13C-102, 58-13C-202, 58-13C-301, 58-13C-302 and 58-13C-509.

• New Mexico Regulation and Licensing Department, Securities Division, Registering Securities and Exemptions.