Most Founders File Nothing Until After the First Check Arrives

Sean Weisbrot: How many startup founders raising money in the US are breaking the law?

Wendy Culbertson: Probably a lot. Um, it's a very, when it comes to securities and capital raising, um, or raising capital in relation to securities, it's a very easy, um, rule to violate.

Sean Weisbrot: Why is that?

Wendy Culbertson: I think it's because, um, a lot, there are a lot, a lot of players who would reach out to the issuers the moment that they know that let's say you are a company or a C-level, um, and you are raising capital. A lot of people are soliciting these, um, C-level companies. Um, hey, I can introduce you to a set of investors and, um. Majority of these issuers don't even know that. Yep. You can pay them. But there is a certain extent to that under the Securities Exchange Act. Um, and even FINRA rules, um, and a lot of these issuers raising capital, all they hear is like, oh, they're gonna help us raise that capital. Um. Faster and finish our round really fast so they just like go with it. Um, without really looking into, um, what is, what can they pay and what are the thresholds under the securities law.

Sean Weisbrot: Hey, business leaders and marketers. What if your brand could be featured right here? This ad spot could be yours. This channel is watched by a dedicated audience of ambitious founders, executives, and professionals who are actively looking for tools and services to help their business grow. If you wanna put your brand in front of this highly dedicated audience, that's difficult to reach. I'm currently looking for a few strategic partners for the channel. To learn more about sponsorship opportunities, click the link in the description. Let's go together. So I think something that a lot of startups aren't aware of is the no success fee versus like consulting fee type. And when I was raising money many years ago for my startup, I found someone who was what's known as an FA, a financial advisor, or at least that's what he called himself. And he said, you know, pay me for my travel expenses and what whatnot. I'll provide you all the receipts and you know, I'll be going to investors, meeting them in person and, and I'll pitch you. And I was like, okay, fine. $40,000 later, I had $0 in my bank account through his efforts. So I know why a lot of startups don't wanna work with someone like that because there's no guarantee of success. But then the problem with a lot of the people that solicit these startups you are saying was if they aren't licensed, they're breaking the law and they're causing the founder to break the law by paying them a success fee.

Wendy Culbertson: Correct. That is a really good point. You know, um, actually, let's step back a little bit, right? Um, because, um, when a company or an issuer raise capital, right? Um, are, are they raising securities or is that a securities transaction? Some of the companies are raising capital in a way of notes, um, like a. Just a purely promissory note. Um, again, it, it really depends on the substance. Um, double check with your secur, uh, your corporate or securities attorney. Um, but so long as the transaction has a securities or a share involved, more likely it is a security. Um, and like. Um, investors, or I'm sorry, uh, issuers companies are trying to raise capital and then they're solicited. Like, it, it really becomes more, um, enticing because like, oh, I only pay them if they give me a result. So it's, it's a result based transaction, right? And a lot of us make sense. I mean, I think that the generation is gearing towards that results based, um, transaction or compensation and, but unfortunately, um. Securities Exchange Act has not really caught up to that. There was a proposal in 2020 to loosen up the finder's fee or a finder's exemption. It wasn't really finalized, and I think about Q3. Q3 of this year, 2025, the SEC is starting to, um, revisit that proposal. Um, so I don't know if that gets passed then maybe it's a lot better. But so far as now the, the rule stands is that under section 15 a, one of the 34 Act, um, you cannot pay someone, um, that. Is not a broker dealer. Sorry. You cannot pay someone, um, who is, uh, you. Sorry, you can, you cannot compensate them for a certain fee that should have been paid to a broker dealer or if it is, uh, an illegal, um, under the, the rule. And going back to that, what is the definition of a broker? A broker, um, and then it, it was defined as any other person who was affecting a securities transaction that is not for their, um, individual purpose. So most likely, if someone is. Asking you like, Hey, I'm gonna help you raise capital. Um, and it's not for yourself, then you are violating and, and, and, and if you are not registered, you are violating that rule. Um, on the other hand, there are a lot of exemption just in, in that statement or in that rule. One is if you are an employee of the. Companies raising capital, and so long as there's also another, you know, sub layer of exemptions there. Um, if you are not being paid an exempt, uh, sorry, a commission or meaning per percentage base out of the capra, uh, capital raised, then you can be, um, that's, that's one of the exemption. Um, and then so long as, um, you are not doing it for another person, so if you are doing it for yourself. More likely it's not a violation. Um, so those, those are like the top two. Um, classic example of a safe harbor or an exemption under that broker definition or broker com commission, uh, compensation. Um, but yeah, going back to what you said, um. There's a lot of people soliciting issuers and like, Hey, I'm gonna help you raise capital. Actually, around, um, COVID season 20 20, 20 21, there's a huge action that the SEC have. Sued and filed other people, I mean, sued people because of, um, failure to reg. They are acting as a broker dealer and they failed to register as a broker dealer. Some of those litigation right now are either dismissed or they've settled. Um, so there's like a good precedent cases to understand how to not violate that rule and how you can violate that rule.

Sean Weisbrot: You had mentioned something really interesting, which was if you're an employee of the company, you can raise, and so what if someone who's not licensed. Says, Hey, why don't you sign an employment agreement with me? Make your, make me your employee, but you don't pay me anything. Or like, you, you hold off my payment because I'm like an intern with you for the first few months. And, you know, uh, I'll only if you confirm my employment, then I start getting paid, you know, within air quotes.

Wendy Culbertson: Yes, I think that's a really good structure, right? Um, you can hire someone like, Hey, help me raise capital. That's gonna be your solely, um, sole responsibility and more, more. So these are, um, in my head, uh, closely the, the investor relations, um, employee of the company, um, trying to raise capital if you hire them, um, and promise them a certain salary, like because this is your job or something like that. Um, that's one of the safe harbors that's being provided under the Securities Exchange Act. Um, although that's the, the only, the key and the, the, the pillar that not to of, not to the pillar to avoid really is that, um, do not pay them based off personage of the capital being raised. Um, if there is like a bonus structure, like let's say, hey, if we hit. Uh, let's say the company's trying to raise a million dollar, that's the maximum and the minimum, let's say $500,000. You can tell your employee, Hey, if we met meet, um, $500,000, the minimum capital being raised, then I'll give you a certain percentage of, uh, you know, of that bonus or something like that. Then that's your, you're closely triggering that. Um, is it a commission based? Right? Um, but if you just say. Like, I'm gonna give you a flat fee of a bonus if we hit that 50,000 mark and or a certain mark like milestones that the company is being raised. Um, that could not be, although that's just one of the many factors to look at. So I'll always recommend to, um. Not only look at that, but also look at the other circumstances around it to make sure that you are really not, um, crossing that line and you are within the purview and within the box of not violating the law.

Sean Weisbrot: What if instead of them paying you a salary while you're doing your investor relations work, but haven't raised anything, they pay you in share.

Wendy Culbertson: Okay. Um, they can, and companies do that all the time. They pay people in shares. Right. Um, and my, um, to, I always go back to that key rule is this, uh, is the calculation of the shares or how did the company determine, um, how much shares they're going to issue or award their, this employee? Is it based off of, um, their performance then good. But if it's always, and if, if it. Ultimately ties into, um, how much capital is raised. Then there's like a question and, and have a, we need to have a thorough look into, okay, um, is this really a violation or not? Or is this, does this meet the safe harbor exemption?

Sean Weisbrot: So you, you had just mentioned when you're looking at three to 5 million or higher, you're probably, uh, going to trigger Reg D. I don't know anything about it. I've heard it a number of times, but I've never looked into the law. So what is the point at which a startup has to file that for a fundraise? 'cause I was under the impression that it was even like at a prese when when you start to talk to VCs, when you start to, to move away from angel investors, you have to file, or maybe even for angels, you have to file. So that would be great to clarify.

Wendy Culbertson: Yes. Um, so we mentioned earlier, right? Um, we have to first identify what is, um, the capital raising event. What, what is the structure? What is the structure that the issuer is trying to, to do here? Um, and let's say they're purely just, Hey, I am going to lend money from you right now, and I'm going to promise to pay you later. So that's a purely promissory note. Um, it's not a securities related, right? Um, but sometimes even though they do that, um, companies are tedious enough to provide like, you know, a good pitch deck, a good, um, business plan basically to their investors or potential lenders. Um, but the moment that you are having a securities transaction. Basically the bar gets heightened. Um, and, uh, you have to disclose a lot more to your potential investors or investors. Um, I would first look at how much the company is trying to raise and based off of that, okay, you're just trying to raise, let's say $3 million, might maybe just consider regulation crowdfunding. Um. And you this a, a classic example of that, uh, are your Kickstarter, right? Um, and that's like a, a crowdfunding. Um, just, just do that. But let's say they go up to, oh, we wanna raise like five to $10 million. Okay. We might look into regulation D. Um. And mind that the regulation and crowdfunding it, it became, um, very famous. The crowding and crowdfunding, that terminology became really famous. But when you go to Regulation D, um. There's a lot more capital raising terminology that they use. Is it a seed funding? Is it a series A? Um, series B and so on. Um, a lot of times it becomes a label, like a fancy label or an interesting label. It's, it's good because it signals to your investors, like, oh, if you say Series C, oh, they're probably on their third, fourth, depending if they skip the family. Friends race, uh, around, right? Um, so it, it quickly signals that you are on the third or fourth round of your capital race for the company. Um, it could signal stability. It could signal like you're really growing and so now you need to step up to the next, um. Um, stage of your business, something like that. But in the back end, from a regulatory perspective, are we still doing that as a regulation, cf, or are we doing as a regulation D? Um, and then if we determine those two, or it could be a regulation, A two, um, regulation and crowdfunding, they have a certain minimum. And then all, you have to file that with the SEC. First. You have to file a form C first with the SEC. After you file that, then you can start raising capital. Um. Then regulation D, you can start drafting your pitch deck, offering memorandum, get that out to your investor. You don't have to file anything with the SCC until, um, 15 days from the first day, from the fir, from the first investment that you receive from your investor. Let's say you're trying to raise $10 million and you receive, um, $10,000 from your investor. Um. That's the, that's the countdown. That's when the countdown starts. Um, then you have to file a Form D with the SCC. It's just a quick form, like hand rising capital, da, da da. And this is the amount I've received. And then you can update that later. Um, so that's form D. And then the Form D has different tiers. Um, there is a 5 0 6 C, 5 0 6 B, and a 5 0 6 C, which basically determines that. Are you targeting up. Uh, non-accredited as well, or are you just targeting all accredited investors? Then you're on the 5 0 6 C. Um, and depending on that as well, um, the 5 0 6 B, which you are targeting a certain number, 35 non-accredited investors, um, the level of disclosure is higher. Like there's a higher bar to that. Um, and versus, um, the 5 0 6 c. Which the level of disclosures could be a little bit lesser heightened because these are sophisticated and, um, accredited investors basically in the knowledge of, in the mind of the SEC. They know what they're doing. Also, you have to, um, uh, consider the, um. Do you want to advertise this on social media or not? Um, the 5 0 6 C um, allows you to have that advertisement, but still be ra. Be very careful on what you advertise out there and how. Um, so those are the. The differences between on high level the crowdfunding, the Reg D, and then the Reg A is pretty much, we call it, sometimes we call it the mini IPO. There's a tier one and a tier two, more likely a tier one. You're targeting a certain states, you're only raising in a certain states, and then tier two you are, um. Most likely offering this to the entire states of the United States. You can include the territories as well. Um, they're also, they also varied on the maximum amount that you're trying to raise. And regulation A requires that you file, um, something with the SEC first, that they have to approve it and qualify. Um, then after the qualification, then you can start raising capital with, uh, or you can send the, the. Offering memorandum and perspectives to your, um, investors or potential investors? Similar with, um, IPO. The only difference between a Reg A and an IPO or Form S one is that the IPO does not have a limit of how much you want to raise. You can raise a hundred million dollars or a billion dollars, that's not a problem as long as you do the, um, form S one or we call IPO.

Sean Weisbrot: That is a lot of information to digest. I'm surprised that they call an equity fund an an equity fundraising event, reg D, but they call a crowdfunding event, reg cf. So they got that one right. But why didn't they call it Reg E and then instead of Reg A, reg I for IPO,

Wendy Culbertson: right. I think it's just, um. Actually Reg Regulation D was created first, or was finalized first, and then the regulation crowdfunding was created together with a jobs act. Um, so it was a little bit more later and newer, um, maybe big. There is no regulation C at that time, so they just inserted in there. Um, but good call. I. I have, I don't know the lo logic behind the SEC creating that. Um, but the first rule, the, the ultimate and first rule is the IPO. That's when you file the Form S one and, and any. All of the umbrella rule, um, for securities, uh, exchange Act is if you are raising capital, it has to be registered with the SEC. That's like the, um, umbrella and golden rule. That's the first rule that you follow. Then, um, the SEC started. Loosening up that rule that they said, oh, you don't have to file a Form S one if you meet these exemptions. And those are some of the exemptions. Um, but not all, because there are also specific exemptions for sophisticated, um, investors.

Sean Weisbrot: I'm surprised that you, for the, I'm surprised that for startup founders. They don't have to submit the form until after they receive their first money. I feel like that's something that should be more highly regulated in that you file the form to tell the SEC, even though I'm a private company, this is my plan because I'm targeting accredited or non-accredited investors. And then they go, yeah, you're good. And then go. Maybe it's because they don't wanna prevent them from being able to get started.

Wendy Culbertson: Um, that is actually a really good question, and thank you for asking that. Um, so the regulation, the, the initial thought is like, that's the other term for regulation. These PPM private placement memorandum, which is private and confidential. Technically, if a, uh, an issuer. Shared the PPM or they're offering memorandum with an investor. Um, the common consensus is that that's purely confidential. You cannot release that to anyone else unless the issuer agrees or they, you know, are, are the ones who are sharing that, um, information with you. Um. And so the, the thought is like, okay, this is purely private. You don't have to disclose anything. Something like that with the SEC. Um, so that's the federal level. You also have to look at state level. Each state requires, lemme rephrase that. Each state have their own different rule when it comes to regulation D or private placements. Um, which, uh, the other term for state law is blue sky. Um. Um, California will have, California state will have a different blue sky law when it comes to private placement management or capital racing versus Florida. Um, maybe Texas, I'm, I'm just making this up, maybe Texas Blue Sky Law says like, okay, we don't have any rule for you, but just follow the federal rule and we're okay with that. Um. California says like, okay, the moment that you raise a capital, you receive a, an investment from an investor who lives in California for more than $250,000, then that's when you have to file something with us. Um, it's usually the California Securities, um, commission, something like that. Um, in some states it's, um, under the Secretary of State office. Um, so it just depends on each state. Um, then you would just have to look at that. Um, so I think the, and this is also almost always, um, forgotten, and there's always a debate to it because if you think about it, there is a rule that the federal law preempts state law, um, but. Sometimes push comes to sho shove. If, if litigation happens, um, the state will enforce their, um, blue sky law when it comes to protecting the interest of the investor. So, in short, what I'm trying to say here and your question is, is really smart that, um, okay, I'm, let's say I'm the company trying to raise capital. I don't have any, uh, I, I don't have to. Disclose anything to the SEC. So who even knows what I have disclosed to my investor is. Neutral or following the regulation sx. Basically there's a guideline on how to draft it and basically the high level is that it should be easier to understand. Um, there is no hidden agenda in your disclosures and you should be as transparent as you can be, stuff like that. Um, because it didn't go through the ice of the SEC. Who knows if your PPM really meets that, you know, transparency and stuff like that. Um, so. One of the ways that this really bubbles up is when your investors are not happy. They invested the money on you, and now they're not happy with how the company's being run, that the company is not making money, and so on. And that's when all this could surface up. And. Um, yeah, the state level securities office or commissioner agency, um, could be involved and or the SEC could start looking into it as well. Hmm.

Sean Weisbrot: Is this filing something that a founder can do on their own, or do they really need a lawyer's help to do?

Wendy Culbertson: Um, I've definitely seen founders who, um, have done on their own, and these are the founders that have experience. Let's say maybe they worked in a bigger company and they have seen the ways, how it's done, and they can do that themselves. Um. But my strong opinion is that if you are just so focused, capital raising activity is so tedious, as you know, right? There's a lot. And then there's a lot of stress because, um, for a company, man, I'm really shooting to, to receive that 250 grand by this month, um, because I want, or I promised my suppliers or something like that, that I'm gonna buy their goods and stuff like that. So, um. A lot of times when a, you know, when the officers of the company, they're just so bogged down and so stressed out with just running the business themselves. My strong opinion is to always just hire someone to worry that for you. Because if you have so many things on your plate, it becomes unmanageable. Now it's a different story if the startup is, um, at, um, ideation stage or idea stage that, um, they needed. Money first before they can do anything else. Um, then it could be a different story, right? That they, they really have in the right mind to handle everything. Um, and so as long as they know how to do it properly and correctly, then they've done their research and um, they've consulted with other people and there's so many startup, um, support out there. Um, who guides in, um, officers how to do it then? Sure. Definitely. You can do it yourself.

Sean Weisbrot: Is there anything I haven't asked you that you feel we would be missing out on if you didn't share?

Wendy Culbertson: If, let's say an issuer, um, gets solicited by a, an unregistered broker dealer and they paid them in commission per the rules, but they are, this person is not registered broker dealer, um, it could result to regulatory action, civil and potentially criminal action of aiding and abetting. Um, so just be mindful of, um. Who is reaching out and what qualifications do they have? Um, and always double check.

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