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Innovation@work: Raising Money by Selling Stock Is NOT a DYI Project


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Innovation@work: Raising Money by Selling Stock Is NOT a DYI Project

By: Kristin Mendoza 

We get it. Budgets are tight when starting a new business and there are a lot of free forms and templates available to guide the ‘do it yourself’ startup founder on basic legal issues and documents. The growing availability of more sophisticated legal documents online may embolden some to take on more complicated legal issues without the benefit of legal counsel. However, the latest securities enforcement action in Massachusetts against a cannabis startup serves as a great example of why this approach is not only problematic but can lead to disastrous results.

With the legalization of the sale of recreational cannabis in Massachusetts, a number of cannabis-related businesses have applied for recreational cannabis licenses, some even seeking out investors to buy stock in their business in order to raise funds for the new business venture.

One such startup, Positronic Farms, Inc., was formed to engage in the cultivation of recreational cannabis and to lease part of its commercial facility to other cannabis businesses. Not only are the capital expenditures for building a cultivation facility significant, but so are the legal and regulatory costs for cannabis-related businesses, all of which require a lot of money.

Relying on an exemption from registration under federal and state securities laws, Positronic Farms put together an offering circular for soliciting investments from private investors. The offering circular disclosed that investors would be purchasing unregistered stock in a privately-held company. It also specified that sales of stock would only be made to accredited investors and that Positronic Farms would hold all documents and funds received from investors in escrow until reaching a minimum of $250,000 in investor commitments.

With offering circular in hand, the founder of Positronic Farms began raising money. Over a period of about 18 months, he raised $1.3 million from approximately 40 investors. The problem was that the founder violated just about every rule applying to exempt private offerings in the process. He did not verify whether his investors were accredited investors under federal securities laws. He advertised the sale of Positronic Farms stock to the general public through online press releases, e-mail messages and online video presentations.

In total, over 735 prospective investors were solicited. He hired individuals to specifically assist in the direct solicitation and sale of Positronic Farms stock and paid those individuals sales-based commissions. Those individuals do not appear to have been properly licensed and registered broker-dealers. Perhaps worst of all, he did not abide by the statements in the Positronic Farms offering circular about escrowing early investments until meeting the $250,000 threshold. Instead, he and the company put those investments immediately into use and even used some of those funds for a different business.

As a result of these failures, the Enforcement Section of the Massachusetts Securities Division filed an administrative complaint against Positronic Farms and its founder on June 19, 2019. The Enforcement Section is seeking to permanently ban both the company and its founder from selling stock to any Massachusetts resident as well as permanently banning the founder from ever holding an executive position, whether as a director or officer, in any other Massachusetts company that plans to sell its securities. In addition, the Enforcement Section is seeking to require Positronic Farms to offer to return the money that it raised from the 40 investors who purchased the unregistered stock and is also seeking the imposition of administrative fines.

The lesson from Positronic Farms is very clear: the sale of unregistered stock in a privately held business should never be undertaken on a “do it yourself” basis. Even if you find a good, free template online to use in crafting an offering circular for your own startup, not knowing how private offerings need to be properly structured under the law, what the restrictions on investor qualification and solicitation activity are, or how to properly notify states of your activities exposes your startup to significant risk.

Likewise, engaging an attorney to assist in only one phase of the offering – such as drafting an offering circular – but not maintaining regular communication with him or her to understand how investment documents should be processed or what filing obligations exist during the offering period is also risky. There is little to no margin for error when trying to raise money through a private offering, so avoid any DIY tendencies you may have and get appropriate legal guidance before undertaking one.

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