Issuing Securities

April 13, 2006

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From an asset protection standpoint, a small business owner should be aware of some securities law issues.

Whenever a corporation is formed, "securities" are issued. The term "security" clearly covers common stock, which will always be issued by a corporation as evidence of ownership. However, preferred stock and bonds, usually issued by larger businesses, also constitute securities.

A limited partnership interest in a limited partnership (LP) is a security. More importantly for the small business owner, a non-manager interest in an limited liability company (LLC) is likely to be deemed a security. The key in both of these cases is that the investor puts up capital, expecting a return to be derived solely from the efforts of others (i.e., the manager-owner of the LLC or the general partner in the LP).

The law is much more settled with respect to the sale of securities by a corporation. Securities laws date to the 1930s and were originally developed to regulate offerings of securities by corporations. The LLC is so new that there has not yet been a definitive determination as to exactly what type of LLC interest is a security.

For example, while Delaware law clearly provides that any interest in an LLC will not be deemed a security unless it is traded on a securities market, this kind of clear-cut rule is lacking in other states.

The corporation may present a better alternative than the LLC where the small business owner intends to make a general and widespread public offering of securities, such as through an Internet offering, for two reasons:

Securities law was developed primarily to govern offerings by corporations. Thus, the law there is more settled.
Both potential investors, and federal and estate regulators, are more familiar with, and thus may be more receptive to, a sale of common stock in a corporation, as opposed to an interest in an LLC.

However, this recommendation would not apply in the case of a small offering made among a group of private investors. In addition, this issue will seldom be a factor for the small business owner.