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NOTE SECURITIES: A TRAP FOR THE UNWARY
Let’s say that Bill and Steve have developed new software and they want to start a business and sell the software commercially. So Bill and Steve form a company (doesn’t matter whether it is a Corporation or LLC). They have some money, but not enough to really get the business going. They decide to find additional capital. What are their options: Banks, Lending sources, or Investors. Perhaps, Bill and Steve are smart enough to know that if they sell some ownership in their company to other individuals, they have sold a security. So they decide that they do not want to give up ownership. They contact several Banks and Lenders who don’t seem very interested in loaning Bill and Steve the money they need.
Bill and Steve start talking to some friends and business acquaintances. They convince these friends and business acquaintances that their software business has merit. These friends and business acquaintances are willing to put up the money Bill and Steve need for the business. So Bill and Steve decide to issue notes to these friends and business acquaintances for the money provided by each.
Have Bill and Steven unwittingly issued a security, and, if so, more importantly have they done so in compliance with the plethora of state and federal securities laws and regulations.
NRS 90.295 defines a security as “a Note, stock, …evidence of indebtedness, a participation in a profit-sharing agreement… an interest in a limited liability company…investment contract…”
Nevada has adopted the “family resemblance” test to determine whether a note is a security. In Nevada, the analysis starts with the presumption that every note constitutes a security. The initial step under the “family resemblance” test is to compare the Note at issue with notes that have been determined not to be securities. These non-security notes generally involve consumer financing of goods, home loans to the borrowers, small business loan by banks that are secured. If the note has not been issued for any of those reasons, then four other factors are analyzed. Generally speaking, if the note was issued by the company to raise money for general business use or to finance some capital transaction and the source of the money is interested in a profit the note is expected to generated, the note is probably a security.
Once the note becomes a security, then compliance with state and federal securities laws is a must. Therefore, if you think you want to raise money for your start-up company or your existing company, you should contact one of our attorney’s at the firm to help guide you through the legal requirements because violations may result in criminal prosecutions.
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