Do Securities Laws Apply to the Family Business?

By Keith Baldwin 

on August 1st, 2016

Posted in Governance & Business Operations

Family-owned businesses, like other privately held businesses, are typically formed as corporations or limited liability companies (LLCs).  They issue shares or LLC interests representing equity ownership.  These equity interests are defined as securities under federal and state law.  Yet some family businesses operate as if they were exempt from the sometimes stringent and unforgiving requirements of the securities laws.  For example, they might issue stock or other securities without first determining if there is a requirement to register the securities, without knowing if there is an exemption from registration, and without providing disclosures about the merits and risks of investing in the company.

These securities issues would not typically arise where stock is gifted to another generation where no purchase or sale is involved.  But there might be thorny questions if stock is being sold to family members by the  company  or purchased from family members by the company or by other family members.  Some family businesses include members who are active in operating the business as well as those who are passive investors.  Some include not only immediate family members of the active participants, but also uncles, aunts, and multiple degrees of cousins in the shareholder group.   In conducting stock transactions involving family members who are unfamiliar with the financial condition, operations or business prospects of the company, there are opportunities for misunderstanding.  Misunderstandings can lead to disputes, and one of the goals of the securities laws is to protect sellers and buyers of securities against fraud.  So a family business could become involved in a messy set of securities claims, even with the best of intentions motivating its securities activities.

It is important to recognize that the securities laws don’t differentiate between family-owned businesses and other businesses when they require registration (or exemption) and full disclosure.

Perhaps what is most different about family businesses is that it is unusual for family members to sue each other under the securities laws—although our experience demonstrates that litigation within families does happen.  It is critical for family business owners to know that an unhappy family member who believes he or she has been wronged in a stock or LLC transaction can be a formidable adversary and can create stress, distraction and, at worst, financial ruin for an otherwise healthy family business.  Attention to basic securities law compliance can prevent serious and costly problems.

So, what do careful family businesses do when they engage in stock (or LLC) transactions?  They get timely advice from a securities lawyer on how to comply with the state and federal laws and how to mitigate risk in an inherently risky area of business and law.

Keith Baldwin is a business transactions and securities lawyer with a thirty-eight year history of serving clients’ legal needs. Keith focuses his practice on business relationships, including mergers and acquisitions, agreements among owner-entrepreneurs, and best practices for corporate governance. Keith can be reached via email at keithbaldwin@dwt.com or directly at 425.646.6133.

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