Understanding the Legal Aspects of Raising Capital

Raising capital is a crucial step in the growth of any business. Whether you're launching a startup, scaling operations, or expanding into new markets, securing funding can be a game-changer. However, raising money is not just about convincing investors—it’s a legal and regulatory process that, if mismanaged, can lead to serious consequences.

From securities compliance to investor relations and contract law, the legal landscape of capital raising is complex. Failing to follow proper procedures can expose your business to lawsuits, penalties, investor disputes, or even criminal liability.

Here’s what every business owner needs to know before raising capital—from choosing the right funding structure to fulfilling long-term legal obligations.

1. Know Your Capital-Raising Options—and Their Legal Impacts

Not all funding is created equal. The way you raise capital affects your control over the business, future liabilities, tax obligations, and legal risk.

Common Capital Structures:

• Equity Financing
• You sell a stake in your company in exchange for capital. Investors become partial owners, which means they may have voting rights, dividend rights, and say in major decisions.

• Debt Financing
• You borrow money—either from banks, private lenders, or by issuing corporate bonds. You’re obligated to repay it with interest, but you retain full ownership.

• Convertible Notes / SAFEs
• These are hybrid instruments. Investors lend money now with the expectation that it will convert to equity later, often at a discount or with a valuation cap.

Legal Considerations:

• Equity deals trigger state and federal securities laws.
• Convertible notes require clear terms to avoid disputes over conversion rights.
• Debt arrangements may require collateral, personal guarantees, or compliance with lending regulations.

Work with a business attorney early to choose the structure that aligns with your goals—and to draft legally sound documents from the start.

2. Comply with Federal and State Securities Laws

One of the most commonly overlooked legal pitfalls in raising capital is noncompliance with securities regulations. Even small, private investments can be considered securities under federal law.

Federal Requirements (SEC):

• If you're issuing stock, convertible notes, or other financial interests, you must either register the offering or qualify for an exemption.
• Most startups rely on Regulation D exemptions (e.g., Rule 506(b) or 506(c)), which limit how you advertise and who can invest.
• Failure to comply may lead to investor lawsuits, fines, or forced rescission of investments.

State Requirements (Blue Sky Laws):

• Many states require notice filings, fees, and investor disclosures, even when the offering is exempt federally.
• Some states prohibit public solicitation altogether unless you're registered.

Don’t assume that a “friends and family” round is exempt. You still need to disclose risk factors and confirm eligibility of investors.

See Meet Our Business Law Team for how attorneys help businesses navigate these rules safely.

3. Draft Investor Agreements with Legal Precision

Once you’ve found investors, you’ll need formal, legally binding agreements. These documents will define ownership, rights, responsibilities, and exit terms—and are critical for avoiding disputes.

Key Clauses to Include:

• Equity structure (preferred vs. common shares)
• Voting rights and board seats
• Exit and buyback terms
• Liquidation preferences (who gets paid first)
• Dividends and distributions
• Valuation and conversion formulas (for convertible notes or SAFEs)
• Anti-dilution clauses
• Dispute resolution provisions

Never use generic templates—terms that seem harmless now could create legal and financial disasters in the future. Let a business attorney tailor agreements to your business model, industry, and investor profile.

4. Protect Your Intellectual Property (IP) Before Fundraising

Investors want to know their money is backing a secure and defensible business. If your intellectual property is not properly registered, assigned, or protected, it can become a dealbreaker.

Pre-Fundraising IP Checklist:

• File trademarks, copyrights, or patents where appropriate.
• Ensure all code, content, or product designs are owned by the company, not individual contributors.
• Use employment contracts and IP assignment agreements with all employees and freelancers.
• Maintain confidentiality through NDAs with third parties.

If your company’s value lies in its brand, technology, or product design, IP must be protected before approaching investors.

5. Maintain Honest, Consistent Communication with Investors

Fundraising is the start of a relationship—not the end of one. Transparent communication builds trust and credibility—and may even reduce your risk of legal action if problems arise.

Best Practices:

• Provide regular financial and performance updates (quarterly or as agreed).
• Disclose material risks and setbacks honestly and in writing.
• Keep cap tables up to date and accessible.
• Be responsive to investor questions and concerns.

Learn more about building trust with legal teams in Why Communication Matters.

6. Prepare for Post-Funding Compliance and Reporting

After the money is in the bank, the legal responsibilities don’t stop. Raising capital comes with ongoing compliance obligations that, if ignored, can lead to serious regulatory and reputational damage.

Ongoing Legal Obligations May Include:

• Filing annual reports with state agencies
• Maintaining accurate financial statements
• Scheduling shareholder meetings and board approvals
• Notifying investors of major changes, such as new funding rounds or mergers
• Fulfilling securities filing obligations (especially if you’re raising in multiple states)

Failing to follow through on these responsibilities can invalidate exemptions, trigger lawsuits, or delay future funding rounds.

Final Takeaway: Raise Capital Strategically and Legally

Raising capital is a high-stakes process. When done right, it unlocks incredible opportunities. But if legal missteps occur, it can lead to lawsuits, fines, loss of control—or even the collapse of your company.

Here’s what you can do to protect your business:

• Start with a legal strategy, not just a pitch deck.
• Vet investors carefully, just as they vet you.
• Use qualified legal counsel to review or draft all documents.
• Comply with all securities regulations at both federal and state levels.
• Keep your operations clean and investor communication transparent.