Startup Fundraising Legal

Selling securities is regulated by federal and state law. Every issuance of stock, SAFE, or convertible note — including to friends, family, and small investors — either requires registration with the SEC or qualifies for an exemption. Most startup financings use Regulation D exemptions, particularly 506(b) and 506(c), and follow well-trodden documentation patterns. This guide covers the mechanics.

Stock and SAFEs are securities

The federal Securities Act of 1933 requires that every offer and sale of a security either be registered with the SEC or qualify for an exemption from registration. Stock (common, preferred), SAFEs, convertible notes, options, warrants, partnership interests, LLC membership interests, and many other instruments are securities for this purpose.

Registration is the IPO path — expensive, slow, and almost never appropriate for private financings. The practical question for every private financing is which exemption applies and what the issuer has to do to satisfy it.

Exemption violations carry significant consequences: SEC enforcement, state regulator actions, rescission rights for investors (the right to return the security and get their money back — with interest), personal liability for officers and directors, and damage to future financings.

Instruments commonly used

• SAFE (Simple Agreement for Future Equity). Y Combinator's contract template that gives the investor the right to equity at a future financing, with terms set by valuation cap and/or discount. Not debt. No interest, no maturity.
• Convertible note. Debt that converts to equity at a future financing or maturity. Bears interest; has a maturity date.
• Common stock. Founder equity, employee equity (usually via options on common). Typically not sold to outside investors.
• Preferred stock. The instrument sold in priced VC rounds. Comes with liquidation preference, anti-dilution, protective provisions, and other rights.
• Warrants. Right to purchase future stock at a fixed price. Often issued to lenders, lease providers, or in side-letter scenarios.

SAFEs in detail

The SAFE (originally introduced by Y Combinator in 2013, revised in 2018 from pre-money to post-money) is the dominant pre-seed and seed instrument in US startup financing. Standard SAFE variants:

• Valuation Cap. Sets the maximum valuation at which the SAFE will convert. Investor benefit: if the next round is priced higher, the SAFE converts at the cap (lower price per share for the investor).
• Discount. Sets a percentage discount to the next-round price. Investor benefit: converts at e.g. 80% of the priced-round price.
• Cap and Discount. Both terms; investor gets the better of the two at conversion.
• MFN (Most Favored Nation). No cap or discount, but the investor gets the benefit of any better terms granted to later SAFE investors.

The 2018 post-money SAFE made dilution calculations more predictable: the cap is now applied on a post-money basis (after the SAFE money is included), so the founder can calculate exact dilution at signing rather than after the fact.

SAFE conversion happens at the next priced equity financing ("Equity Financing"), at a liquidity event (acquisition, IPO), or at dissolution. SAFE holders typically receive preferred stock at the priced round's price, modified by the cap and/or discount.

SAFEs avoid the maturity-date pressure of convertible notes and avoid debt characterization concerns. Their drawback for issuers: post-money SAFEs can create more dilution than founders expect, especially when stacked. The SAFE conversion calculator shows the math.

Convertible notes

Convertible notes pre-dated SAFEs and remain common, particularly in markets and stages where SAFEs haven't fully displaced them. Notes are debt instruments — the company owes the noteholder the principal plus accrued interest until conversion or maturity.

Standard convertible note terms:

• Principal. The amount lent.
• Interest rate. Typically 4–8% simple interest, accruing until conversion or repayment.
• Maturity date. 18–24 months typical. At maturity, the note must be repaid, converted (sometimes at a default mechanism), or amended.
• Conversion trigger. Next qualified financing (typically a priced equity round of a specified minimum size).
• Conversion mechanics. Outstanding principal plus accrued interest converts to the priced-round security, with cap and/or discount applied.
• Acquisition treatment. If acquired before conversion, noteholders typically receive 1x or 2x principal or a negotiated alternative.

The maturity-date pressure is the principal difference from SAFEs. Approaching maturity, the parties either convert into a not-yet-real "round" at a negotiated price, repay (rare and disruptive), or extend the maturity. Extensions are common but require investor cooperation.

Priced equity rounds

A priced equity round sells preferred stock at a fixed valuation. The standard documents in a US venture-backed Series A:

• Term Sheet. Non-binding (except for some specific provisions) summary of the deal terms. Typically 4–8 pages.
• Stock Purchase Agreement (SPA). The agreement under which the company sells preferred stock to investors. Contains representations and warranties of the company.
• Amended and Restated Certificate of Incorporation. Amended charter creating the preferred stock series and specifying its rights, preferences, and privileges.
• Investors' Rights Agreement (IRA). Registration rights, information rights, preemptive rights, ROFR/Co-Sale (sometimes in separate agreements).
• Voting Agreement. Drag-along, board composition, voting commitments.
• Right of First Refusal and Co-Sale Agreement (ROFR/Co-Sale). Transfer restrictions on founder common stock and rights for investors to participate in proposed sales.
• Indemnification Agreements. Between the company and each director.
• Management Rights Letters. Required by some funds to qualify for VCOC status under ERISA.
• Side letters. Investor-specific provisions not in the main documents.

The National Venture Capital Association (NVCA) publishes model forms for all of these documents; they are the industry default starting point for priced rounds. Customizing from the NVCA models is faster and cheaper than drafting from scratch.

Heavily-negotiated provisions: valuation (the deal headline), liquidation preference (1x non-participating is current standard), anti-dilution protection (broad-based weighted average standard), protective provisions (preferred consent for specified company actions), board composition, preemptive rights, drag-along, registration rights.

Regulation D exemptions

Regulation D is the most-used set of exemptions for private placements. Three rules within Regulation D:

• Rule 504. Up to $10 million in any 12 months; permitted to non-accredited investors; subject to state qualification requirements.
• Rule 506(b). Unlimited dollar amount; permitted to up to 35 non-accredited investors plus unlimited accredited; no general solicitation.
• Rule 506(c). Unlimited dollar amount; only accredited investors; general solicitation permitted; investor accreditation must be verified.

Rules 506(b) and 506(c) are the workhorses for VC and angel financings. 504 is occasionally used for very small offerings.

506(b)

The traditional private placement exemption. Key requirements:

• No general solicitation or general advertising.
• Up to 35 non-accredited investors permitted, plus unlimited accredited.
• If non-accredited investors are included, more disclosure is required (similar to S-1 disclosure level), so in practice 506(b) financings limit themselves to accredited investors.
• Issuer must reasonably believe each investor is accredited; self-certification through a representation in the subscription agreement is sufficient.
• Form D notice filing with the SEC within 15 days of the first sale.
• State notice filings (Blue Sky) in each state where an investor is located.

"No general solicitation" is the practical constraint: the issuer cannot publicly market the offering. Existing relationships with potential investors are required — the SEC's pre-existing substantive relationship doctrine. The boundaries here are subtle and matter for issuers using demo days, online platforms, or social media.

506(c)

Added by the JOBS Act in 2012; permits general solicitation in exchange for stricter verification:

• Unlimited general solicitation and advertising permitted.
• All purchasers must be accredited investors.
• Issuer must take reasonable steps to verify accredited status — self-certification is not sufficient.
• Form D filing and state notice filings as with 506(b).

Verification methods include: reviewing tax returns or W-2s to verify income; reviewing brokerage and bank statements plus credit reports to verify net worth; obtaining written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney, or CPA; checking specific evidence for other accreditation categories (knowledgeable employees, holders of certain professional certifications).

506(c) is the right exemption when public marketing of the offering is valuable (general solicitation to a broad audience) and all investors will be accredited. 506(b) remains more common when the issuer is fundraising through pre-existing investor relationships.

Accredited investor definition

The SEC's accredited investor definition has evolved. Key categories:

• Individual income over $200,000 (or $300,000 jointly with spouse/spousal equivalent) in each of the two most recent years, with reasonable expectation of the same for the current year.
• Individual net worth over $1,000,000, excluding primary residence (and excluding mortgage debt up to the residence's fair market value).
• Holders of certain professional certifications (Series 7, Series 65, Series 82 in good standing).
• "Knowledgeable employees" of certain private funds.
• Entities with assets over $5 million not formed for the specific purpose of the investment.
• Entities owned entirely by accredited investors.
• Banks, registered investment companies, business development companies, certain regulated entities.
• Family offices with assets under management over $5 million.

Check current SEC definitions before relying on a specific category, as the rules have been periodically updated.

State Blue Sky filings

Even when an offering is exempt from federal registration, state securities laws ("Blue Sky" laws) apply in each state where an investor is located. For Rule 506 offerings (both b and c), federal law preempts state registration requirements but states retain authority over notice filings, fees, and anti-fraud enforcement.

For a typical 506 offering:

• File Form D with the SEC within 15 days of first sale (electronically via EDGAR).
• File state notice (typically a copy of Form D plus the state's cover form) in each state where an investor resides.
• Pay state filing fees (vary by state, typically $100–$500).
• File any required amendments and renewal notices.

NASAA (North American Securities Administrators Association) maintains the Electronic Filing Depository (EFD) for filing Form D state notices in many states electronically.

Failure to file Form D or state notices does not invalidate the federal exemption but can trigger state enforcement actions and bar use of Reg D for future offerings.

Standard documents

Typical documents for a SAFE or convertible note financing:

• SAFE or convertible note (one per investor, often substantially identical)
• Investor questionnaire or subscription agreement establishing accreditation
• Form D filing with SEC and applicable state notices
• Board approval of issuance (board consent or meeting minutes)
• Updated cap table reflecting new commitments

For a priced equity round, add: term sheet, SPA, amended charter, IRA, Voting Agreement, ROFR/Co-Sale, indemnification agreements, management rights letters, disclosure schedule, opinion of counsel, closing certificates, secretary's certificate.

Side letters and MFN

Side letters provide investor-specific provisions outside the main agreements: ERISA compliance language, MFN rights (most-favored-nation: investor gets the benefit of any better terms given to later investors), specific information rights, transfer rights, regulatory accommodations. Side letters require careful drafting to avoid unintended consequences for other investors and to comply with disclosure requirements.

International investors

Investors located outside the US can typically invest in US private placements under the same Reg D exemptions, with additional considerations:

• Regulation S provides a separate "offshore" exemption for offerings outside the US.
• Tax withholding obligations may apply to interest, dividends, or sale proceeds paid to non-US persons.
• FATCA reporting may apply to certain non-US investors.
• The home country's securities laws may apply to the offering in that country.
• Some non-US investors will need W-8 forms; others need other documentation.

Common mistakes

• General solicitation under 506(b). Public pitches, demo days open to the public, social media solicitation can disqualify the exemption. Once disqualified, the offering becomes an unregistered sale.
• Friends and family without accreditation analysis. "He's family" doesn't make someone an accredited investor. Selling securities to non-accredited investors without complying with 506(b)'s 35-investor and disclosure requirements is an exemption violation.
• No Form D filing. Required within 15 days. Late or missing Form D can bar future use of Reg D.
• No state notices. Failure to file Blue Sky notices in investor states can trigger state enforcement.
• Promising returns or guarantees. Securities laws prohibit specific or guaranteed return representations in private placements.
• Bad investor representations. A subscription agreement representation that the investor is accredited is the issuer's defense in an enforcement action. Skipping or shortcutting this exposes the issuer.
• Inadequate disclosure. Even in exempt offerings, anti-fraud provisions apply — material misstatements or omissions create liability.
• Stacking SAFEs without modeling dilution. Several rounds of SAFEs at different caps can produce more dilution at conversion than founders expect. Run the math at SAFE conversion calculator and cap table dilution calculator.
• Maturity-date drift on notes. Notes approaching maturity without a financing in sight require negotiation; ignoring it is a breach.
• Promising equity to advisors without documentation. Verbal promises of equity that don't get papered create disputes later. Use an advisor agreement and stock option grant or restricted stock award.

FAQ

Do I need a lawyer for a SAFE round? Y Combinator's standard SAFE templates can be used without legal review; if you're modifying the form, accepting modifications, or stacking multiple SAFEs, get counsel. State Blue Sky filings and accreditation diligence still need handling.

How much does a priced Series A cost in legal fees? Company-side legal fees for a Series A commonly run $30,000–$60,000+ including all documentation, negotiation, and closing. Investors' counsel fees are typically capped (often $30,000–$50,000) and paid by the company at closing.

Can I raise from non-accredited investors? Yes, but the practical paths (Reg CF, 504 with state qualification, 506(b) with disclosure obligations) all add cost and disclosure burden. Most early-stage financings limit to accredited investors as a result.

What's the difference between a SAFE and convertible note? A note is debt with interest and maturity; a SAFE is not. A SAFE has no maturity pressure but may not convert if the company never has a priced round.

Do I need a PPM? A private placement memorandum is not required for 506(b)/506(c) when only accredited investors are participating; it's required when non-accredited investors are included. PPMs are typically used to provide disclosure protecting against anti-fraud claims even when not technically required.

Can I advertise my fundraise on LinkedIn? Only under 506(c) with accredited verification. Under 506(b), this is general solicitation and disqualifies the exemption.

What's a Reg CF offering? Regulation Crowdfunding allows raising up to a statutory limit per 12 months from both accredited and non-accredited investors through SEC-registered funding portals. Different process, more disclosure, but reaches retail investors.