Yes, a private corporation can sell its common stock to family and friends, but it is not as simple as a handshake. Under the Securities Act of 1933, every offer or sale of securities must either be registered with the SEC or qualify for a specific legal exemption.
Since full registration is expensive and time-consuming, most private companies use “safe harbor” exemptions under Regulation D.
Common Exemptions for Family & Friends
| Exemption | Fundraising Limit | Investor Restrictions | Key Requirement |
|---|---|---|---|
| Rule 504 | Up to $10M / year | No limit on number or type. | Must file Form D with the SEC. |
| Rule 506(b) | Unlimited | Unlimited “Accredited” + up to 35 non-accredited. | No public advertising. Must have a pre-existing relationship. |
| Section 4(a)(2) | N/A | Limited number of “sophisticated” people. | The original “private placement” exemption. |
The “Family & Friends” Checklist
To stay compliant and protect your corporation, follow these four pillars:
- Substantive Pre-existing Relationship: You must prove you knew the investor before the stock offer. This prevents the SEC from viewing the sale as a “public” solicitation.
- Disclosure (The PPM): Even if they are family, you should provide a Private Placement Memorandum (PPM). This document outlines the risks of the investment so they cannot later claim they were misled if the company fails.
- Accredited vs. Non-Accredited:
- Accredited: Individuals with $1M+ net worth (excluding primary home) or $200k+ annual income.
- Non-Accredited: Most family/friends. If you include them, the legal disclosure requirements become much stricter and more expensive.
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- Blue Sky Laws: You must check the laws of the state where the investor lives. For example, if you are in Wyoming but sell to a cousin in California, you must comply with California’s “Blue Sky” filing requirements.
The Risks of “Informal” Sales
If you sell stock without an exemption:
- Rescission Rights: Investors can legally demand 100% of their money back if the company doesn’t do well.
- Personal Liability: Founders can be held personally responsible for the lost investment.
- Future Funding: Institutional investors (VCs) may refuse to fund you later if your “cap table” (the list of owners) was created through illegal stock sales.
Would you like me to draft a sample “Investment Suitability Questionnaire” to help you verify if your friends/family are eligible to buy stock?