From an asset protection standpoint, a small business owner should be aware of some securities law issues.
Whenever a corporation is formed, "securities" are issued. The term "security" clearly covers common stock, which will always be issued by a corporation as evidence of ownership. However, preferred stock and bonds, usually issued by larger businesses, also constitute securities.
A limited partnership interest in a limited partnership (LP) is a security. More importantly for the small business owner, a non-manager interest in an limited liability company (LLC) is likely to be deemed a security. The key in both of these cases is that the investor puts up capital, expecting a return to be derived solely from the efforts of others (i.e., the manager-owner of the LLC or the general partner in the LP).
The law is much more settled with respect to the sale of securities by a corporation. Securities laws date to the 1930s and were originally developed to regulate offerings of securities by corporations. The LLC is so new that there has not yet been a definitive determination as to exactly what type of LLC interest is a security.
For example, while Delaware law clearly provides that any interest in an LLC will not be deemed a security unless it is traded on a securities market, this kind of clear-cut rule is lacking in other states.
The corporation may present a better alternative than the LLC where the small business owner intends to make a general and widespread public offering of securities, such as through an Internet offering, for two reasons:
- Securities law was developed primarily to govern offerings by corporations. Thus, the law there is more settled.
- Both potential investors, and federal and estate regulators, are more familiar with, and thus may be more receptive to, a sale of common stock in a corporation, as opposed to an interest in an LLC.
However, this recommendation would not apply in the case of a small offering made among a group of private investors. In addition, this issue will seldom be a factor for the small business owner.