Raising a Friends & Family Round? The Securities Exemptions Founders Should Understand Before Taking the Money
For many startups, the first outside capital does not come from a venture capital fund or institutional investor. It comes from people who already know and believe in the founders: parents, siblings, friends, colleagues, mentors, and other members of the founders’ personal and professional networks.
This is commonly called a friends and family round, or an F&F round.
But there is an important legal point founders often miss:
There is no federal securities-law exemption called the “friends and family exemption.”
The Securities and Exchange Commission (SEC) specifically notes that labels such as “friends and family round,” “angel round,” “seed round,” and “Series A” do not determine which securities-law requirements apply. If a startup sells stock, convertible notes, SAFEs, membership interests, or other securities to raise capital, the company generally must either register the offering or identify an exemption from registration.
For an early-stage company considering an F&F raise, several exemptions may potentially be relevant. The appropriate pathway depends on factors such as who the investors are, whether they are accredited, how the company finds them, how much the company intends to raise, and where the company and investors are located.
First: A Friends & Family Round Is Still a Securities Offering
One of the most common misconceptions is that securities laws become relevant only when a company raises money from professional investors.
That is not the case.
A founder might think:
“My aunt is investing $20,000.”
“My former boss wants to put in $50,000.”
“Three friends want to invest using convertible notes.”
“We aren't raising from the public, so securities laws shouldn't apply.”
The relationship between the founder and investor can be relevant to the analysis, but calling someone a friend or relative does not itself exempt the transaction.
The company still needs to determine which registration exemption covers the offering.
For many early-stage companies, the analysis begins with Section 4(a)(2) of the Securities Act and Regulation D.
Option 1: Rule 506(b) of Regulation D
Rule 506(b) is one of the most commonly used exemptions for private offerings.
It can be particularly useful when founders are raising capital privately from people with whom they already have relationships.
Under Rule 506(b), an issuer may raise an unlimited amount of capital and may sell securities to an unlimited number of accredited investors. The rule can also permit sales to a limited number of non-accredited investors, subject to additional requirements.
Why Rule 506(b) Can Work for Friends & Family Rounds
The major advantage of Rule 506(b) is that every investor does not necessarily have to be accredited.
Rule 506(b) permits an offering to include up to 35 non-accredited investors during the applicable 90-calendar-day period, provided those non-accredited purchasers, alone or together with a purchaser representative, satisfy the required sophistication standard—that is, they have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the investment.
That distinction can matter significantly in an F&F round.
A founder's parents, siblings, longtime friends, or professional contacts may strongly believe in the business but may not satisfy the financial criteria for accredited-investor status.
Rule 506(b) may provide a pathway for including certain non-accredited investors, but doing so increases the compliance burden.
The Disclosure Issue
When non-accredited investors participate in a Rule 506(b) offering, additional disclosure requirements can apply. A startup should not assume that simply providing the investor with a pitch deck, SAFE, or convertible note is sufficient.
The offering documents and disclosure process should be designed around the exemption actually being relied upon.
This is one reason founders should identify the securities exemption before accepting investment funds, rather than attempting to reconstruct the compliance file after closing.
You Generally Cannot Publicly Advertise a 506(b) Round
Rule 506(b) prohibits general solicitation and general advertising.
That means founders need to be particularly careful about promoting an investment opportunity through unrestricted channels such as:
public social-media posts;
unrestricted websites;
mass email campaigns;
advertisements; or
broadly promoted investment solicitations.
A private conversation with existing personal or professional contacts presents a very different securities-law analysis from posting, “We are raising $500,000—DM me if you want to invest” on LinkedIn.
The SEC has explained that a pre-existing, substantive relationship can be important in avoiding communications that constitute general solicitation.
For a traditional, genuinely private friends-and-family raise, that limitation may be manageable. But founders should establish their fundraising strategy before broadly announcing the round.
Option 2: Section 4(a)(2) — The Traditional Private Offering Exemption
Section 4(a)(2) of the Securities Act exempts transactions by an issuer “not involving any public offering.”
This is the statutory private-placement exemption from which Rule 506(b) derives.
Unlike Rule 506(b), however, Section 4(a)(2) does not provide the same bright-line safe harbor. The analysis is more dependent on the particular facts and circumstances.
The SEC identifies considerations including whether purchasers have sufficient financial and business sophistication, whether they have access to the type of information normally provided in a registered offering, and whether the securities are acquired without a view toward public redistribution. Public advertising is generally incompatible with the exemption.
The SEC also cautions that as the number of purchasers increases and their relationship with the company and management becomes more remote, establishing the exemption becomes more difficult.
For that reason, founders should not treat Section 4(a)(2) as a generic exemption that automatically covers any small private raise.
Rule 506(b) may sometimes offer greater regulatory certainty because it provides a defined safe harbor, while a direct Section 4(a)(2) analysis is more fact-specific.
Option 3: Rule 504 of Regulation D
Another exemption founders sometimes overlook is Rule 504 of Regulation D.
Rule 504 currently permits eligible companies to offer and sell up to $10 million of securities during a 12-month period.
Unlike Rule 506(b), Rule 504 does not impose the same federal accredited-investor limitation.
That can initially make it sound attractive for a friends-and-family round containing non-accredited investors.
There is an important tradeoff, however.
State Securities Laws Matter Much More Under Rule 504
Rule 506 offerings generally benefit from federal preemption of many substantive state registration requirements, although state notice filings and fees can still apply.
Rule 504 does not provide the same broad preemption. The SEC notes that Rule 504 offerings must comply with applicable state registration and qualification requirements or qualify for available state exemptions.
Therefore, Rule 504 is not automatically “simpler” just because the investors can be non-accredited.
Imagine, for example, that a startup has investors in California, Florida, New York, Texas, and Illinois.
The company may need to analyze the securities laws of each relevant jurisdiction before deciding whether Rule 504 provides an efficient pathway.
Rule 504 also generally prohibits general solicitation, subject to certain exceptions.
Option 4: Regulation Crowdfunding
Sometimes the founder's intended raise does not really resemble a traditional friends-and-family private placement.
Perhaps the founder wants to:
raise money from a large community;
permit smaller investments;
include people without substantial wealth;
advertise the fundraising campaign publicly; or
expand beyond people with whom the founders already have relationships.
In that situation, Regulation Crowdfunding (Reg CF) may warrant consideration.
Eligible companies may currently raise up to $5 million during the applicable 12-month period under Regulation Crowdfunding. The offering must be conducted through an SEC-registered intermediary—either a registered broker-dealer or funding portal.
Reg CF permits participation by both accredited and non-accredited investors, although non-accredited investors are subject to statutory investment limits. Accredited investors are not subject to those Reg CF investment limits.
The tradeoff is additional infrastructure and compliance.
A Regulation Crowdfunding offering involves Form C disclosures, use of a registered intermediary, financial-statement requirements that vary depending on the circumstances, advertising rules, ongoing reporting obligations, and other regulatory requirements.
For a founder raising $200,000 from six people the founder already knows, that structure may be unnecessarily cumbersome.
For a company that wants to raise from a broader community, however, Reg CF may solve a problem that Rule 506(b) does not.
What About Rule 506(c)?
Rule 506(c) is another Regulation D exemption and permits general solicitation.
That makes it attractive when a startup wants to publicly market its fundraising round.
But there is a major distinction:
All purchasers in a Rule 506(c) offering must be accredited investors.
The issuer must also take reasonable steps to verify their accredited-investor status.
That often makes Rule 506(c) a poor fit for the classic friends-and-family round if some relatives or friends are non-accredited.
It can, however, be highly relevant where a founder's network consists entirely of accredited investors and the company wants the freedom to publicly solicit investment.
The Exemption Should Follow the Actual Investor Pool
The practical mistake is choosing an exemption before understanding who will actually be investing.
Before structuring an F&F offering, founders should create an investor list and identify, among other things:
Who are the proposed investors?
How does each investor know the founders or company?
Which investors are accredited?
Which are non-accredited?
Where does each investor reside?
How much will each investor invest?
Has the company already publicly discussed the offering?
What security will the company issue?
How much does the company expect to raise?
Those answers may materially change the appropriate exemption.
For example, a $400,000 raise involving ten existing contacts who are all accredited investors presents a different compliance profile from a $400,000 raise involving fifteen relatives and friends, eight of whom are non-accredited.
And both are different from a founder who wants to advertise a $400,000 raise to thousands of followers online.
The Security You Use Does Not Eliminate the Exemption Analysis
Founders sometimes focus heavily on whether they should issue a:
SAFE;
convertible promissory note;
preferred stock;
common stock; or
LLC membership interest.
That is an important corporate and economic decision.
But using a SAFE or convertible note does not eliminate securities-law compliance.
A company still needs to determine how the offer and sale of that instrument complies with federal and applicable state securities laws.
In other words:
The financing instrument and the securities exemption answer two different questions.
The instrument establishes the investment's contractual and economic terms.
The exemption establishes the regulatory pathway through which the security may be offered and sold without registration.
A properly drafted convertible note does not cure an improperly conducted securities offering.
Form D and State Blue Sky Filings Should Not Be an Afterthought
Regulation D offerings also carry filing obligations.
For Rule 506(b), Rule 506(c), and Rule 504 offerings, issuers generally file Form D electronically with the SEC within 15 days after the first sale.
Founders should also evaluate state securities, or “Blue Sky,” requirements based on where investors reside.
The federal exemption and state-law analysis should therefore be incorporated into the financing timeline—not addressed months after the money arrives.
A Simple Decision Framework for Founders
Although every offering requires its own analysis, founders can begin by asking four questions.
1. Are all investors accredited?
If yes, a Regulation D offering may be relatively straightforward, depending on how investors are being solicited.
If no, the company needs to consider whether Rule 506(b), Rule 504, Regulation Crowdfunding, Section 4(a)(2), or another available exemption fits the proposed transaction.
2. Does the company want to publicly advertise the raise?
If yes, Rule 506(b) generally will not work because general solicitation is prohibited.
Rule 506(c) permits general solicitation but requires all purchasers to be accredited investors and requires reasonable verification of that status. Reg CF may provide another alternative for a broader investor base.
3. How much is the company raising?
Offering size can affect which exemptions are available and whether the compliance cost associated with a particular pathway makes practical sense.
4. Where are the investors located?
Especially under exemptions such as Rule 504, state securities requirements can materially affect the structure and cost of the offering.
The Bigger Lesson: Structure the Round Before Taking the Checks
Friends-and-family rounds often feel informal because the relationships are informal.
The transaction is not.
Once someone provides money in exchange for stock, a SAFE, convertible note, membership interest, or another security, the company has entered the securities-regulation framework.
That does not mean an early-stage capital raise needs to become prohibitively complicated.
It means the company should determine the regulatory pathway before the first investment is accepted.
For founders, the better sequence is generally:
Determine the target raise and financing instrument.
Identify the proposed investors.
Determine accredited-investor status and investor sophistication where relevant.
Identify the applicable federal exemption.
Analyze applicable state securities requirements.
Prepare the financing and disclosure documents.
Obtain required corporate approvals.
Execute the financing documents and accept investments.
Complete Form D and applicable state notice filings when required.
Maintain a complete capitalization and securities-compliance record.
Doing this work before closing can help avoid a situation where a company preparing for its next financing round discovers that its earliest securities issuances were inadequately documented or conducted under an unclear exemption.
Planning a Friends & Family Raise?
A friends-and-family round can be an effective way to capitalize an early-stage company, but the personal relationship between the founder and investor does not replace securities-law compliance.
The appropriate structure may involve Rule 506(b), Section 4(a)(2), Rule 504, Regulation Crowdfunding, Rule 506(c), or another federal or state exemption, depending on the investor pool and how the offering is conducted.
StartSmart Counsel works with startups and growing companies on securities offerings, founder equity, convertible notes, private placements, corporate governance, and capital-raising compliance.
Before accepting investment funds, founders should understand not only what they are offering investors, but also which exemption allows them to offer it.
Contact StartSmart Counsel at 786.461.1617 to schedule a consultation and explore the appropriate structure for your company's friends-and-family financing round.
This article is provided for general informational purposes only and does not constitute legal advice. Securities-law exemptions are highly fact-specific, and federal and state requirements may apply.
