The Friends and Family Investment Round

As the saying goes: your network is your net worth. For many startups that are just starting to raise capital, friends and family are the best source of funding. However, securities laws both at the state and the federal level require a startup issuing securities to either register the offering with the SEC and the state, or find an exemption that allows the startup to complete the offering without a great deal of regulatory compliance work.

The big hurdle with the friends and family round surrounds the idea of accredited investors. For many founders their network is full of contacts who believe in their vision, but do not fall into the definition of an accredited investor. To compound things further, many rules require increased disclosures, such as audited financials, if the startup will allow non-accredited investors into the round (see Rule 506). If a large chunk of friends and family round is chewed up with legal and accounting costs, the whole ordeal starts to become more of a hassle then it’s worth.

This post explores two viable options that allow a California company to raise capital from friends and family—some of which who are non-accredited investors— without the large burden of legal and accounting costs.

The two options we’ll analyze are SEC Rule 504 and SEC Rule 147, both of which require a California startup to also consider Section 25102(f) of the CA Securities Code.

Rule 504

Of the two ways Regulation D allows a company to accept investment from non-accredited investors, Rule 504 is the more practical. Rule 506 allows a startup to include up to 35 non-accredited investors, but you must provide the investors with the same information as is provided in a registered offering. This requirement generally makes it too costly to conduct a small raise from friends and family.

Under Rule 504, a startup can raise up to $1 million over a twelve month period, and you can accept investment from non-accredited investors without the information disclosures. The two things to factor into a Rule 504 raise are:

  • No general solicitation of the offering is allowed; and
  • Unlike Rule 506, which preempts state registration requirements, Rule 504 does not.

Therefore, if an issuer relies on Rule 504 they must find a state securities exemption to keep the compliance cost at a minimum. For a CA startup this is where 25102(f) comes in.

CA Rule 25102(f)

Pursuant to 25102(f) a company can sell securities to an unlimited number of accredited investors and company executive, and up to 35 non-accredited investors, as long as the unaccredited investors satisfy one of the following stipulations:

  • The investor has a preexisting personal or business relationship with the company or its principals/founders; or
  •  The investor has the ability to protect their interests due to their financial experience or the fact that they have experienced professional advisors.

Additionally, in order for the transaction to be compliant with 25102(f), all purchasers must state in writing that they are purchasing for their own account, the offering must not be advertised to the public, and you must file a 25102(f) exemption notice with the CA department of business oversight.

Speaking generally, the idea of a preexisting person and/or business relationship is to allow the investor to evaluate the character, experience and circumstances of the person with whom the relationship exists. As for financial experience, the rule is looking to see if the investor has previous experience investing in these types of offerings, and/or has experience operating or working with a similar venture.

For a first time startup it is all but imperative that the analysis of a pre-existing personal or business relationship and financial experience of the non-accredited investor be analyzed with the assistance of legal counsel. Unfortunately there is not a black and white rule for either, and the experience of a lawyer can go a long ways to protect the startup from downstream issues.

Intrastate Exception

The second federal exemption to consider (and remember, whenever you satisfy a federal exemption you must also consider state rules, such as 25102(f)) is the federal Intrastate Exemption. The federal Intrastate Exemption exempts “any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.”

The goal of this federal exemption is to allow an a company who is doing business primarily in the one state to offer securities to investors in the same state without extensive regulatory compliance. This safe harbor rule is intended to make it feasible for startups to complete an offering to accredited and non-accredited investors provided some key factors are met.

To comply with Rule 147 the CA company must satisfy the following**

  • The startup must be incorporated in CA and its principal office must be in CA
  • 80% of the startup’s gross revenues and assets are in CA
  • The proceeds from the raise must be used for services or property in CA
  • Cannot offer the securities to non-residents for a period of nine months from the date of last sale and for the nine-month period all resales must be to CA residents
  • Securities must contain a legend evidencing that the securities have not be registered under the Securities Act and setting forth other limitation of resale, transfer and written confirmation of the purchaser’s residence

**Rules discussed at a high level, a longer discussion with legal counsel is necessary to ensure compliance with all of the Intrastate rules.

Just like Rule 504, if the Federal Intrastate Exemption applies the startup must now consider state rules. For CA startups, the rule generally relied upon is 25102(f) as discussed above.


A key consideration: just because you can take money from friends and family members who are not accredited investors doesn’t mean you should. With all startups there is a high chance of failure. For the sake of your relationships, and for legal reasons, it’s a good rule of thumb to only take investment from someone who can bear the risk of loss. The more likely it is that loss of the investment would be a significant hit to the investor’s savings, the more likely it is to damage the relationship and potentially cause legal trouble (such as claiming fraud or misrepresentation).

Completing a friends and family raise can be critical to your success and also very exciting, but it’s not without its traps. You should always consult an attorney to ensure that you’re taking the right steps to set you up for success.

Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.