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To Disclose or Not Disclose to Your Investor?

This blog is a part of the "Cleaning House" series on preparing your business for fundraising. See the first article on How to Prepare Your Business for Funding, and our second article on Cleaning House: An Audit for Your Business.


Whether looking for funding, trying to locate an investor or even selling a business outright, one of the most critical questions to consider is whether to disclose an issue. These are questions to ask pre-funding. Generally, when in doubt, disclose. Ask, "is this something I would want to know if I was investing?" This process will help the entrepreneur think like an investor rather than like a business owner/developer. Think like an Investor. Would you invest? If not, why not? Make changes accordingly.

Selling Securities. The act of obtaining an equity investment in a small business is the act of selling a security. In SEC v W.J. Howey Co 328 U.S. 293 (1946), the Supreme Court defined a security as:

  • an investment of money due to
  • an expectation of profits arising from
  • a common enterprise
  • which depends solely on the efforts of a promoter or third party.

The sale of securities is among the most highly regulated of business activities. In Michigan, the sale of securities is regulated by the Michigan Uniform Securities Act MCL 451.2101 ("MUSA"). All exemptions from federal regulation are incorporated into the MUSA. A thorough discussion of federal and state exemptions is beyond the scope of this seminar. However, §509(2) of MUSA states that:

"[A] person is liable to the purchaser if the person sells a security in violation of section 301, or by means of an untrue statement of a material fact or an omission to state a material fact necessary in order to make the statement made, in light of the circumstances under which it is made, not misleading, the purchaser not know the untruth or omission, and the seller not sustaining the burden of proof that the seller did not know and, in the exercise of reasonable care, could not have known of the untruth or omission."

MCL 451.509(2)(a) gives the purchaser of a security purchased in violation of §2 above the right to recover the purchase price of the security plus interest at 6%. (The language cited above is very similar to §10(b)5 of the Securities Exchange Act 15 U.S.C §78j(b), but as stated earlier, a thorough discussion of the rights and obligations of an issuer under the federal securities laws is beyond the scope of this presentation). In other words, one who fails to disclose a material fact is giving their investor an unrestricted right to re-sell the investment back plus 6% interest, in addition to all other rights that the Purchaser may have for the Seller's failure to disclose.

When in doubt, disclose and disclose in writing. Leave no doubt that the information necessary for an investor to make a decision of whether or not to invest, has been fully and properly disclosed in writing. This is one of many reasons why legal counsel should be actively involved in the preparation of the business plan, pitch preparation and revenue projections.

Join us at our office in Bloomfield Hills at 4 p.m. the first Tuesday of every month for the Hertz Schram Deal Incubator where we discuss issues on funding like this one in a casual environment. RSVP for this free event today by emailing: Ksilver@hertzschram.com.

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