One of the leading tests on if a tool is a security or not is “what the character of the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.” Marine Bank v. Weaver, 455 U.S. 551, 555-56 (1982)(citations omitted). The Supreme Court also indicated a security would include the “countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” Id.
This definition, and the definition in the various legislative Acts, is extremely broad. This language is designed to collect as many different types of securities as possible to ensure no fraud occurs in the transactions. This means it may be “easier” to assume something is a security regardless of if the tool is a security or not.
The problem for companies, especially startups and entrepreneurs, is this broad definition tends to mean the friends and family round can be a security. While some people have the rich uncle or neighbor, most of the time friends and family run the risk of not being supported under the SEC securities exemption rules.
While the standard is intentionally broad and vague, it does not necessarily follow that an instrument is a security if it has one or several markers of being a security. For example, in Weaver, the instrument in question involved a set monthly payment, a share of the profits, the right to use a barn and a pasture, and the right to veto future borrowings. However, because of the individualistic and unique nature of the document, it was not a security according to the United States Supreme Court.
When looking at raising capital, securities are almost always going to be relevant in the discussion. Sometimes the difficulties in registering the security can be overcome and even the best choice. In other instances, there may be a security and an exemption allowing for limited or no registrations. Speak with an attorney to help find and understand the various exceptions and non-security options available to you.