So, let’s say you want to be part of a local investing group. If there is a local investing group functioning in your community already, it would be best to join forces with them, since there is usually more to be gained by working together rather than separately. If you don’t have a working group nearby, or you decide to have a different focus or structure than an existing group, or you have issues with interpersonal dynamics in an existing group, then you should explore what it takes to start a local investing group from scratch.
In an ideal startup situation, you would have these five elements present among your potential members before launching your group:
1. A core group of committed volunteer organizers that can work well together, communicate effectively, have many quality ties in the community, and can stay organized. A few groups are led by just one extremely well-connected, charismatic individual who has a cast of helpers supporting them, but most groups have a small handful of core leaders that share responsibilities and change roles every so often to prevent burnout.
2. KEY: A critical mass of local investors with investable cash who are ready and committed to putting some of their money to work with local small businesses and nonprofits.
3. A shared set of values around investing locally. Members should be motivated to support the group’s cause, and they should be able to agree on how the group will (at least initially) define “local” and what types of investments the group will be focusing on.
4. Buy-in and support from respected members of the community that may or may not be members of the group, including financial, accounting, and legal professionals, business people and business leaders, key nonprofits, and members of local government, media, and educational institutions. At the early stages, if you cannot get widespread buy-in and support, at least try for openness to the concept. Widespread skepticism should be a warning that your community is not ready to embrace local investing.
5. For at least a few members, a willingness to learn and navigate federal and state securities laws and regulations, as they apply to the group and to businesses that come to the group.
How Do Securities Laws Apply?
Regarding securities laws, there are at least two aspects of the law that every group should be aware of. First, and most importantly, you must be sure that your group does not fall under federal and state laws and regulations that cover broker-dealers. If your group does, you should either change your group’s structure and function to avoid this categorization, or if you cannot, quit now (and please tell us about it). Broker-dealers are large and well-funded business organizations that are subject to an overwhelming amount of regulatory scrutiny that local investing groups cannot afford to be sucked into. Generally speaking, broker-dealers are engaged in the business of facilitating investment transactions. As long as your group does not accept compensation for any “services” it may provide to the community, it will most likely not be considered to be in the business of facilitating investments, and therefore not subject to broker-dealer regulation. You are strongly advised to check your state laws regarding broker-dealers to ensure that your group does not fall under their regulatory umbrella. We are planning to build a public online library of relevant state laws; if you learn the legal specifics of your state, please contact us so we can add your state to the library.
The second aspect of securities laws and regulations that local investing groups should know about is how they relate to the local businesses that come to your group with investing opportunities. Since the purpose of securities law is to protect investors, the brunt of compliance, along with the potential consequences of noncompliance, falls on these businesses. However, just because the businesses are on the hook, instead of your group, does not mean that you don’t need to know about how the law affects them. Very few local small business owners and managers know about securities laws or have the time or inclination to figure them out. Therefore, local investing groups have two roles to play here: 1) Creating a process, or a pathway, for local business people to connect with members of your group that will not cause them to violate securities laws as a matter of course, and 2) Educating local business people on how to conduct themselves in order to avoid violations, as well as which legal pathways they may want to take with their investment offerings. A great way to accomplish the second job is to refer local business people to our How to Raise Money Locally course (when published). This course is also recommended for leaders of local investing groups, as it will help them better understand what businesses experience from their side of the equation, and better support them.
We focus more on how to help local entrepreneurs connect with local investors in the next guide, Organizing Business Showcases. For now, the legal basics that you need to know are that, with a few exceptions, local small businesses are not allowed to make public offerings of their investment opportunities. This means that they cannot advertise their opportunities, cannot speak publicly about them, and cannot even speak privately about them with people they do not have a pre-existing relationship with. The interpretation of this principle varies by state; this is important because generally, state securities regulators, not the federal SEC, will take the lead on local investment matters that are brought to their attention. Therefore, it’s crucial to know how your state regulators interpret what constitutes a public offering and what doesn’t – it may be published on their website, and they might be happy to tell you if you call them – and it’s definitely advisable to structure your group’s process to accommodate them. (Again, please let us know what you learn about how your state regulators approach local investing so we can share that knowledge on this site.)
The basic recommended solution to the restriction against unregistered public offerings is for businesses to avoid discussing investment-related issues with people they do not have a pre-existing relationship with. In public, and in private with people they do not already know, business people can discuss almost anything—their personal and business history, their business’ mission and values, the opportunities and challenges they have, and any other non-financial matters—but not investment-related information, including terms, amounts, financial projections, and details of previous investments they have offered. Creating the frameworks that help both investors and entrepreneurs navigate these subtle boundaries is a key role of local investing groups. Local business people should be encouraged to network extensively, meet people that are interested in supporting their business, and build relationships with them over time. Then, in private, with people they have built pre-existing relationships with, they can engage in investment-related discussions and negotiations. Aside from the potential to mobilize investment, this kind of active networking can lead to a wide variety of benefits, such as business partnerships, mentoring relationships, civic initiatives, and community collaborations.
Some securities regulators take the position that a business owner that gets to know a potential investor with the intention of eventually soliciting them for investment funds is actually making a public offering. While it may be difficult for anyone to know the real intention of a business owner, if you are operating in a state where regulators take this position, there are a few things that local investing networks should consider doing to reduce the chances that a local business person will be viewed as making a public offering when they work with the group’s members. For example, membership in your network could be open to more than just investors, more inclusive of all kinds of people that want to support your local economy, especially those that are part of your local economy ecosystem (more on that later). Similarly, your network’s name and mission could reflect the values of supporting local businesses in a variety of ways (such as supporting “buy local” campaigns, or arranging local business mentoring sessions), rather than exclusively through investing. This way, if your network sponsors community outreach events and/or business showcases, business people that participate by discussing their business and business opportunities publicly (or, on the side, privately with people they do not have a pre-existing relationship with) should be less likely to be interpreted as making a public offering. Put another way, your local investing network can potentially create a safer environment for businesses to connect and network simply by having a name, mission, membership, and focus that is truly more expansive than local investing alone. Investment clubs, on the other hand, are by their very nature dedicated to investing, and all their members are by definition investors, so the foregoing does not apply to them. The extent to which business people could be perceived by securities regulators as making public offerings when they deal with investment clubs is mostly untested and unclear, as far as we know, and would vary state to state regardless.
Creating Your Agreements
Now that we have considered those crucial legal aspects, let’s get back to the process of starting your group. Once you have assembled enough of the five recommended elements among your prospective members (volunteer organizers, committed investors, shared values, community buy-in, and a reasonable handle on the legal issues), your group is ready to proceed. Your founding members will need to have a series of meetings in person to discuss, negotiate, and ultimately agree on these things:
1. The group’s name.
2. A mission statement: Relatively short and sweet. Ideally, it should include some civic ideals, such as building relationships and helping the community thrive economically.
3. Whether the group will be a network or an investment club. If the group is a network, will it be members-only or open membership?
4. If the group will be a registered legal entity, and if so, which entity. Clubs must be legal entities, typically LLCs or General Partnerships. There is no standard approach for networks. They can choose to register as nonprofits, which involves some costs and bureaucracy, or they can avoid registration entirely, effectively operating as informal networks rather than as formal entities. Some networks are adopted by nonprofit fiscal sponsors, which allow them to receive tax-deductible donations without being registered directly. Your network can always start unregistered and register later, as needs dictate.
5. How the group will specifically define “local,” in terms of geography, ownership, and other possible factors. Consider a business that employs people locally but is owned by someone outside the area; is it local?
6. What kinds of investments the group wants to focus on. Some groups focus on food investments only, or loans only. Others, like LION, allow anything but discourage real estate mortgages because they are so capital-intensive and are perceived to have a lower local multiplier effect.
7. How the group will govern itself, including defining and filling initial leadership/operational roles, such as Events Coordinator, Membership Coordinator, and Business Outreach Coordinator. For clubs, how will the members vote on investments, and how much do they need to contribute to become members? Even networks that are led by just one person instead of a group can benefit from the perspectives and feedback of other members, perhaps in the form of an advisory group or board.
8. Members-only networks and investment clubs should create a Membership Agreement (also known as a Partnership or Operating Agreement) which is a legal document that memorializes the group’s agreements. It should be written and agreed upon by all founders, and signed by subsequent new members. Open-membership networks do not require it, but can still benefit from a similar document that includes relevant points as a “statement of principles.” Membership Agreements should integrate all of the above items, plus the following:
a) The process of becoming a member, and who is eligible.
b) The process of leaving the group, voluntarily or not.
c) The process of gathering and sharing information about business or investing opportunities.
d) How expenses will be covered and accounted for.
e) How disputes will be resolved.
f) How the Membership Agreement can be amended, or changed.
g) What should be kept confidential, if anything.
h) Waivers of liability and any securities legalese needed (i.e., “This group’s activities shall not constitute an offer to sell, or the solicitation of an offer to buy, securities or any other type of investment or financing vehicle.”)
i) For networks, a commitment by all members that they will make their own investment decisions, not hold anyone else liable for the consequences of their own decisions, and consult their own advisors if needed.
j) Any other guiding principles all members wish to agree on. Remember, any legal agreement should be reviewed by an attorney that specializes in the issues that the agreement pertains to, although it can be challenging to find attorneys that are familiar enough with securities laws and regulations.
Once everything has been decided, your founding members or leaders have all agreed to the key terms and signed the group’s Membership Agreement (if there is one), and the legal entity (if any) has been registered, congratulations! You are ready to go. If you’re an investment network, it’s time to begin spreading the word throughout your community, recruiting new members, and reaching out to businesses that may want to offer local investing opportunities. (If you’re an investment club, you’re subject to somewhat different requirements, so please read more about our Introduction on Investment Clubs and Networks and Special Considerations for Investment Clubs pages. Generally, you cannot engage in general solicitation for new members of your club.)
You might also decide to set up a social media page, a website, and/or an e-mail list for informing your community about your group’s mission and how business people, potential investors, and other interested folks can work with you. Give the local newspaper a heads-up. Contact us to add your group to our Group Directory so others on our site can find you, and let the world know you have arrived!