How to Tell if Your Start-Up, Music, or Real Estate Financing is a Security – and What to Do About It

Washington DC’s Kennedy Center is a major performing arts center that operates as a private-public partnership under the auspices of the Smithsonian. According to a recent New York Times article, the Center has a $268 Million budget, $43 Million of which is funded by the federal government. 

In February, vowing to make programming changes, President Trump overhauled the Center’s leadership.  Trump replaced President Biden’s board appointees, fired the Center’s president and several other top personnel, and appointed himself as Chairman.  Among those removed from the Board was Chairman David M. Rubenstein, who first was appointed to by President George W. Bush and was set to step down in 2026. The leadership changes brought to forefront the funding challenges faced by all arts organizations, even large ones like the Kennedy Center, which are designed to operate as nonprofits.  

A March 28, 2025 Washington Post article reported that the Center was facing a $100 Million operating deficit in fiscal year 2025. Like most arts organizations, grants and donations are a significant revenue source, and according to the article, made up 49 percent of the Center’s fiscal year 2023 budget.  

Many arts organizations, including Kennedy Center, select their board with the expectation they will help with fundraising either through their connections or even make significant contributions themselves.  For example, a New York Times article reported that during his 15 years as Chairman, Rubenstein had donated more than $100 Million Dollars to the Center.

Other arts organizations, often those with finances that cannot support many full-time staff,  populate their board with individuals who have the skill sets they need to support their mission. And a board could have members in both categories. Neither strategy is inherently better than the other – the key is finding the best strategy for the organization’s needs.  

The same is true with for-profits – whether they be a startup, real estate investment, established business, music royalty fund, or a music group seeking to finance their tour. While a non-profit may rely on donations, it’s less likely that a for-profit enterprise will be able to solely base their fundraising on the generosity of others who don’t expect anything in return. And, the approach to fundraising must meet the issuer’s needs.

 This article discusses the types and respective popularity of exempt securities offerings and the types of issuers for which they might be most appropriate.

 What is an Investment Contract?

 Before starting fundraising, someone should determine whether they need to comply with securities laws. Donations with no possibility of a financial return on the part of the donors, such as GoFundMe campaigns, don’t trigger federal securities laws. Donations tied with a product, such as when a music group provides donors who contribute a certain amount a free mug, t-shirt, or poster, such as what one might see on Kickstarter or IndieGoGo, also usually won’t trigger securities laws.

 However, selling stock, LLC interests, and certain loans can require securities law compliance. And no matter how it’s structured, any time there’s an opportunity for a return on the financial contribution, the “contribution” will probably become an investment contract under the Securities Act of 1933 (Securities Act). The Securities Act doesn’t define “investment contract.” However, in 1946, in SEC v. W.J. Howey Co. the US Supreme Court crafted a definition of “investment contract,” which has remains largely unchanged today.

 Howey involved the sale of the orange groves with the optional management agreement, something that doesn’t seem much like a security, such as a stock or bond. However, the Supreme Court held that the sale of orange groves was an “investment contract.” In Howey, the Court held that a business transaction is an investment contract if:

1.       There is an investment of money (or other assets).

2.       The investment is in a common enterprise (generally this means a pooling of assets).

3.       There is an expectation of a profit.

4.       The profit comes from the efforts of a promoter or a third party.

Since Howey, a number of unlikely investments, including whiskey warehouse receipts, pay phones and ATMs with placement contracts, interests in a lumber mill, commercial real estate, and music royalty funds have been found to be investment contracts.

Securities Law Exemptions

Once something is a security, the Securities Act requires that securities offerings be registered with the SEC unless an exemption exists. Registering securities is costly and time-consuming, which works best for large operations. So, most smaller issuers offer securities under an exemption.

Offerings must comply with state securities laws in addition to federal securities laws. Qualifying under state securities laws increases the cost and time involved in the offering, which can be burdensome for smaller offerings or new issuers. This article discusses only federal exemptions which preempt state securities laws.

Regulation D

Before the 2010s, most unregistered securities used the private placement exemption under Rule 506(b) of Regulation D (Reg D). Rule 506(b) was adopted under Section 4(a)(2) of the 1933 Act, known as the private placement exemption. So, Rule 506(b) prohibits general advertising and general solicitation of investors.  So, someone involved in a Rule 506(b) offering can’t market to investors through social media posts, large email blasts, group texts, radio ads, etc. In an increasingly digital world, these limitations can seriously hamper marketing efforts.

In contrast to Rule 506(b), Rule 506(c) permits general advertising. So, someone raising money under Rule 506(c) can engage in a social media campaign, advertise the offering on their website, and engage in wide scale direct US mail or emails advertisements.

Being able to publicly advertise a campaign might sound like it would almost always be the best way to pursue fundraising since it would bring publicity to the issuer while also maximizing the possibility of identifying investors.  However, there’s a tradeoff for the ability to advertise -- Rule 506(c) offerings may be sold only to accredited investors. Rule 506(b) offerings, on the other hand, can include up to 35 non-accredited investors.

To be accredited, individual investors must meet specified requirements regarding their income, net worth, securities licensure, or have specified business relationships to the issuer. For example, individuals must have a net worth of $1 Million (excluding their home) or annual income of $200,000 (or $300,000 with their spouse or partner).

Whether limiting the offering to accredited investors poses a problem depends on the target audience. It might not be a problem for a commercial real estate fund with a minimum investment of $25,000 to require investors to be accredited. However, a Rule 506(c) offering wouldn’t be appropriate for a singer songwriter trying to finance their first album, whose target audience is comprised of fans, who might not have enough net worth or income to be accredited.

Rule 506(b) permits investors to self-certify their accredited status. Rule 506(c) does not. So, 506(c) offerings require more scrutiny into investors’ financial situations than Rule 506(b) offerings, making Rule 506(c) offerings less attractive for investors who want to keep their financial information private.

Regulation CF

Regulation CF (Reg CF), governing equity crowdfunding, is exemption. While crowdfunding sounds like a great idea, Reg CF includes restrictions on who can use it and how funds can be raised.

Reg CF can be used only to raise equity for operating companies and can’t be used for “blind check” companies. So, Reg CF isn’t available to a blind real estate fund, for a musician to finance a to-be-determine project,  or other investments whose assets or purposes haven’t yet been determined. This restriction poses a challenge for funds which may raise funds to buy assets and  must make the offering before identifying all the assets the fund will own. It also could be a challenge for a music group who wants to see how much money they can raise before deciding whether to allocate the funding to recording, touring, equipment purchase, etc.

Reg CF offerings must be sold only through an authorized investment platform, which adds to the offering costs. Typically, the platform fee includes a fixed fee plus a percentage of the amount of money raised, so platforms only want to back winners.  So, access to the most popular platforms can be competitive. And when the fixed fee is added to the percentage raised, total platform fees for a small offering can be a significant percentage of the funds raised.

Reg CF also limits how much the issuer can raise ($5 Million). While our singer songwriter might not want to raise anywhere near to $5 Million, Reg CF may be unsuitable for larger projects, such as an apartment complex purchase.

Unlike Rule 506(b), there is no limit to how many unaccredited investors can invest.  However, while accredited investors may invest as much as they want under Regulation CF, there are dollar limits ranging from $2,500 to $90,000 on how much unaccredited investors can invest. And dollar limits for unaccredited investors are based on all the investors’ Regulation CF offerings in which the investors has invested, so someone needs to verify how much investors have invested across all platforms.

The small investment amounts translate to a large number of investors. Most investment funds are limited liability companies that are taxed as partnerships and must provide annual tax documents allocating profits and losses to their investors. So, having a large number of investors adds to the issuer’s administrative burden. While corporations and limited liability companies that elect to be taxed as corporations need not allocate profits and losses to individual investors, Reg CF still adds to the regulatory burden and accounting costs because it requires all issuers to file annual reports with the SEC for up to several years after the offering.

Regulation A/A+

Although some refer to Regulation A (Reg A+) as an exemption, it actually is a streamlined registration process. Sometimes called "mini-IPOs," Reg A+ provides two tiers of offerings under which companies can raise up to $75 Million in a 12-month period. Since Reg A offerings require SEC review, they generally take longer and cost more than Rule 506 offerings. And Reg A+ issuers must file annual reports with the SEC, which adds to the ongoing cost and regulatory burden.

Many Reg A+ offerings are sold on platforms like those used for Reg CF, so issuers will have to pay platform fees.  Plus, only some Reg A+ offerings require qualification under state securities laws as well as compliance with federal securities laws, which adds to the offering’s regulatory burden.

Although unaccredited investors can invest in Reg A+, like Reg CF, the amount they can invest is limited. Still, Reg A+ is getting attention from some issuers who need to raise more than $5 Million, want access to unaccredited investors, and can afford the time and expense involved in an SEC review and ongoing reporting burden.

Conclusion

Raising money, whether it be for a start-up, artistic endeavor, or real estate investment, can involve walking through a minefield of legal regulation, and one wrong step can cause a fundraising plan to blow up.  While it may be possible it may seem like an unnecessary expense, one of the best “investments” these endeavors can make in their futures is to have an experienced securities attorney on their team.  Not only can a securities attorney help ensure securities law compliance, but they also can help find the best fundraising option for the specific need – and sometimes, can structure a fundraising so it’s not a security and doesn’t need to comply with securities laws.

© 2025 by Elizabeth A. Whitman

Any references to clients and their legal situations have been modified to protect client confidentiality.

DISCLAIMER: The content of this blog is for informational purposes only and does not provide legal advice to any person. No one should take any action regarding the information in this blog without first seeking the advice of an attorney. Neither reading this blog nor communication with Whitman Legal Solutions, LLC or Elizabeth A. Whitman creates an attorney-client relationship. No attorney-client relationship will exist with Whitman Legal Solutions, LLC or any attorney affiliated with it unless a written contract is signed by all parties.