Kim Lisa Taylor, Esq., is the founder and managing attorney of Syndication Attorneys, PLLC. She has guided entrepreneurs through hundreds of securities offerings totaling more than $5 billion. She is the author of two best-selling books on raising capital, How to Legally Raise Private Money and How to Raise Capital for Real Estate Legally, and hosts the Raise Capital Legally podcast and YouTube channel.
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When an investor in a friends and family raise passes away, their interest passes to their estate and ultimately to their heirs, who have no independent relationship with the sponsor. The sponsor's relationship with the original investor does not carry over to the heirs, so the offering documents and compliance record are what the heirs will review.
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Raising money from friends and family is still a securities offering. The phrase "it's just friends and family" often implies an informal arrangement outside the formal rules, but the reality is that this type of raise has a specific place in federal securities law and carries the same compliance obligations as any other offering.
Where Friends and Family Fit Under Securities Law
Raising capital from a pre-existing personal network corresponds to Rule 506(b) under the SEC's Regulation D, sometimes referred to informally as the "country club rule," reflecting its original purpose of allowing a close-knit group who already knew each other to invest together. Under 506(b), a sponsor can raise unlimited capital with no restriction on the number of accredited investors and can include up to 35 non-accredited but sophisticated investors, provided two conditions are met: no general advertising or solicitation to the public, and a documented pre-existing substantive relationship with every investor established before the offering begins.
For a group of longtime friends and family, that relationship is often genuine, but it still must be documented. The sponsor must be able to demonstrate, for each individual, that a substantive conversation about their financial situation took place before the specific offering was presented.
Three Scenarios Where the Relationship Stops Protecting You
None of the following scenarios depend on how well or how long an investor has been known to the sponsor. Each introduces a new party to the relationship who was never part of the original trust.
The investor passes away. When an investor dies, their interests in the entity pass to their estate and ultimately to their heirs, who have no independent relationship with the sponsor and no context for the history behind the investment. If the deal is underperforming, or if any compliance issues existed in the original offering, heirs have far less reason for patience than the original investor may have had, making full compliance and a solid deal structure essential before any offer is made.
Divorce. An investor's interest in the entity is typically treated as a marital asset and may be divided in a divorce settlement, placing an ex-spouse, who has no relationship with the sponsor, in the position of an interest holder. Where a divorce is contentious, opposing counsel reviewing the marital estate will often scrutinize offering documents, distribution history, and the PPM itself for any leverage, such as a securities violation, to force a buyout and recoup the investment's value.
A significant change in the investor's financial circumstances. An investor accredited at the time of investment may later experience a business failure, market downturn, or health crisis that alters their financial position. If distributions stop or a capital call arises around the same time, the investor may seek a hardship withdrawal, and if the offering was not compliant or the governing documents lack clear hardship or withdrawal provisions, the sponsor may be unable to defend against a forced rescission.
What the Relationship Actually Protects
A documented pre-existing, substantive relationship protects a sponsor specifically on the question of solicitation. Because the investor's financial suitability or sophistication was known before the offering began, presenting the opportunity directly does not constitute general solicitation under 506(b). It doesn't protect against distribution disputes, documentation gaps, inadequate risk disclosures, or suitability issues, and it offers no protection at all once the interest passes to a new party such as an heir, an ex-spouse, or a bankruptcy trustee, who did not choose the relationship and is primarily focused on cashing out the value of the investment.
Documentation That Matters Even With People You Know
Three categories of documentation remain essential regardless of the closeness of the relationship. A properly drafted PPM should disclose material risks, describe the fee structure and distribution waterfall, and give investors the information needed to make an informed decision. Documented suitability conversations begin the required substantive relationship. Even brief records confirming that a suitability discussion took place before the offering and that the investor met the applicable criteria (financial qualifications and/or sophistication), should exist for every investor. An operating agreement should accurately reflect how the entity actually operates in practice.
These documents are not formalities. They are what any future interest holder will ultimately review, whether that person is the original investor, an heir, an ex-spouse, or a trustee.
Frequently Asked Questions
Is raising money from friends and family a securities offering?
Yes. A friends and family raise has a specific place in federal securities law and carries the same compliance obligations as any other offering.
Which exemption applies to a friends and family raise?
Raising capital from a pre-existing personal network corresponds to Rule 506(b) of Regulation D. It requires no general advertising or solicitation to the public and a documented pre-existing substantive relationship with every investor, established before the offering begins.
What happens to an investment when an investor passes away?
The interest passes to the investor's estate and ultimately to their heirs. The heirs have no independent relationship with the sponsor, so the original relationship does not protect the sponsor with them.
Does a pre-existing relationship protect the sponsor in a dispute?
Only on the question of solicitation. It does not protect against distribution disputes, documentation gaps, inadequate risk disclosures, or suitability issues, and it offers no protection once the interest passes to an heir, an ex-spouse, or a bankruptcy trustee.
What documentation do I need when I raise money from people I know?
A properly drafted PPM, documented suitability conversations for every investor, and an operating agreement that accurately reflects how the entity operates in practice.
How Can I Make Sure My Friends and Family Raise Is Compliant?
Sponsors who may have previously raised capital informally from friends and family and want to ensure compliance going forward may schedule a consultation at syndicationattorneys.com/schedule.
To learn more about raising capital legally, get a free digital copy of one of our books.
Suggested Next Reads:
> You Drafted Your Own Syndication Docs. Here’s What’s Probably Missing.
> PPM vs. Operating Agreement: The Inconsistency That Kills Sophisticated LP Deals
Conclusion
Sponsors who may have previously raised capital informally from friends and family and want to ensure compliance going forward may schedule a consultation at syndicationattorneys.com/schedule.
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This content provides general information on federal securities law and is directed to non‑Florida residents or companies. It is not legal advice and is not intended as advertising or solicitation of legal services for Florida residents or Florida law matters. Use of this content or contacting us about it does not create an attorney–client relationship.
