A “security” is, broadly speaking, an investment in a venture by a person who has a reasonable expectation of profits from the investment with such profits resulting from the entrepreneurial or managerial efforts of others.

Why is it important to know what a security is?  Because if something is a security, it is subject to a great deal of regulation at both the state and federal level.  A business cannot offer a security to investors without first registering the offer with government regulators or identifying an exemption to the registration requirement and completing any filings associated with such exemption.  Complying with securities regulations can be quite time-consuming and costly.

So, let’s say you and some buddies are starting a co-op – do you have to be concerned about securities regulation?

As you might guess, that depends on several factors!

First, what type of co-op is it?  Is it a worker co-op in which all of the members actively participate in the management and day-to-day operations?  In that case, arguably, membership in the co-op is not a security because the definition of a security requires that the profits to the investor must result from the “efforts of others.”

If it is a co-op in which members are not actively involved in the management, such as a consumer co-op grocery store, memberships may be considered securities.  This would depend on whether the members expect to receive a profit from their membership.  Do the members expect to receive patronage dividends at the end of the year?  If so, this type of membership would certainly seem to be a security and therefore subject to securities regulation.

But wait!  Before you panic, these memberships are likely to fall under some exemptions from securities regulation.  Let’s start with federal securities law.  There is an exemption from federal securities registration for offerings to residents of the state in which the co-op conducts most of its business and in which it is incorporated.  To rely on this exemption, you must make sure that all of your members live in the state in which you operate and are incorporated.  If even one membership is sold to someone outside the state, you could lose the exemption.  For a summary of federal securities law, see the SEC’s page on small business and securities regulations.

Now, what about state securities law?  Every state is different.  In California, there is an exemption from securities regulations for co-ops whose  members’ do not invest more than $300.  In Maryland, there is a blanket exemption of memberships in consumer co-ops from securities regulations.

It’s important to be aware of these issues before selling memberships in your co-op (or an investment in any small business)!

For some interesting observations about how securities laws stack the deck against small businesses, check out a recent article by Michael Shuman.

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