What to do if investor is interested in your band?

November 8, 2011

Dear Music Lawyer,

Someone is interested in investing $5,000 in my band. He's a friend of a friend and said he wants to sign a contract. Do music lawyers write investor contracts? What should we do? We could really use the money.

—Lance

Dear Lance,

Taking on investors raises a number of legal and tax issues depending on how many investors a band wants to take on and how much money they plan to raise. I typically refer bands that want investment contracts drafted to corporate lawyers and accountants because there is a complex set of federal and state securities laws that regulates how one can legally accept equity investors. It's imperative that a band check with someone familiar with these ever-evolving rules and any required paperwork that needs to be filed with the U.S. Securities & Exchange Commission before accepting the money to avoid any problems down the road.

It's also important that you are aware of the type of investor from whom you may accept money. You would be wise to only accept money from what are known as "accredited investors." For an individual to qualify as an accredited investor, he or she must satisfy either an income or net worth standard.

The income standard currently requires the investor to have income that exceeds $200,000 in each of the two most recent years or joint income (i.e., with his/her spouse) that exceeds $300,000 in each of those two years. The potential investors must also have a reasonable expectation of reaching the same income level in the current year.

The net worth standard requires an investor, at the time of investment, to have an individual net worth of over $1,000,000 excluding the investor's primary residence.

In sum, the accredited investor standard seems aimed at making sure a person is accepting money from a sophisticated individual who is unlikely to be able to claim that he or she was unaware of the investment risks.

Of course, people can and do take money from non-accredited investors, but there are limits to how much money can be accepted from such investors and additional disclosures are required under the securities laws to ensure that the non-accredited investor was fully informed of the risks (including loss of all of his or her investment). Whether a potential investor was fully informed is difficult to pinpoint so the general consensus seems to be to stick with accredited investors who really are savvy and have enough resources to survive any potential loss.

Finally, you will need to learn how to treat investment income when the band files its own tax returns. If you don't already have a band accountant, it would be wise to get one prior to taking on investors.

—Amy E. Mitchell