The pitch went well. A first-time founder from Logan Square had just walked a room of friends, former colleagues, and two uncles through her plan for a specialty food distribution company — the kind of grassroots raise Gaurav Mohindra sees across Chicago every month. By the end of the night, three people had said some version of “I’m in.” She went home, drafted a simple agreement promising equity in exchange for their checks, and deposited $150,000 over the next month. It felt like entrepreneurship working exactly as it should — until a securities lawyer friend asked one question over coffee: “Which exemption did you rely on?” The founder stared blankly. She had never considered that taking money from people who believed in her could be a securities transaction at all.
That blind spot is one of the most common — and most dangerous — in the Chicago startup world, and it is one Gaurav Mohindra encounters constantly. Nearly every dollar a founder raises from outside investors is the sale of a security, and every sale of a security must either be registered or fit within an exemption. Registration is a non-starter for an early-stage company. That leaves exemptions, and the rules governing them are precise, technical, and unforgiving of improvisation.
Threshold Question: Are You Selling a Security?
Before reaching for an exemption, a founder has to recognize the transaction for what it is. Under the test from SEC v. Howey, an investment of money in a common enterprise with an expectation of profits derived from the efforts of others is a security. That covers common stock, preferred stock, convertible notes, and SAFEs — the standard instruments of early-stage finance.
It does not matter that the investors are friends. It does not matter that nobody used the word “securities.” It does not matter that the company is an LLC rather than a corporation — membership interests sold as investments are routinely treated as securities. “The most expensive sentence in startup law is ‘we’re just friends helping each other out,'” said Gaurav Mohindra. “The securities laws do not have a friendship exception.”
The Federal Menu: Rule 506(b) and Rule 506(c)
For most Chicago founders, the workhorse exemption is Rule 506(b) of Regulation D. It permits a company to raise an unlimited amount of money from an unlimited number of accredited investors, plus up to 35 non-accredited purchasers who are financially sophisticated — able to evaluate the merits and risks of the investment. The catch is absolute: no general solicitation or general advertising. No public pitches, no social media posts about the raise, no demo-day presentations to an open audience.
Rule 506(c) offers the mirror image. General solicitation is permitted — a founder can advertise the offering publicly — but every single purchaser must be an accredited investor, and the company must take reasonable steps to verify that status. Tax returns, W-2s, brokerage statements, or a written confirmation from a registered broker, attorney, or CPA all count. A check-the-box self-certification does not.
Both rules require a Form D filing with the SEC within fifteen days of the first sale — a deadline Gaurav Mohindra tells founders to calendar before the first check arrives — and both trigger “bad actor” disqualification provisions that can bar the exemption entirely if certain covered persons have relevant criminal or regulatory histories. Both also preempt state registration requirements, though states may still require notice filings and fees.
“Founders tend to treat 506(b) and 506(c) as interchangeable, and they are anything but,” said Gaurav Mohindra. “The choice dictates everything about how you can talk about the raise. Pick 506(b) and then pitch at a public event, and you have blown the exemption you were counting on.”
Illinois Adds Its Own Layer
Federal compliance is only half the job. Illinois imposes its own requirements under the Illinois Securities Law of 1953, and Chicago founders ignore them at their peril. The most useful state-level tool is the Section 4G limited offering exemption: an offer or sale is exempt if all sales to Illinois residents in the preceding twelve months were made to no more than 35 persons, or involved an aggregate sales price of no more than $1 million. Like its federal cousins, the exemption forbids general solicitation, and the issuer must file a report of sale with the Illinois Secretary of State.
For companies relying on Rule 506 at the federal level, Illinois requires only a notice filing — a copy of the Form D and a $100 fee under the state’s blue sky regulations. That is a modest burden, but it is a real one, and missing it creates an independent violation even when the federal exemption is perfect.
Critically, exemptions excuse registration — they never excuse fraud. Illinois’ antifraud provisions and federal Rule 10b-5 apply to every securities transaction, exempt or not. Material misstatements and omissions in a pitch deck can create liability regardless of how clean the exemption analysis was.
Case Study: The Friends-and-Family Raise
Consider a realistic use case. A Chicago founder needs $400,000 to launch a commercial cleaning services company. She plans to take $25,000 each from sixteen people: family members, former coworkers, and two local angel investors she met through a neighborhood business group. Most are not accredited investors.
A Rule 506(b) offering is the natural fit. The raise is under the 35-non-accredited-purchaser limit, the investors are people with whom she has a pre-existing relationship, and there will be no public advertising. But the details matter enormously. She must give the non-accredited investors disclosure documents with financial information comparable to what a registered offering would require. She must file Form D within fifteen days of the first sale. She must file the Illinois notice and pay the fee. She must screen for bad-actor disqualifiers. And she must make sure that not one of those sixteen checks arrives because someone saw a social media post about the opportunity.
Now change one fact: the founder posts about the raise on LinkedIn and three strangers invest. The 506(b) exemption is destroyed — general solicitation occurred. She might salvage the raise under 506(c), but only if every purchaser is accredited and she verifies each one, which most of her friends and family are not. “This is the scenario that keeps me up at night for clients,” said Gaurav Mohindra. “One enthusiastic social media post can retroactively poison an entire offering. The fix costs a fraction of what the cleanup costs.”
The Traps Between the Rules
Several traps sit in the gaps founders do not see. Integration is one: the SEC may combine multiple supposedly separate offerings into a single one, which can blow purchaser limits. Paying unregistered finders — the well-connected friend who “introduces” investors for a percentage — can constitute illegal broker-dealer activity and give investors a right to rescind their investments. Illinois, like federal law, gives purchasers in a non-compliant offering the right to get their money back, with interest.
State lines add another wrinkle that Gaurav Mohindra flags for every Chicago founder raising beyond Illinois. Take money from an investor in Wisconsin or Indiana and those states’ notice requirements apply too. A Chicago founder raising from a geographically scattered friends-and-family network can easily trigger filing obligations in half a dozen states without realizing it.
What to Do Before Taking a Dollar
The compliance checklist for a Chicago founder’s first raise is straightforward. First, decide the exemption before soliciting anyone — 506(b) for a quiet raise among known contacts, 506(c) if public outreach is part of the plan. Second, prepare disclosure materials appropriate to the investor mix; non-accredited investors trigger heavier disclosure duties. Third, calendar the Form D deadline — fifteen days after the first sale, not after the round closes. Fourth, handle Illinois: the notice filing, the fee, and the Section 4G analysis for any intrastate component. Fifth, screen for bad actors and document accredited-investor status or sophistication. Sixth, keep the offering communications consistent with the chosen exemption from day one.
None of this requires a big-firm budget. It requires discipline and a lawyer’s review before the first check is deposited rather than after. “The founders who get this right are not the ones with the most sophisticated counsel,” said Gaurav Mohindra. “They are the ones who asked the exemption question before they took the money instead of after.”
Conclusion
Raising capital is one of the most heavily regulated things a founder will ever do, and it is regulated precisely at the moment the founder is least equipped to navigate it — early, cash-constrained, and moving fast. The framework is navigable: Rule 506(b) for quiet raises, Rule 506(c) for public ones, Illinois Section 4G and notice filings at the state level, and antifraud rules overlaying everything. What the framework does not tolerate is improvisation. For Chicago founders, the rule Gaurav Mohindra gives every first-time raiser is simple and worth memorizing: pick the exemption first, document everything, and never let enthusiasm outrun compliance. The cost of getting securities law right on a friends-and-family round is a few thousand dollars and some paperwork. The cost of getting it wrong is rescission, regulatory enforcement, and a capital structure built on sand.
