California Finance Lenders Law: When An “Investor” Is A Lender
By: Henry Loh, Associate
In the typical investment situation, whether with a publicly listed company or with an entrepreneur starting a new business from home, the financier provides financing to the company or entrepreneur (the “issuer”) in exchange for an equity interest. In such a transaction, the burden of legal compliance with state Blue Sky Laws and federal securities laws generally lies with the issuer.
In many seed money transactions, the primary goal of the financier is to assist the business in getting off the ground. Seed money may be provided in small amounts, perhaps $10,000 or less. In some situations, the financier chooses to provide seed money in the form of a loan, usually in modest amounts.
Providing a loan provides the financier some business benefits over an investment model, because lenders, as compared to investors, may have stronger rights to recover funds. In addition, many of the new entrepreneurs may be sole proprietorships rather than a corporate entity, which means there are no "securities" to be issued or owned.
However, when a financier decides to become a lender rather than an investor, the burden of regulatory compliance generally shifts from the issuer (the company selling equity interests or securities) to the lender. Under the California Finance Lenders Law (California Financial Code, Sections 22000-22780), any person in the business of being a finance lender is required by law to obtain a California Financial Lender License.
Generally, a person is in the business of being a finance lender if he or she provides either (a) a consumer loan, or (b) more than one commercial loan of $5,000 or more in any 12-month period. The lender is permitted to rely upon the representations of the borrower or the terms of the loan documents in determining whether the loan is a consumer or commercial loan. However, the Finance Lenders Law provides that any loan of less than $5,000 is deemed to be a consumer loan, regardless of the actual purpose. See California Financial Code Section 22204(a).
Financiers, particularly those intending to be and calling themselves an investor, should be aware of the California requirement to obtain a Financial Lender License (in certain circumstances). One of the benefits of the Financial Lender License, beyond compliance with the law, is that those holding a Financial Lender License are exempt from California usury laws.