Raising venture capital is often treated as a milestone to celebrate. Legally, it’s the point where a founder goes from running a company to being accountable to outside investors, with their money at stake and lawyers on call. Most founders who get into trouble aren’t villains. They’re people moving fast, saying optimistic things, and signing documents they didn’t fully read.

Here are the most common ways funding rounds turn into legal problems, and how to avoid them.

1. Overselling in the pitch

Every founder pitches optimistically, but there is a line between optimism and misrepresentation. Stating that you have “signed customers” when you have letters of intent, presenting projections as booked revenue, or claiming a partnership that is still a conversation can all cross it.

In England and Wales, a person who makes a misrepresentation can be liable in damages even if it wasn’t fraudulent, unless they prove they reasonably believed it was true under the Misrepresentation Act 1967. The Act doesn’t extend to Scotland or Northern Ireland, which have their own rules. If a statement is knowingly false, it can become a crime. Under section 2 of the Fraud Act 2006, fraud carries up to 10 years’ imprisonment on conviction on indictment. Misrepresentation Act 1967 +2

In the US, the anti-fraud rule, SEC Rule 10b-5, covers securities sold by private companies too, not just public markets (WilmerHale analysis). Theranos is the extreme case: Elizabeth Holmes was sentenced to 11 years and three months after being convicted on three counts of investor fraud and one of conspiracy (Jurist report). tbsnews

The lesson: Label projections as projections. Keep evidence for every factual claim in your deck, and correct earlier statements if circumstances change before closing.

2. Promoting the round in the wrong way

Many founders don’t realise that fundraising is itself a regulated activity.

  • UK: Section 21 of the Financial Services and Markets Act 2000 says you can’t communicate an invitation or inducement to engage in investment activity in the course of business unless you’re authorised or an authorised person has approved the content. Most start-ups rely on exemptions instead, such as those for certified high-net-worth or self-certified sophisticated investors. These have conditions on wording, investor declarations and record-keeping, and the criteria have been revised in recent years, so check the current rules. Vestd’s founder’s guide to financial promotion is a practical starting point. Breaching the restriction is a criminal offence.
  • US: Under Regulation D, Rule 506(b) offerings can’t use general solicitation. Rule 506(c) allows it, but only if every purchaser is accredited and you take reasonable steps to verify that (SEC compliance guide). Tweeting “we’re raising!” with deal terms can jeopardise a 506(b) exemption. You also need to think about Form D filings and state “blue sky” rules. If an exemption you relied on falls away, investors may have rescission rights.

3. Paying the wrong people for introductions

“Finders” who introduce founders to investors for a success fee are a classic trap. In the US, a person who solicits investors and takes transaction-based pay has generally had to register as a broker-dealer. The SEC proposed a limited finders’ exemption in 2020 (Jones Day summary), so check its current status. In the UK, arranging deals in investments can be a regulated activity requiring FCA authorisation. Both the intermediary and the company can end up exposed.

The lesson: Check whether anyone taking a fee on your round is properly authorised before you sign anything.

4. Giving warranties you can’t stand behind

Investment documents such as the share subscription agreement contain warranties: statements about your cap table, IP ownership, contracts, litigation, tax, compliance, and accounts. Founders often give these personally, and breaches can trigger claims against them individually.

Common landmines:

  • IP not actually owned by the company. Code written by freelancers without an assignment, or work created while employed elsewhere, can undermine your ownership.
  • Cap table errors. Informal promises of equity to advisers or early hires that were never documented.
  • Undisclosed liabilities. Side agreements, disputes, or regulatory issues that never made it into the disclosure letter.

Disclosure against the warranties is your protection. Being vague or incomplete leaves you exposed.

5. Getting share issuance and tax mechanics wrong

Issuing shares is a formal process. In the UK, directors need authority to allot shares, must respect pre-emption rights unless disapplied (both in Part 17 of the Companies Act 2006), and must file the appropriate returns at Companies House. Skipping steps can create shares that are open to challenge, which tends to surface during due diligence for your next round.

Tax traps are just as common:

  • Employee equity: Granting shares or options at an undervalued price can trigger income tax and NIC liabilities. Companies must also report to HMRC: the annual employment related securities return is due by 6 July, with penalties for late or inaccurate filings.
  • SEIS/EIS: If you promise investors tax relief and the company doesn’t qualify, they’ll come to you. HMRC’s advance assurance service is explained on GOV.UK, but an assurance based on limited disclosure isn’t valid, and relief can be withdrawn if HMRC later finds the company failed to disclose relevant facts.

6. Treating investor money as your own

Once you have institutional money, related-party dealings get scrutinised. Under the Companies Act 2006, a company can’t lend to a director, or guarantee a director’s loan, without member approval (section 197). Sales or purchases of substantial assets involving directors also need member approval (section 190). Using company funds for personal expenses, paying yourself unapproved bonuses, or routing payments to founder-linked entities can breach both the law and your investment covenants. It also destroys trust, which is the real currency of a VC relationship.

7. Director duties when the money runs out

VC funding encourages growth spending, and a high burn rate combined with a missed next round is how directors get into trouble. UK directors owe the general duties in sections 171–177 of the Companies Act 2006. In BTI 2014 LLC v Sequana SA [2022] UKSC 25, the Supreme Court confirmed that when a company is insolvent or bordering on insolvency, or insolvent liquidation or administration is probable, the duty to act for the company’s benefit includes creditors’ interests (Baker McKenzie summary).

Continuing to trade when there is no reasonable prospect of avoiding insolvent liquidation risks wrongful trading claims. Under section 214 of the Insolvency Act 1986, a court can order a director to contribute to the company’s assets on the liquidator’s application. Directors have a defence if they took every step to minimise losses to creditors.

In the US, directors’ fiduciary duties are shaped by state law, and conflicts between common and preferred shareholders have generated plenty of litigation.

8. Signing terms you didn’t understand

Not every legal problem is a breach of the law. Some are just contracts. Founders often discover too late that they agreed to:

  • Exclusivity or no-shop clauses that bar talking to other investors
  • Aggressive vesting, leaver, or clawback provisions
  • Drag-along or veto rights that hand control to investors
  • Personal guarantees or joint and several liability

These rarely feel dangerous at signing, and often become very expensive in a dispute.

How to protect yourself

  1. Use a specialist lawyer early, especially for the term sheet, documents, and exemptions.
  2. Build a data room and disclosure trail so every claim can be evidenced.
  3. Clean up your house first: IP assignments, cap table, contracts, and filings.
  4. Keep investor communications consistent and put material updates in writing.
  5. Separate personal and company finances completely.
  6. Take advice at the first sign of distress, not after the cash is gone.

Venture capital isn’t dangerous, but it changes your legal position. You’re no longer just building a business; you’re making representations, giving warranties, and holding other people’s money. Founders who treat compliance as part of the raise rather than an afterthought usually sail through. The ones who don’t often find out in a due diligence request, a shareholder dispute, or something worse.

About | My name is Sohrab Vazir. I’m a business consultant, venture scout and former technology founder.

Reference list

Legislation and cases

BTI 2014 LLC v Sequana SA [2022] UKSC 25. Available at: https://www.bailii.org/uk/cases/UKSC/2022/25.html (Accessed: 21 September 2026).

Companies Act 2006, c. 46, Part 17. London: The Stationery Office.

Companies Act 2006, c. 46, ss. 170–177. Available at: https://www.legislation.gov.uk/ukpga/2006/46/part/10/chapter/2 (Accessed: 21 September 2026).

Companies Act 2006, c. 46, s. 190. Available at: https://www.legislation.gov.uk/ukpga/2006/46/section/190/data.htm (Accessed: 21 September 2026).

Explanatory Notes to the Companies Act 2006, paras 404–406: Sections 197 to 214, Loans, quasi-loans and credit transactions. Available at: https://www.legislation.gov.uk/ukpga/2006/46/notes/division/8/3 (Accessed: 21 September 2026).

Financial Services and Markets Act 2000, c. 8, s. 21. Available at: https://legislation.gov.uk/ukpga/2000/8/section/21 (Accessed: 21 September 2026).

Fraud Act 2006, c. 35, ss. 1–2. Available at: https://www.legislation.gov.uk/ukpga/2006/35/section/2/data.html (Accessed: 21 September 2026).

Insolvency Act 1986, c. 45, s. 214. Available at: https://www.legislation.gov.uk/ukpga/1986/45/section/214/data.htm (Accessed: 21 September 2026).

Misrepresentation Act 1967, c. 7. Available at: https://www.legislation.gov.uk/ukpga/1967/7/data.htm (Accessed: 21 September 2026).

Books, articles, guidance and web sources

Goodwin (2026) UK employee share plans: 6th of July HMRC reporting deadline – May 2026. JD Supra. Available at: https://www.jdsupra.com/legalnews/uk-employee-share-plans-6th-of-july-3828451/ (Accessed: 21 September 2026).

Herbert Smith Freehills Kramer (2022) BTI v Sequana – key UK Supreme Court insolvency ruling clarifies stance on creditor duties, 25 October. Available at: https://www.hsfkramer.com/notes/apac-rti/2022-10/bti-v-sequana-key-uk-supreme-court-insolvency-ruling-clarifies-stance-on-creditor-duties (Accessed: 21 September 2026).

HM Revenue & Customs (2024) Venture capital schemes: apply for advance assurance. GOV.UK. Available at: https://www.gov.uk/guidance/venture-capital-schemes-apply-for-advance-assurance (Accessed: 21 September 2026).

HM Revenue & Customs (n.d.a) Tell HMRC about your employment related securities. GOV.UK. Available at: https://www.gov.uk/guidance/tell-hmrc-about-your-employment-related-securities (Accessed: 21 September 2026).

HM Revenue & Customs (n.d.b) VCM60220 – Venture Capital Schemes Manual: venture capital schemes: the Seed Enterprise Investment Scheme: advance assurance requests: information needed. GOV.UK. Available at: https://gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm60220 (Accessed: 21 September 2026).

Jones Day (2020) SEC proposes conditional exemption from broker-dealer registration for finders, October. Available at: https://www.jonesday.com/en/insights/2020/10/sec-proposes-conditional-exemption-from-brokerdealer-registration-for-finders (Accessed: 21 September 2026).

JURIST (2022) Theranos ex-CEO sentenced to 135 months in prison for defrauding investors, inflicting $121M total loss. Available at: https://www.jurist.org/news/2022/11/elizabeth-holmes-sentenced-to-135-months-in-prison-for-defrauding-theranos-investors-judge-determines-121m-total-loss-to-investors (Accessed: 21 September 2026).

Lee, Y.-Y. (2011) SEC reaffirms the broad reach of Rule 10b-5 to private companies. WilmerHale, 22 December. Available at: https://www.wilmerhale.com/en/insights/publications/sec-reaffirms-the-broad-reach-of-rule-10b-5-to-private-companies-december-22-2011 (Accessed: 21 September 2026).

Legal Information Institute (n.d.) Rule 10b-5. Cornell Law School. Available at: https://www.law.cornell.edu/wex/rule_10b-5 (Accessed: 21 September 2026).

Macfarlanes (2023) New rules for financial promotions for high net worth individuals and sophisticated investors. Available at: https://www.macfarlanes.com/what-we-think/2023/new-rules-for-financial-promotions-for-high-net-worth-individuals-and-sophisticated-investors/ (Accessed: 21 September 2026).

TBS News (2022) Elizabeth Holmes sentenced to more than 11 years in prison for Theranos fraud. Available at: https://www.tbsnews.net/world/elizabeth-holmes-sentenced-more-11-years-prison-theranos-fraud-534538 (Accessed: 21 September 2026).

U.S. Securities and Exchange Commission (n.d.) Eliminating the prohibition against general solicitation and general advertising in Rule 506 and Rule 144A offerings: small entity compliance guide. Available at: https://www.sec.gov/info/smallbus/secg/general-solicitation-small-entity-compliance-guide (Accessed: 21 September 2026).

Usmani, P. (2022) United Kingdom: Supreme Court confirms existence of directors’ “creditor duty”. Baker McKenzie, 7 October. Available at: https://insightplus.bakermckenzie.com/bm/banking-finance_1/uk-supreme-court-confirms-existence-of-directors-creditor-duty (Accessed: 21 September 2026).

Vestd (n.d.) Understanding financial promotion: what founders need to know. Available at: https://www.vestd.com/blog/understanding-financial-promotion-what-founders-need-to-know (Accessed: 21 September 2026).