Legal Definitions - capital-risk test

Definition: The capital-risk test is a method used to determine if a transaction is considered an investment contract and therefore subject to securities laws. This test is applied when a franchisee provides a substantial portion of the capital used by a franchiser to start its operations.

Example: Let's say that a franchiser needs $1 million to start a new business. The franchiser finds a franchisee who is willing to invest $800,000 in exchange for a share of the profits. In this case, the capital-risk test would likely classify this transaction as an investment contract subject to securities laws.

Explanation: The example illustrates how the capital-risk test is applied. If a franchisee provides a significant amount of the capital needed to start a business, then the transaction is considered an investment contract. This means that the franchisee is investing money with the expectation of receiving a return on their investment, which is subject to securities laws.