So let’s say you’ve just started a small company and want to offer shares, whether to yourself, investors, employees, or others. What sort of requirements will you have to comply with? There are many, whether on the federal level (through the SEC and IRS) or on the state level. SEC registration requirements can present some of the more complicated and difficult issues to understand when starting a company. In this article, I’ll try to concisely address and clarify some of those issues.

The term securities actually can mean many different things, such as stock, interests (in the case of a partnership or LLC) and forms of debt, among others. Each of these types of securities, in turn, can have many varieties. But, unless you’re angel or venture-backed, or have serious plans to expand rapidly through outside funding, your company will most likely be offering a relatively straightforward type of securities.  Often this will be something like a single class of stock to a small group of founders.

Federal securities laws generally require businesses selling securities to not only give investors full disclosure of all material facts, but also to register the sale with the SEC, unless an exemption is met. More often than not, exemptions can be met, but the exemption requirements are quite technical, and an understanding of the exemptions usually requires the advice of a competent securities attorney. Companies will want to qualify for an exemption because SEC security registrations can be extremely expensive, among other reasons.

There are handful of exemption categories, some of which have sub-categories.  On its web site, the SEC has a good outline of these exemptions, and the requirements to qualify.  Check out the link entitled, “Are There Legal Ways To Offer and Sell Securities Without Registering With the SEC?”.  More details about the exemptions are on the site, and I don’t want to be redundant here, so I’ll briefly summarize them as best I can in laymen’s terms.

• Instrastate Offering Exemption

This exemption is for local businesses that are incorporated in the same state where they offer securities, carry out most of their business in that state and offer their securities only to residents of that state.  In this day and age, meeting all of these requirements can be difficult.  

• Private Offering Exemption

Purchasers must be “sophisticated investors” (which is further explained on the SEC’s web site), or be able to bear economic risk of the investment; have access to the type of information normally provided in a prospectus; and agree not to sell or distribute the securities to the public.  The company also may not publicly solicit or generally advertise the offering.  As the SEC acknowledges, there’s a lot of grey in defining the boundaries of this exemption.

• Regulation A

The so-called “small securities offering” exemption, Reg A applies to public offerings not exceeding $5 million in any 12-month period.  Companies relying on this exemption still have tedious SEC filing requirements.

• Regulation D

If you know anything about securities laws, chances are you’ve heard of Reg D, which actually consists of 3 exemptions: Rules 504 - 506.

504

504 exempts offerings up to $1 million over a 12 month period.  Like the other Reg D exemptions, public solicitation and advertising may not be used to offer the securities, and the purchasers must receive “restricted” securities, which means the securities may not be sold without registration or an applicable exemption.  Under specific circumstances, 504 may be used for a public offering of unrestricted securities.

505

505 exempts offerings up to $5 million in any 12-month period in cases where securities are sold to an unlimited number of “accredited investors” (further defined by the SEC) and up to 35 other persons.  Purchasers must buy the securities for investment only, not for resale, and the securities must be “restricted”.

506

506 goes hand-in-hand with the Private Offering Exemption (referenced above).  506 is actually a so-called “safe harbor” rule that provides objective standards to rely on to meet the requirements of the Private Offering Exemption.

• Accredited Investor Exemption
  

This exemption applies to offerings to “accredited investors” where the total offering price is less than $5 million.  This exemption is a lot like 505, and similarly does not permit any advertising or public solicitation.

• California Limited Offering Exemption

This one gets its name from Cal Corp Code 25102(n).  If the conditions of that Code section are satisfied, then under SEC Rule 1001, exemptions will be granted for offerings in amounts up to $5 million (again that’s the magic number). The offering must be made by a California company to “qualified purchasers”, which are defined in a similar way as the “accredited investors” under Regulation D.

• Exemption for Sales of Securities through Employee Benefit Plans — Rule 701

Only companies not subject to Exchange Act requirements (i.e., fairly large companies) are permitted to rely on this exemption, which allows companies to offer up to $1,000,000 in securities to employees over a 12 month period, or even more if certain formulas are satisfied.  The employee securities must be “restricted” and may not be offered or sold to the public.

There you go, it’s all easy enough to understand, right?  I know, pretty dense stuff.  And just like so many other things legal, even if these exemptions might appear relatively straightforward on first sight, they can quickly become complicated when applied to a real-world scenario.  But hopefully this post at least gives readers a basic idea of what the federal securities laws are, and how they might apply in certain situations.

One last thing: Don’t forget that even if your offering is exempt from federal registration requirements, you are still subject to the antifraud provisions of the federal securities laws (i.e., your company will be liable for any false or misleading statements), and you must still comply with securities laws in each state where securities are offered.

Tags: federal securities laws registration requirements sec exemptions small business

This entry was posted on Thursday, October 1st, 2009 at 1:00 am and is filed under Corporate, Securities. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.