Private Securities Offerings

If your corporation is doing a stock offering, we can help you get it done in compliance with complex private securities offering laws. In a perfect world, the sale of shares of stock would be a simple and quick transaction: An investor would give the corporation a check, the corporation would issue the investor a stock certificate, and the proceeds of the sale would be used to grow the corporation. Unfortunately, the sale of securities, even for stock sales of less than $1,000,000, must comply with complicated federal and state laws governing private securities offerings.

Prior to the passage of the federal Securities Act of 1933, the sale of securities was solely regulated by the states. In 1911, Kansas became the first state to pass a law to regulate the issuance of securities. By 1913, Missouri and 22 other states had adopted laws similar to the Kansas law. Today, all 50 states have similar, but not identical, securities laws, which are called “blue sky laws.” (The unusual “blue sky law” name originated in 1910 from the Kansas State Banking Commissioner, who urged the enactment of a law to protect investors from fraudulent securities that were backed by nothing but “blue sky.”)

Before commencing any proposed offering, you should have an experienced securities attorney review information about your corporation and the proposed group of potential investors. After reviewing the background information on the offering, the attorney will usually prepare a legal memorandum, a private placement memorandum and a subscription agreement.

Legal Memorandum. A legal memorandum is provided to the Board of Directors of the corporation to describe (i) the federal private offering exemption that will be relied upon, (ii) the state private offering exemptions that will be relied upon for residents of all the states in which you will be offering the securities, and (iii) the types of notices and amounts of fees that will need to be provided to the Securities and Exchange Commission and any other applicable state securities regulators.

Private Placement Memorandum. A Private Placement Memorandum is provided to potential investors to set forth a written disclosure of all “material” (i.e., significant) information about the corporation and the risks of the offering (along with any additional information that is required to be included under federal and state law).

Subscription Agreement. A form of Subscription Agreement will be signed by investors purchasing shares in the offering. The Subscription Agreement will normally require the completion of an investor questionnaire, to confirm financial eligibility to purchase the securities.

A private securities offering must be correctly documented in order to reduce the potential liability that the securities offering will bring to the corporation, its directors, and its executive officers. If a securities offering has not been properly registered or exempted under applicable securities laws, a purchaser of securities generally can, within one year after purchase, file a lawsuit against the corporation to seek rescission of his or her purchase. A purchaser of securities generally can also file a lawsuit (within the earlier of two years after discovery of the facts constituting the violation or five years after the purchase of securities) against the corporation and its directors and executive officers for damages caused by an untrue statement of a material fact or an omission of a material fact that was made in the offering. There is other potential liability, including criminal penalties for willful violations of securities law.

Set forth below are the summaries of certain federal securities offering exemptions that can be useful to startups and businesses who are conducting a securities offering in the United States. It should be noted that the SEC Rule 506(b), Rule 504 and Rule 506(c) exemptions differentiate between "accredited" and "non-accredited" investors. An individual investor is an “accredited investor” only if he or she (i) is a director or executive officer of the corporation issuing the securities, (ii) has an individual net worth (or joint net worth with a spouse) that exceeds $1 million, excluding the value of the investor’s primary residence, (iii) has an individual income that exceeds $200,000 in each of the two most recent years, and has a reasonable expectation of reaching the same individual income level in the current year, or (iv) has a joint income that exceeds $300,000 in each of the two most recent years, and has a reasonable expectation of reaching the same joint income level in the current year. See SEC Rule 501(a)(5).

Unlike the other exemptions set forth below, the Regulation A "Conditional Small Issues Exemption" requires that the offering circular be subject to the prior review and qualification by the SEC. The Regulation A exemption has the primary advantage of permitting non-affiliate purchasers to resell their securities immediately. As Regulation A securities are not "restricted securities," non-affiliates of the issuing company are not subject to the transferability restrictions set forth under Rule 144.

It should be noted that federal exemptions from securities registration requirements are generally unavailable to a larger company issuing securities that has (i) more than $10,000,000 in assets and has (iI) 2,000 or more stockholders or 500 or more non-accredited stockholders. See Section 12(g) of the Securities Exchange Act (15 U.S.C. §78l(g).

Type Summary of Federal Securities Offering Exemption Who May Invest
Section 4(a)(2) No limit on total amount of securities sold. No filings required with the SEC. State securities offering exemption requirements apply. Customarily utilized at the time of incorporation of a startup for the initial stock issuance to a small group of founders who are the initial directors and officers of the company. State securities offering exemption requirements apply. Small Group of Founders (no general solicitation)
Rule 506(b) (limited to accredited investors) No limit on total amount of securities sold. Form D filed with the SEC. Potential investors receive information through a Private Placement Memorandum that is not filed with or qualified by the SEC. Preemption of state securities offering exemption requirements. Accredited Investors Only (no general solicitation)
Rule 504 (with no state securities registration) $5,000,000 limit on total amount of securities sold in a 12 month period. Form D filed with the SEC. Potential investors receive information through a Private Placement Memorandum that is not filed with or qualified by the SEC. State securities offering exemption requirements apply. All Investors (no general solicitation)
Rule 506(c) No limit on total amount of securities sold. Form D filed with the SEC. Potential investors receive information through a Private Placement Memorandum that is not filed with or qualified by the SEC. Verification of accredited investor status required. Preemption of state securities offering exemption requirements. Accredited Investors Only (general solicitation to public)
Regulation Crowdfunding $1,070,000 limit on total amount of securities sold in a 12 month period. Form C filed with the SEC. Potential investors receive information through an offering statement that is publicly filed with the SEC, but has not been qualified by the SEC. Investment by each investor is limited as follows: (i) if either annual income or net worth is less than $107,000, investment is limited to the greater of either $2,200 or 5% of the lesser of annual income or net worth and (ii) if both annual income and net worth are equal to or more than $107,000, investment is limited to 10% of annual income or net worth, whichever is lesser, but no more than $107,000. Preemption of state securities offering exemption requirements. Company must periodically file financial information with the SEC (subject to certain exemptions for smaller companies). All Investors (general solicitation to public)
Regulation A, Tier 2 $50,000,000 limit on total amount of securities sold in a 12 month period. Form 1-A filed with the SEC. Potential investors receive information through an offering circular that is filed with the SEC, and has been qualified by the SEC. Investment by non-accredited investors limited to 10% of annual income or net worth. Preemption of state securities offering exemption requirements. Company must periodically file financial information with the SEC. All Investors (general solicitation to public)

It should be noted that several companies are offering internet platforms and software for the issuance of securities under the SEC Rule 506(c) and Regulation Crowdfunding exemptions. These internet platforms include SeedInvest and StartEngine. In addition, companies also can utilize software, such as Carta, to manage their cap tables.

Securities purchased in a private securities offering have the disadvantage of being subject to certain complex resale restrictions. These restrictions tend to significantly reduce the liquidity of privately held shares.

Affiliates of issuers of securities are subject to certain additional resale restrictions for control securities that are set forth in
SEC Rule 144(b)(2). An “affiliate” of an issuer has been ambiguously defined by the SEC as “a person that directly, or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with such issuer.” See 12 C.F.R. § 230.144(a)(1). SEC Rule 405 defines “control” as “the possession, direct, or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract or otherwise.” 12 C.F.R. § 230.405. The SEC has stated that an individual's "status as an officer, director or 10% shareholder is one fact which must be taken into consideration" in determining affiliate status. See American Standard, SEC No Action Letter Fed. Sec. L. Rep. ¶ 79,071 (Oct. 11, 1972).

Affiliates and non-affiliates of a non-reporting company can generally resell securities that they purchased in a Section 4(a)(2) or Regulation D private placement under certain resale exemptions, which include those set forth in the chart below:

Exemption Non-Affiliate Resale Affiliate Resale
Rule 144 A non-affiliate stockholder is generally permitted under SEC Rule 144(b)(1) to conduct a private or a public resale of securities to both accredited and non-accredited investors, if the stockholder has held the shares for at least one year. An affiliate stockholder is generally permitted under SEC Rule 144(b)(2) to conduct a private or a public resale of securities to both accredited and non-accredited investors, if the stockholder has held the shares for at least one year, and the following additional requirements are met: (i) the company makes publicly available certain specified information on a quarterly basis, (ii) the amount sold by the affiliate does not exceed 1% of the outstanding shares during a three month period, (iii) the sales must be handled as routine brokerage transactions, and (iv) a notice is filed with the SEC on Form 144, if the sale involves more than 5,000 shares or the aggregate dollar amount is greater than $50,000 in any three month period.
Section 4(a)(7) A non-affiliate stockholder is generally permitted under Section 4(a)(7) of the Securities Act to privately resell their securities to accredited investors, if (i) the class of securities has been authorized or outstanding for at least 90 days, (ii) no general solicitation or advertising is done, (iii) certain specified information is provided to the purchaser (including balance sheet and profit and loss statements for the preceding two years), and (iv) the seller complies with certain other restrictions and requirements. An affiliate stockholder is generally permitted under Section 4(a)(7) of the Securities Act to privately resell their securities to accredited investors, if (i) the class of securities has been authorized or outstanding for at least 90 days, (ii) no general solicitation or advertising is done, (iii) certain specified information is provided to the purchaser (including balance sheet and profit and loss statements for the preceding two years), and (iv) the seller complies with certain other restrictions and requirements.
Rule 144A A non-affiliate stockholder is generally permitted under SEC Rule 144A to conduct a resale of securities to a qualified institutional buyer ("QIB"), through a general solicitation and without a minimum holding period. A QIB includes (i) certain types of financial institutions (such as insurance companies, small business investment companies, business development companies, 501(c)(3) charitable organizations, employee benefit plans, investment companies, registered investment advisors and banks) that, in the aggregate, own and invest on a discretionary basis at least $100 million in securities of unaffiliated issuers and (ii) a registered broker-dealer that owns and invests on a discretionary basis at least $10 million in securities of unaffiliated issuers. An affiliate stockholder is generally permitted under SEC Rule 144A to conduct a resale of securities to a QIB, through a general solicitation and without a minimum holding period.

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