By Thomas S. Cullen, published on September 18, 2004, in Savannah Morning News.
At some point, most businesses experience a need for additional cash – whether it’s for normal growth, working capital needs, financing a capital expenditure, funding the acquisition of new technology or the costs of the expansion of a business.
Although some businesses may satisfy this need through bank loans, other businesses need to raise capital by selling their stock or other securities.
Know the securities laws
Raising capital through a security offering is subject to the securities registration provisions of the federal Securities Act and the securities laws of every state in which the securities are offered (which means each state in which an individual to whom securities are offered resides).
Generally, the federal and state securities laws require that before any security can be offered or sold, the security must be either registered or exempt from registration. The federal and state securities laws also regulate fraud in connection with the offer or sale of securities, require disclosures about the company selling the securities and its securities, and provide remedies for securities violations.
Most securities offerings are structured to comply with exemptions from the registration requirements of the federal and state securities laws. There are a number of federal exemptions from the registration requirements of the federal Securities Act, some of which are self-executing and some of which require affirmative actions to be taken by the company.
Most state securities laws contain exemptions that correspond in part with the exemptions provided in the federal Securities Act; however, the securities laws of the states are not identical and, therefore, the laws of each state in which securities are going to be offered must be reviewed prior to any offering.
The most frequently utilized exemptions from the registration requirements of the federal Securities Act are (1) the intra-state exemption; (2) the “private offering” exemption; and (3) Regulation D offerings.
The intra-state exemption provides a self-executing exemption from the registration requirements of the federal Securities Act for offers and sales of securities to residents of a single state.
There is no corresponding state law exemption and, therefore the company must comply with each appropriate state’s securities laws.
The “private offering” exemption provides a self-executing exemption from the registration requirements of the federal Securities Act for non-public offerings. There is no clear definition of a “non-public offering;” however, this exemption is typically utilized for offerings to very small groups, typically of five or fewer persons.
There is no “safe-harbor” for the company and there is not typically a corresponding state law exemption. If the company intends to sell its securities to more than five persons, it should not rely solely on the private offering exemption.
Regulation D provides an exemption from the registration requirements of the federal Securities Act for offers and sales of securities to certain types and numbers of investors provided that the company complies with the terms of the regulation.
Pursuant to Regulation D, a company can sell its securities to an unlimited number of accredited investors, plus 35 sophisticated persons who are not accredited investors.
An accredited investor includes institutional investors, directors and executive officers of the offering company, individuals with specified net worths or annual income, and certain other defined entities. Securities offered in Regulation D offerings may not be offered through any form of general solicitation or advertising. The exemption also requires a filing to be made with the Securities and Exchange Commission.
In a Regulation D offering, the company must provide the prospective investors with certain disclosures, including detailed information about the company, the offering, the intended use of the proceeds of the offering, the risks involved, and the management of the company.
In most cases, if the offering complies with the requirements of Regulation D, the offering will also be exempt from the registration requirements of each of the states in which the securities are being offered.
Risks of Noncompliance
Failure to comply with the provisions of the federal and state securities laws subjects both the company and its principals, individually as participants in the offering, to potential criminal and civil liability.
In addition, the company and its principals, individually, may be permanently prohibited from selling or offering securities to persons in the states in which the violations occurred or in the United States.
Additionally, and more frequently, the failure of the company to comply with the provisions of the federal and state securities acts will provide each investor with the right to rescind its investment in the company. Therefore, if the company does not comply with the provisions of the federal and state securities laws, the investors in the company will not assume the risk of losing their investments.
The company assumes the risk of the investor rescinding its investment in the company, and the principals of the company, as participants in the offering, personally risk losing not only their investments in the company but also becoming the personal guarantors of the investors in the illegal offering for the total amount of their