| Business NH Magazine has published several very timely and informative articles of value to small commercial property and business owners. I recommend you subscribe to ensure you get these great articles. In the meantime I will continue to repost the most interesting for the benefit of my clients and readers. Knowledge is power... keep building your power base by feeding yourself with knowledge! ~bf Raising Capital Not Red Flags |
Business NH Magazine
Businesses looking for capital investments to help them grow traditionally knock on the doors of venture capitalists, financial institutions and other expert investors. But in a sluggish economy, those doors are answered less and, when they do open, yield less fruit.
That has led companies to seek capital from individuals in the form of stocks, loans and other investments. The challenge is ensuring those doors don't become traps for people unfamiliar with securities law-traps that can lead to hefty fines and fees in order to break free.
No matter the form of the transaction, it is likely that a security is being issued in connection with that capital, and businesses need to ensure they are complying with all securities laws, both federal and state. That can be a particular challenge in cases where capital is being raised without the direct advice and expertise of legal counsel.
The Letter of the Law
So what is a security? The answer is broad and includes common securities like stocks, but can also cover just about any way a person invests in a business to generate revenue or the repayment of that contribution. That could include money someone intends to loan to or invest in a company. The bottom line is if it acts like a security and is an investment in a company, it is a security for the purpose of securities laws.
Securities law kicks in once a company issues a security. Companies should be concerned with three things regarding that transaction: first, the method by which the security is offered; second, to whom it is sold; and third, what the company says (or fails to say) when it is offered.
Most securities are issued privately, using exemptions to the law, or "safe harbors" to prevent their offering from becoming a public offering. That is because securities issued in public offerings usually need to be registered with the Securities and Exchange Commission (SEC) and come with cumbersome filing requirements and expenses most companies can't bear. Complying with available exemptions to avoid the costs and time of a public offering depends in part on how the securities are offered and to whom they are issued.
Broadly speaking, a public offering to invest in a business is just that: An offering made to some wider audience. So an article or notice published in a newspaper, magazine, on television or radio, or on the Internet are modes of public offerings. But beware. Do you want to give your neighbors a chance to invest in your company? That, too, could be considered a public offering.
Making a Private Offering
For companies looking to make private offerings of securities, there are four common exemptions to public offerings under federal law. But before seeking to exempt themselves from the public offering process, companies need to insure they know who their investors are and what laws apply to the different types.
Under securities law, there are two main types of investors: accredited investors and non-accredited investors.
An accredited investor meets one of the following net worth and asset tests:
• A person with a net worth of at least $1 million (excluding the value of their primary residence);
• A person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years. Also, there should be a reasonable expectation of the same income level in the current year;
• A trust with assets of at least $5 million that is not formed to acquire the specific securities offered and whose purchases are directed by a knowledgeable investor.
Non-accredited investors are those who do not meet the net worth and asset tests listed above and are generally considered to be more risky sources of capital.
Once a company has identified the appropriate investors, it can then consider the exemptions their offering falls under. The four common options are SEC Rule 504, Rule 505 and Rule 506 of the safe harbor laws, as well as a "private offering" exemption. Each rule has many nuances, so consulting with an attorney is vital to avoid expensive fees and fines.
The Most Common Path: SEC Rule 506
Companies seeking exemption from cumbersome requirements of a public offering most often use SEC Rule 506. That is because you can raise as much capital as you want without being required to register the securities with the state (although a state may still require the same filings you make with the SEC).
All non-accredited investors, either alone or with a purchaser representative, must be considered sophisticated, meaning they have sufficient knowledge and experience in financial and business matters to enable them to evaluate the merits and risks of the prospective investment. If this standard is not met, more extensive disclosure rules apply.
SEC Rule 504
Rule 504 provides an exemption for the offer and sale of up to $1 million of securities in a 12-month period.
Unlike the other three exemptions, you may use public solicitation or advertise the securities sale.
There are no specific disclosure requirements for this type of offering, but you should provide sufficient information to investors to avoid violating the anti-fraud provisions of the securities laws. This means information provided to investors must be free from false or misleading statements. Similarly, don't exclude information if the omission makes what you provide to investors false or misleading.
However, there are potential hurdles. You may be required to register the securities under applicable state laws, which can be time-consuming and expensive.
SEC Rule 505
Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, you may sell to an unlimited number of "accredited investors" and up to 35 other persons who don't meet the standards of accredited investors or sophisticated non-accredited investors.
Purchasers must buy securities for investment only, and not for resale. You may not use general solicitation or advertising to sell the securities.
It is up to you to decide what information you give to accredited investors, so long as it does not violate the anti-fraud prohibitions. Still, you must give non-accredited investors disclosure documents that generally are the same as those used in public offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well. As under Rule 504, you may be required to register the securities under applicable state laws.
Private Offering Exemption
The private offering exemption excludes from registration "transactions by an issuer not involving any public offering." To qualify for this exemption, the purchasers of the securities must meet three requirements:
• Meet the criteria of a sophisticated investor or be able to bear the investment's economic risk;
• Have access to the type of information normally provided in a public offering;
• Agree not to resell or distribute the securities to the public.
Under this exemption, you can't use any form of public solicitation or general advertising in connection with the offering. The precise limits of this private offering exemption are uncertain. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show a transaction qualifies for this exemption.
State Securities Laws
If you rely on Rule 504 or Rule 505 of the federal safe harbors, you must also find an applicable exemption from registration under the securities laws of the state from which you are selling as well as the state in which each buyer lives. In NH, some of the most commonly used statutory exemptions include:
• The "limited offering" exemption, which limits the number of purchasers of a securities offering to no more than 10 during any 12 consecutive months and 25 during the issuer's existence;
• Sales to existing holders of the issuer's securities;
• The "pre-incorporation offering" exemption, which, among other things, limits the aggregate number of holders of all of the issuer's securities to no more than 10 people. Sales must be completed within 60 days after the date of incorporation or the formation of the issuer.
In some instances, you can combine the state exemptions. While complying with the exemption rules may seem burdensome, failure to do so is even worse. Companies who offer securities as a private offering and do not meet all exemption rules likely must return the investment to the investor with interest- and that frequently comes at a time when the company can't fund it.
The message is follow the rules or you will likely have to pay up.
John Bentas is part of the Corporate Department at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association. He can be reached at john dot bentas at mclane.com or 603-628-1306. McLane has offices in Concord, Manchester and Portsmouth, as well as Woburn, Massachusetts.
That has led companies to seek capital from individuals in the form of stocks, loans and other investments. The challenge is ensuring those doors don't become traps for people unfamiliar with securities law-traps that can lead to hefty fines and fees in order to break free.
No matter the form of the transaction, it is likely that a security is being issued in connection with that capital, and businesses need to ensure they are complying with all securities laws, both federal and state. That can be a particular challenge in cases where capital is being raised without the direct advice and expertise of legal counsel.
The Letter of the Law
So what is a security? The answer is broad and includes common securities like stocks, but can also cover just about any way a person invests in a business to generate revenue or the repayment of that contribution. That could include money someone intends to loan to or invest in a company. The bottom line is if it acts like a security and is an investment in a company, it is a security for the purpose of securities laws.
Securities law kicks in once a company issues a security. Companies should be concerned with three things regarding that transaction: first, the method by which the security is offered; second, to whom it is sold; and third, what the company says (or fails to say) when it is offered.
Most securities are issued privately, using exemptions to the law, or "safe harbors" to prevent their offering from becoming a public offering. That is because securities issued in public offerings usually need to be registered with the Securities and Exchange Commission (SEC) and come with cumbersome filing requirements and expenses most companies can't bear. Complying with available exemptions to avoid the costs and time of a public offering depends in part on how the securities are offered and to whom they are issued.
Broadly speaking, a public offering to invest in a business is just that: An offering made to some wider audience. So an article or notice published in a newspaper, magazine, on television or radio, or on the Internet are modes of public offerings. But beware. Do you want to give your neighbors a chance to invest in your company? That, too, could be considered a public offering.
Making a Private Offering
For companies looking to make private offerings of securities, there are four common exemptions to public offerings under federal law. But before seeking to exempt themselves from the public offering process, companies need to insure they know who their investors are and what laws apply to the different types.
Under securities law, there are two main types of investors: accredited investors and non-accredited investors.
An accredited investor meets one of the following net worth and asset tests:
• A person with a net worth of at least $1 million (excluding the value of their primary residence);
• A person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years. Also, there should be a reasonable expectation of the same income level in the current year;
• A trust with assets of at least $5 million that is not formed to acquire the specific securities offered and whose purchases are directed by a knowledgeable investor.
Non-accredited investors are those who do not meet the net worth and asset tests listed above and are generally considered to be more risky sources of capital.
Once a company has identified the appropriate investors, it can then consider the exemptions their offering falls under. The four common options are SEC Rule 504, Rule 505 and Rule 506 of the safe harbor laws, as well as a "private offering" exemption. Each rule has many nuances, so consulting with an attorney is vital to avoid expensive fees and fines.
The Most Common Path: SEC Rule 506
Companies seeking exemption from cumbersome requirements of a public offering most often use SEC Rule 506. That is because you can raise as much capital as you want without being required to register the securities with the state (although a state may still require the same filings you make with the SEC).
All non-accredited investors, either alone or with a purchaser representative, must be considered sophisticated, meaning they have sufficient knowledge and experience in financial and business matters to enable them to evaluate the merits and risks of the prospective investment. If this standard is not met, more extensive disclosure rules apply.
SEC Rule 504
Rule 504 provides an exemption for the offer and sale of up to $1 million of securities in a 12-month period.
Unlike the other three exemptions, you may use public solicitation or advertise the securities sale.
There are no specific disclosure requirements for this type of offering, but you should provide sufficient information to investors to avoid violating the anti-fraud provisions of the securities laws. This means information provided to investors must be free from false or misleading statements. Similarly, don't exclude information if the omission makes what you provide to investors false or misleading.
However, there are potential hurdles. You may be required to register the securities under applicable state laws, which can be time-consuming and expensive.
SEC Rule 505
Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, you may sell to an unlimited number of "accredited investors" and up to 35 other persons who don't meet the standards of accredited investors or sophisticated non-accredited investors.
Purchasers must buy securities for investment only, and not for resale. You may not use general solicitation or advertising to sell the securities.
It is up to you to decide what information you give to accredited investors, so long as it does not violate the anti-fraud prohibitions. Still, you must give non-accredited investors disclosure documents that generally are the same as those used in public offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well. As under Rule 504, you may be required to register the securities under applicable state laws.
Private Offering Exemption
The private offering exemption excludes from registration "transactions by an issuer not involving any public offering." To qualify for this exemption, the purchasers of the securities must meet three requirements:
• Meet the criteria of a sophisticated investor or be able to bear the investment's economic risk;
• Have access to the type of information normally provided in a public offering;
• Agree not to resell or distribute the securities to the public.
Under this exemption, you can't use any form of public solicitation or general advertising in connection with the offering. The precise limits of this private offering exemption are uncertain. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show a transaction qualifies for this exemption.
State Securities Laws
If you rely on Rule 504 or Rule 505 of the federal safe harbors, you must also find an applicable exemption from registration under the securities laws of the state from which you are selling as well as the state in which each buyer lives. In NH, some of the most commonly used statutory exemptions include:
• The "limited offering" exemption, which limits the number of purchasers of a securities offering to no more than 10 during any 12 consecutive months and 25 during the issuer's existence;
• Sales to existing holders of the issuer's securities;
• The "pre-incorporation offering" exemption, which, among other things, limits the aggregate number of holders of all of the issuer's securities to no more than 10 people. Sales must be completed within 60 days after the date of incorporation or the formation of the issuer.
In some instances, you can combine the state exemptions. While complying with the exemption rules may seem burdensome, failure to do so is even worse. Companies who offer securities as a private offering and do not meet all exemption rules likely must return the investment to the investor with interest- and that frequently comes at a time when the company can't fund it.
The message is follow the rules or you will likely have to pay up.
John Bentas is part of the Corporate Department at the law firm of McLane, Graf, Raulerson & Middleton, Professional Association. He can be reached at john dot bentas at mclane.com or 603-628-1306. McLane has offices in Concord, Manchester and Portsmouth, as well as Woburn, Massachusetts.
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