Are There Legal Ways To Offer and Sell Securities
Without Registering With the SEC?
Yes! Your company's securities offering may qualify for one of several exemptions from the
registration requirements. We explain the most common ones below. You must remember,
however, that all securities transactions, even exempt transactions, are subject to the antifraud
provisions of the federal securities laws. This means that you and your company will be
responsible for false or misleading statements (whether oral or written). The government
enforces the federal securities laws through criminal, civil and administrative proceedings.
Some enforcement proceedings are brought through private law suits. Also, if all conditions of
the exemptions are not met, purchasers may be able to obtain refunds of their purchase price. In
addition, offerings that are exempt from provisions of the federal securities laws may still be
subject to the notice and filing obligations of various state laws. Make sure you check with the
appropriate state securities administrator before proceeding with your offering.
Intrastate Offering Exemption
Section 3(a)(11) of the Securities Act is generally known as the "intrastate offering exemption."
This exemption facilitates the financing of local business operations. To qualify for the intrastate
offering exemption, your company must:
be incorporated in the state where it is offering the securities;
carry out a significant amount of its business in that state; and
make offers and sales only to residents of that state.
There is no fixed limit on the size of the offering or the number of purchasers. Your company
must determine the residence of each purchaser. If any of the securities are offered or sold to
even one out-of-state person, the exemption may be lost. Without the exemption, the company
could be in violation of the Securities Act registration requirements. If a purchaser resells any
of the securities to a person who resides outside the state within a short period of time after the
company's offering is complete (the usual test is nine months), the entire transaction, including
the original sales, might violate the Securities Act. Since secondary markets for these securities
rarely develop, companies often must sell securities in these offerings at a discount.
It will be difficult for your company to rely on the intrastate exemption unless you know the
purchasers and the sale is directly negotiated with them. If your company holds some of its
assets outside the state, or derives a substantial portion of its revenues outside the state where it
proposes to offer its securities, it will probably have a difficult time qualifying for the
exemption.
You may follow Rule 147, a "safe harbor" rule, to ensure that you meet the requirements for this
exemption. It is possible, however, that transactions not meeting all requirements of Rule 147
may still qualify for the exemption.
Private Offering Exemption
Section 4(2) of the Securities Act exempts from registration "transactions by an issuer not
involving any public offering." To qualify for this exemption, the purchasers of the securities
must:
have enough knowledge and experience in finance and business matters to evaluate the
risks and merits of the investment (the "sophisticated investor"), or be able to bear the
investment's economic risk;
have access to the type of information normally provided in a prospectus; and
agree not to resell or distribute the securities to the public.
In addition, you may not 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 that the transaction qualifies for the exemption. You should know that if
you offer securities to even one person who does not meet the necessary conditions, the entire
offering may be in violation of the Securities Act.
Rule 506, another "safe harbor" rule, provides objective standards that you can rely on to meet
the requirements of this exemption. Rule 506 is a part of Regulation which we describe more
fully elsewhere.
Regulation A
Section 3(b) of the Securities Act authorizes the SEC to exempt from registration small
securities offerings. By this authority, we created Regulation A, an exemption for public
offerings not exceeding $5 million in any 12-month period. If you choose to rely on this
exemption, your company must file an offering statement (consisting of a notification, offering
circular, and exhibits) with the SEC for review.
Regulation A offerings share many characteristics with registered offerings. For example, you
must provide purchasers with an offering circular that is similar in content to a prospectus. Like
registered offerings, the securities can be offered publicly and are not "restricted," meaning they
are freely tradeable in the secondary market after the offering. The principal advantages of
Regulation A offerings, as opposed to full registration, are:
The financial statements are simpler and don't need to be audited;
There are no Exchange Act reporting obligations after the offering unless the company has
more than $10 million in total assets and more than 500 shareholders;
Companies may choose among three formats to prepare the offering circular, one of which
is a simplified question-and-answer document; and
You may "test the waters" to determine if there is adequate interest in your securities
before going through the expense of filing with the SEC.
All types of companies which do not report under the Exchange Act may use Regulation A,
except "blank check" companies, those with an unspecified business, and investment companies
registered or required to be registered under the Investment Company Act of 1940. In most
cases, shareholders may use Regulation A to resell up to $1.5 million of securities.
If you "test the waters," you can use general solicitation and advertising prior to filing an
offering statement with the SEC, giving you the advantage of determining whether there is
enough market interest in your securities before you incur the full range of legal, accounting, and
other costs associated with filing an offering statement. You may not, however, solicit or accept
money until the SEC staff completes its review of the filed offering statement and you deliver
prescribed offering materials to investors.
Regulation D
Regulation D establishes three exemptions from Securities Act registration. Let's address each
one separately.
Rule 504
Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a
12-month period. Your company may use this exemption so long as it is not a blank check
company and is not subject to Exchange Act reporting requirements. Some of the most important
characteristics of a Rule 504 offering are:
You can sell securities to an unlimited number of persons;
You can use general solicitation or advertising to market the securities; and
Purchasers receive securities that are not "restricted." This means that they may sell their
securities in the open market without registration or other sales limits imposed on privately
placed securities.
Rule 504 does not require issuers to give disclosure documents to investors. Nonetheless, you
should take care to provide sufficient information to investors to avoid violating the antifraud
provisions of the securities laws. This means that any information you provide to investors must
be free from false or misleading statements. Similarly, you should not exclude any information if
the omission makes what you do provide investors false or misleading.
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 do not need to satisfy the sophistication or wealth
standards associated with other exemptions). Purchasers must buy for investment only, and not
for resale. The issued securities are "restricted." Consequently, you must inform investors that
they may not sell for at least a year without registering the transaction. You may not use general
solicitation or advertising to sell the securities.
An "accredited investor" is:
a bank, insurance company, registered investment company, business development
company, or small business investment company;
an employee benefit plan (within the meaning of the Employee Retirement Income Security
Act) if a bank, insurance company, or registered investment adviser makes the investment
decisions, or if the plan has total assets in excess of $5 million;
a charitable organization, corporation or partnership with assets exceeding $5 million;
a director, executive officer, or general partner of the company selling the securities;
a business in which all the equity owners are accredited investors;
a natural person with a net worth of at least $1 million;
a natural 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 and a reasonable
expectation of the same income level in the current year; or
a trust with assets of at least $5 million, not formed to acquire the securities offered, and
whose purchases are directed by a sophisticated person.
It is up to you to decide what information you give to accredited investors, so long as it does not
violate the antifraud prohibitions. But you must give non-accredited investors disclosure
documents that generally are the same as those used in registered offerings. If you provide
information to accredited investors, you must make this information available to the
non-accredited investors as well. You must also be available to answer questions by
prospective purchasers.
Here are some specifics about the financial statement requirements applicable to this type of
offering:
Only financial statements for the most recent fiscal year need be certified by an
independent public accountant;
If a company other than a limited partnership cannot obtain audited financial statements
without unreasonable effort or expense, only the company's balance sheet (to be dated
within 120 days of the start of the offering) must be audited; and
Limited partnerships unable to obtain required financial statements without unreasonable
effort or expense may furnish audited financial statements prepared under the federal
income tax laws.
Rule 506
As we discussed earlier, Rule 506 is a "safe harbor" for the private offering exemption. If your
company satisfies the following standards, you can be assured that you are within the Section
4(2) exemption:
You can raise an unlimited amount of capital;
You cannot use general solicitation or advertising to market the securities;
You can sell securities to an unlimited number of accredited investors (the same group we
identified in the Rule 505 discussion) and up to 35 other purchasers. Unlike Rule 505, all
non-accredited investors (either alone or with a purchaser representative) must be
sophisticated-is, they must have sufficient knowledge and experience in financial and
business matters to make them capable of evaluating the merits and risks of the prospective
investment;
It is up to you to decide what information you give to accredited investors, so long as it
does not violate the antifraud prohibitions. But you must give non-accredited investors
disclosure documents that generally are the same as those used in registered offerings. If
you provide information to accredited investors, you must make this information available
to the non-accredited investors as well;
You must be available to answer questions by prospective purchasers;
Financial statement requirements are the same as for Rule 505; and
Purchasers receive "restricted" securities. Consequently, purchasers may not freely trade
the securities in the secondary market after the offering.
Accredited Investor Exemption - Section 4(6)
Section 4(6) of the Securities Act exempts from registration offers and sales of securities to
accredited investors when the total offering price is less than $5 million.
The definition of accredited investors is the same as that used in Regulation D. Like the
exemptions in Rule 505 and 506, this exemption does not permit any form of advertising or
public solicitation. There are no document delivery requirements. Of course, all transactions are
subject to the antifraud provisions of the securities laws.
California Limited Offering Exemption - Rule 1001
SEC Rule 1001 provides an exemption from the registration requirements of the Securities Act
for offers and sales of securities, in amounts of up to $5 million, that satisfy the conditions of
25102(n) of the California Corporations Code. This California law exempts from California
state law registration offerings made by California companies to "qualified purchasers" whose
characteristics are similar to, but not the same as, accredited investors under Regulation D. This
exemption allows some methods of general solicitation prior to sales.
Exemption for Sales of Securities through Employee Benefit Plans - Rule
701
The SEC adopted Rule 701 to exempt offers and sales of securities if made to compensate
employees. This exemption is available only to companies that are not subject to Exchange Act
reporting requirements, and is limited to offers and sales of $5or less. The amount that a
company may offer or sell under this exemption may be limited further depending on factors
such as the amount of company assets, the number of the company's outstanding securities and
previous securities sales. Employees receive "restricted securities" in these transactions and
may not freely offer or sell them to the public.
Are There State Law Requirements
in Addition to Federal Ones?
The federal government and state governments each have their own securities laws and
regulations. If your company is selling securities, it must comply with federal and state
securities laws. If a particular offering is exempt under the federal securities laws, that does not
necessarily mean that it is exempt from any of the state laws.
Historically, most state legislatures have followed one of two approaches in regulating public
offerings of securities, or a combination of the two approaches. Some states review small
businesses' securities offerings to ensure that companies disclose to investors all information
needed to make an informed investment decision. Other states also analyze public offerings
using substantive standards to assure that the terms and structure of the offerings are fair to
investors, in addition to the focus on disclosure.
To facilitate small business capital formation, the North American Securities Administrators
Association ("NASAA"), in conjunction with the American Bar Association, developed the
Small Corporate Offering Registration ("SCOR"). SCOR is a simplified "question and answer"
registration form that companies also can use as the disclosure document for investors. SCOR
was primarily designed for state registration of small business securities offerings conducted
under the SEC's Rule 504, for sale of securities up to $1,000,000. Currently, more than 40 states
recognize SCOR. To assist small business issuers in completing the SCOR Form, NASAA has
developed a detailed "Issuer's Manual."
In addition, a small company can use the SCOR Form to satisfy many of the filing requirements
of the SEC's Regulation A exemption, for sales of securities of up to $5,000,000, since the
company may file it with the SEC as part of the Regulation A offering statement.
To assist small businesses, some states coordinate SCOR or Regulation A filings through a
program called "Regional Review." Regional Reviews are available in the New England states,
several western states, and many midwestern states.
Companies seeking additional information on SCOR, Regional Reviews or the "Issuer's
Manual" should contact NASAA.
What Resources Are Available Through
the U.S. Small Business Administration?
When assessing your capital needs, you should consider programs offered through the U.S.
Small Business Administration (SBA). Congress established the SBA in 1953 to aid, counsel,
and protect the interests of the Nation's small business community. The SBA accomplishes this
in part by working with intermediaries, banks, and other lending institutions to provide loans
and venture capital financing to small businesses unable to secure financing through normal
lending channels. The SBA offers financing through the programs listed below.
7(a) Loan Guaranty Program:
This is the SBA's primary lending program and was designed to meet the majority of the small
business lending community's financing needs. In addition to general financing, the 7(a) program
also encompasses a number of specialized loan programs. The following are a few of the many
specialized loan programs:
Low Doc
This program is designed to increase the availability of funds under $100,000 and streamline or
expedite the loan review process.
CAPLines
An umbrella program to help small businesses meet their short-term and cyclical
working-capital needs with five separate programs.
International Trade
If your business is preparing to engage in or is already engaged in international trade, or is
adversely affected by competition from imports, the International Trade Loan Program is for
you; and
DELTA
Defense Loan and Technical Assistance is a joint SBA and Department of Defense effort to
provide financial and technical assistance to defense-dependent small firms adversely affected
by cutbacks in defense.
Microloan Program
This program works through intermediaries to provide small loans from as little as $100 up to
$25,000.
Certified Development Company (504 Loan) Program
This program, commonly referred to as the 504 program, makes long term loans available for
purchasing land, buildings, machinery and equipment, and for building, modernizing or
renovating existing facilities and sites.
Small Business Investment Company Program
Small Business Investment Companies (SBICs), which the SBA licenses and regulates, are
privately-owned and managed investment firms that provide venture capital and start-up
financing to small businesses.
To find additional information on these and other financial programs please contact your local
SBA District Office (call 1-800-8-ASK-SBA for the nearest office) or look on SBA's Web site
(http://www.sbaonline.sba.gov).
Additional Financial Resources and Information from the SBA's Office of
Advocacy
Angel Capital Electronic Network (ACE-Net)
The Office of Advocacy of SBA has established an Internet site where small companies may list
their Regulation A and Regulation D 504/SCOR stock offerings. ACE-Net is a cooperative
effort between SBA and nine universities, state-based entities, and other non-profit
organizations to provide a listing service where small companies may list their stock offering
for review by high net worth investors (accredited investors). In addition, ACE-Net anticipates
providing mentoring and educational services for small companies needing business planning
and securities information. You can find the ACE-Net Internet site at the following URL:
sbaonline.sba.gov.
Small Business Lending in the United States
The Office of Advocacy of SBA has ranked the nearly 10,000 banks in the country on a
state-by-state basis to determine which banks are "small business friendly." The state-by-state
directory helps small businesses locate which banks in their area are more likely to lend to
small business. The directory is available over the Internet at: sba.gov.
Where Can I Go for More Information?
The staff of the SEC's Office of Small Business and the SEC's Small Business Ombudsman will
be glad to assist you with any questions you may have regarding federal securities laws. For
information about state securities laws, contact NASAA or your state's securities administrator,
whose office is usually located in your capital city.
The entire text of the SEC's rules and regulations is available through the U.S. Government
Printing Office or from several private publishers of legal information. In addition, numerous
books on this subject have been published, and some are available at public libraries. As of this
writing, the following volumes of Title 17 of the Code of Federal Regulations (the SEC's rules
and regulations) were available from the Government Printing Office:
Vol. II -Parts 200 to 239. SEC Organization; Conduct and Ethics; Information and
Requests; Rules of Practice; Regulation S-X and Securities Act of 1933.
Vol III -Parts 240 to End. Securities Exchange Act of 1934; Public Utility Holding
Company, Trust Indenture, Investment Company, Investment Advisers, and Securities
Investor Protection Corporation Acts.
For additional information about how to obtain official publications of Commission rules and
regulations, contact:
Superintendent of Documents
Government Printing Office
Washington DC 20402-9325
For copies of SEC forms and recent SEC releases:
Publications Section
U.S. Securities and Exchange Commission
450 Fifth Street N.W., Stop C-11
Washington, D.C. 20549
Telephone: (202) 942-4046 E-mail address: publicinfo@sec.gov
Other useful addresses, telephone numbers, Web sites, and e-mail:
SEC's World Wide Web site:
www.sec.gov
SEC Office of Small Business:
SEC Small Business Ombudsman
U.S. Securities and Exchange Commission
450 Fifth Street, N.W., Stop 7-8
Washington, D.C. 20549
Telephone: (202) 942-2950
E-mail addresses:
e-prospectus@sec.gov
help@sec.gov
North American Securities Administrators Association
10 G Street, N.E., Suite 710
Washington, D.C. 20002
(202) 737-0900
NASAA's World Wide Web site: nasaa.org
U.S. Small BusinessAdministration
SBA's World Wide Web site: sbaonline.sba.gov
Angel Capital Electronic Network
ACE-Net World Wide Web site (through SBA site):
sbaonline.sba.gov |
