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 offering 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.

There are numerous federal private offering exemptions, including those that permit the sale of securities to the public, such as the intrastate offering and crowd-funding exemptions. However, as most startup companies and small businesses do not solicit or advertise their securities to the public, the most frequently used exemptions are: (i) a Rule 506(b) offering to “accredited investors” only (which is not subject to state offering document requirements) and (ii) a Rule 504 offering of up to $5,000,000 to both accredited and non-accredited investors (which is subject to any state offering document requirements) . Both of these private offering exemptions offer the advantage of being able to prepare a private offering memorandum that does not have to include certain disclosures and audited financial information found in a prospectus of a registered securities offering. The reduced disclosure requirements can significantly lower the cost of legal and accounting fees to prepare the offering documents and conduct the offering.

A Rule 506(b) offering that is restricted to “accredited investors” has the advantage of permitting the sale of securities in an amount that exceeds $5,000,000. 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. A Rule 506(b) offering also has the advantage of being automatically exempt from the registration, qualification and offering document requirements of state law. However, the issuer must file a notice and pay a Rule 506(b) filing fee to each state in which its securities are sold.

A Rule 504 offering, while being restricted to a maximum of $5,000,000, has the advantage of permitting the sale of securities to investors who do not meet the high net worth requirements of accredited investors. The Rule 504 offering has the disadvantage of requiring compliance with the private offering exemption requirements of each state in which residents are offered securities.

It should be noted that securities sold in Rule 506(b) and Rule 504 offerings are “restricted securities” that are subject to certain resale restrictions under both federal and state law. You should consult with an attorney to confirm that the securities have been held for a permissible period of time, under a federal and state resale exemption, before attempting to resell them.

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Dave Berson
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dberson@banktaxlaw.com

This website provides general information about legal issues and developments in the law. Such materials are for informational purposes only and may not reflect the most current legal developments. These informational materials are not intended, and must not be taken, as legal advice on any particular set of facts or circumstances. You need to retain an attorney for advice on specific legal issues.

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