Legal Issues with Raising Capital
Federal Security Laws
The Federal Security and Exchange Commission (the SEC) regulates the sale of securities. The Securities
Exchange Act of 1933 (§5) makes it unlawful to solicit or sell securities unless a registration statement is
filed with the SEC. However, certain exemptions may apply. Regulation D of the Code of Federal
Regulations governs the limited offering and sale of securities without registration; rules 501-506 set
forth those exemptions.
Rule 506 of Regulation D is considered a safe harbor because it does not place any limitations on the
amount of investment than can be solicited. The rule does require the following: (1) an exclusion of any
general solicitation or advertising; (2) an offering to no more than 35 non-accredited, but sophisticated,
investors who have knowledge and experience in business matters; and (3) access to disclosure
documents and the opportunity to investigate the offering.
Furthermore, Rule 506 allows for an offering to an unlimited number of accredited investors. An
accredited investor is defined, in part, as “Any natural person whose individual net worth at the time of
his purchase exceeds $1,000,000 or any natural person who had an individual income in excess of
$200,000 in each of the two most recent years or joint income with that person’s spouse in excess of
$300,000 in each of those years”1. In addition institutional investors such as a bank, broker or dealer,
insurance company, investment company, SBA-licensed Small Business Investment Company, or other
investment funds are considered the same.2
If the offering qualifies under one of the private placement exceptions under rule D, then to obtain a
valid exemption from registration, Form D must be filed with the SEC no later than 15 days after the sale
of the private securities.
State Security Laws
The California Corporations Code §25110 sets forth the requirements for qualification for a transaction
of securities. It states that it is unlawful for any person to offer or sell any security in an issuer
transaction unless such a sale has been qualified or unless such security or transaction is exempted or
not subject to qualification and that any offering to the contrary shall be considered an unqualified offer
or sale.
A variety of exemptions are included in the California Corporations Code3. Most similar to the federal
exemptions are those include in §25102(f)(1-4) which include provisions to the following: (1) sales of the
security are not made to more than 35 persons, including persons not in the state; (2) all purchasers
must either have a preexisting personal or business relationship with the offeror or any of its partners,
officers, directors, or controlling persons, or managers; (3) or if not affiliated with the offeror must be
reasonably assumed to have financial experience and the capacity to protect their own interest in
connection with the transaction; (4) each purchaser represents that they are purchasing for their own
account and not with a view to or for sale in connection with any distribution of the security; and (5) the
offer and sale of the security is not accomplished by the publication of any advertisement.
1
CFR Regulation D Rule 501(a)5-6
2
CFR Regulation D Rule 501(a)1-2
3
A comprehensive list of exemptions can be found in the CCC §25111, 25112, 25113, 25140, and 25143
SEC.gov Resources
The Security Exchange Commission provides a variety of online resources for investor and entrepreneurs
to navigate their way through the morass of legal issues related to offering securities. Listed below are
key excerpts from the site with links to additional resources and forms.
Regulation D Offerings: http://www.sec.gov/answers/regd.htm
Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or
meet an exemption. Regulation D (or Reg D) provides three exemptions from the registration
requirements, allowing some smaller companies to offer and sell their securities without having to
register the securities with the SEC. For more information about these exemptions, read our
publications on Rules 504, 505, and 506 of Regulation D.
While companies using a Reg D exemption do not have to register their securities and usually do not
have to file reports with the SEC, they must file what’s known as a "Form D" after they first sell their
securities. Form D is a brief notice that includes the names and addresses of the company’s owners and
stock promoters, but contains little other information about the company.
Accredited Investors: http://www.sec.gov/answers/accred.htm
Under the Securities Act of 1933, a company that offers or sells its securities must register the securities
with the SEC or find an exemption from the registration requirements. The Act provides companies with
a number of exemptions. For some of the exemptions, such as rules 505 and 506 of Regulation D, a
company may sell its securities to what are known as "accredited investors."
The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:
1. a bank, insurance company, registered investment company, business development company,
or small business investment company;
2. 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;
3. a charitable organization, corporation, or partnership with assets exceeding $5 million;
4. a director, executive officer, or general partner of the company selling the securities;
5. a business in which all the equity owners are accredited investors;
6. a natural person who has individual net worth, or joint net worth with the person’s spouse, that
exceeds $1 million at the time of the purchase;
7. 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
8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose
purchases a sophisticated person makes.