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Start Ups and Emerging Companies – 101: Securities Laws

January 14, 2013

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The Federal Securities Acts of 1933 ("Securities Act") generally requires that stock and other securities must be registered (or exempted from registration) prior to the sale.  Registration is time-consuming and expensive, so most offerings (sales of stock) are made in reliance on an exemption to registration.  Typically, the start up will rely on one of two exemptions: (1) exemptions for nonpublic offerings, or (2) exemptions for limited offerings under Rule 506 of Regulation D. 

Nonpublic Offerings

Nonpublic offerings may be exempt from registration under Section 4(2) of the Securities Act, which exempts "transactions by an issuer not involving any public offering".  This exemption would typically be relied upon in connection with the initial sale/issuance of stock to the company's founders and insiders.

Regulation D, Rule 506

Offerings may also be exempt from registration under Rule 506 of Regulation D (aka, the "Private Offering Exemption")  Under the Private Offering Exemption, an issuer may sell shares to an unlimited number of accredited investors, and to 35 non-accredited investors.  Accredited investors are those investors that meet certain qualifications to establish that they are presumably wealthy enough or sufficiently sophisticated such that they are able to protect their own interests and bear the economic risk of the investment.

Rule 501 of Regulation D defines an "accredited investor" as:

  • 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 who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
  • 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 in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

Non-Accredited Investors

The start up should think carefully before selling stock to a non-accredited investor.  With the exception of the initial sale of stock to founders and insiders, the start up may be required to provide non-accredited investors with substantial disclosures under a Private Placement Memorandum (PPM). 

The Private Placement Memorandum typically contains a disclosure of all material information relevant to the investment in the company.  Generally, the Private Placement Memorandum will include a level of information sufficient to protect against a future claim by the investor that his or her decision to invest was based (at least in part) on the company's failure disclose or misstatement of a fact that an investor would deem material in deciding whether to invest in the company.  This disclosure document may be expensive and time consuming to prepare.

While disclosures are recommended for sales of stock to an accredited investor, such disclosures are not required by statute.

For more information, please contact:

Derek Ridgway

925-746-8484 Direct Phone
925-746-8493 Fax

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