Wed, 07/22/2009 - 09:31
Green is in. For decades, we’ve talked about the emergence of green tech and green business. The current political and social momentum we have for the green industry is perhaps the strongest any of us have ever witnessed. Green is not always cheap. Wind farms, solar tech, alternative fuels, innovative construction designs or materials; they all cost money. Even with all the incentives and initiatives available to pursue a green business, in this difficult economic environment, green entrepreneurs have a harder time finding greenbacks to fund their business.
When we ask investors for money, even if they are friends or family, we have to understand the impact of securities laws on the raising of capital. The subject of securities law is lengthy and complex and may be more effective at inducing a state of drowsiness than any drug ever manufactured, but this article will try to explore some of the basics securities concepts in an easy-to-understand manner. Of course, this article is not intended to give legal advice and one should always consult a qualified corporate attorney for proper guidance when starting a business and raising capital.
Any discussion of securities laws should start with an understanding of what constitutes a “security”. The definition is typically extremely broad, and though it varies depending on whether you are looking at the federal laws or the laws of each state governing the securities area, the basics are usually the same. It has long been understood that stocks or bonds of a company are securities. What many people don’t realize is that a whole myriad of other things could be considered securities. For example, promissory notes or even investments in orange groves and chinchillas have been considered securities. Suffice to say, if you are going around asking people to invest in your business, there is an extremely good chance that you are offering securities for sale.
There are federal and state laws that govern the sale of securities. The Securities Act of 1933, otherwise commonly known as the “Truth in Securities Act”, is the starting point for federal securities regulation for companies looking to issue securities. Each state also has its own version of the securities laws, and these laws are commonly referred to as “blue sky” laws. The bottom line is that if you are selling securities or offering to sell securities, you have to comply with federal law as well as the relevant state blue sky laws. Depending on the type of securities you issue, there may be other laws, rules, or regulations that apply as well. Note, in particular, that offers of securities may be improper even if no sale is made. That means the simple act of asking someone to buy some shares in a startup company could be illegal even if the actual sale is never completed. Failure to comply with the securities laws can lead to investor suits or fines and even jail sentences.
The securities laws are there to protect investors. According to the SEC, the two basic objectives of the Securities Act of 1933 are to “require that investors receive financial and other significant information concerning securities being offered for public sale; and prohibit deceit, misrepresentations, and other fraud in the sale of securities.” The objectives for the state blue sky laws are typically similar. Generally speaking, anyone seeking to sell securities must first register or qualify the securities with the appropriate governmental body.
The process of registration or qualification can be an extremely trying process involving much expense and time. Consequentially, most businesses opt not to qualify the securities they plan to offer or sell and seek an exemption instead. Remember, that one needs to find an exemption for all securities law that they are affected by. For example, if you are a California company selling securities in New York to New York residents, finding an applicable exemption that relieves you from California laws does nothing for you as far as New York blue sky laws or federal laws are concerned. For entrepreneurs that seek to sell their company’s stock to investors in many states, it gets a bit unwieldy trying to find an exemption for every state’s securities laws.
Fortunately, one of the most popular federal exemptions from registration of securities employed by companies also enables them to avoid having to register or qualify the securities under state laws. Under the National Securities Markets Improvement Act of 1996, state securities registration requirements for securities offered pursuant to the provisions of Rule 506 of Regulation D under the Securities Act of 1933 are preempted by federal law. In other words, companies that offer securities under the exemption promulgated by Rule 506 of Regulation D are also exempted from registration under the various states’ blue sky laws. Note that some states still impose a notice filing with applicable fee and that the preemption doesn’t affect all types of securities or all types of person.
In reality, Rule 506 of Regulation D is not the actual exemption itself. Rather, it is a safe harbor from the exemption found under Section 4(2) of the Securities Act of 1933. Section 4(2) provides a seemingly broad exemption for “transactions by an issuer not involving any public offering”. However, the precise limits of this exemption are somewhat uncertain. Rule 506 of Regulation D was provided to give assurance to companies that they would be within the Section 4(2) exemption by satisfying certain requirements. Companies using the Rule 506 exemption do not have to register their securities but do have to file a Form D with the SEC. While preemption of the state laws means that they will not have to register or qualify the securities under the various states’ blue sky laws, they may still be required by the applicable states to pay certain fees and make notice filings.
There are a number of other exemptions from registration available from federal securities laws other than Rule 506 of Regulation D. Similarly, states generally have a number of exemptions that companies can rely on as well. Which exemptions are available and which exemptions are practical to use will depend on the individual circumstances of each securities offering. All of the exemptions have criteria that one must satisfy in order to successfully claim them. Therefore, if you are interested in raising money for your business, you should consult with a qualified securities attorney regarding what you can or cannot do while raising capital. If you accidentally take actions that disallow you from taking advantage of all of the exemptions, then you will have to register or qualify your securities in order to legally sell them. Again, that process of registration or qualification will generally be much more painful and expensive than simply finding an exemption.
Don’t forget, even if you successfully comply with the securities registration laws, you are still subject to all other laws, including, for example, anti-fraud provisions of the various securities laws. Due to the complexity of the area of securities laws and the issues involved, entrepreneurs or attorneys representing entrepreneurs in starting a business should consult with an experienced securities attorney for guidance. In fact, a seasoned attorney in the securities area will usually also have valuable industry experience and contacts to share. In today’s environment, one can’t get enough help with raising money.
Jor Law, Esq. is a business and corporate attorney and a founding shareholder of Homeier & Law, P.C. He can be reached at (818) 450-1550 x552 or by visiting his firm's website: www.homeierlaw.com. Copyright © 2009. All Rights Reserved. May not be duplicated, reprinted, or distributed in any form without permission by the author.
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