Jerry J. Goldstein

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Raising Business Capital For Your California Entity

There are many ways for startups to raise capital. At the outset, entrepreneurs use their own funds and perhaps ask friends and family members to contribute or lend them money. As the startup grows, the startup might well decide to raise money by soliciting investment. This alternative requires compliance with Regulation D issued by the Securities and Exchange Commission (SEC) if the amount sought is large, and possibly with state securities laws. For smaller amounts, compliance only with state securities laws is required. These laws and regulations are designed to protect investors and prevent fraud.

Is Securities Registration Necessary?

Unless an exemption applies, the federal Securities Act of 1933 requires a business that wants to offer stock for sale to raise capital to register the offering with the SEC. The registration forms require four categories of information:

  • The company must describe its properties and business
  • The securities to be sold must be described, in detail
  • The company should set forth so-called “risk factors” to disclose risks phased generally with all startup and early phase companies
  • The business must provide information about its management
  • Financial statements must be provided. Independent accountants must certify the financial statements.

The registration materials, together with prospectuses, are made available for public inspection on the SEC’s EDGAR database.

Regulation D Exemptions From Registration

Securities registration is an expensive and cumbersome process. To ease the burdens of registration on both startups and established businesses, the SEC promulgated Regulation D. This regulation allows a business to avoid registration if it complies with one of the exemptions from registration set out in the regulation.

There are three exemptions from registration, contained in two rules, Rule 504 and Rule 506. There used to be a Rule 505, but in 2016 the SEC repealed it and folded its provisions into Rule 504 and amended that rule.

The Rule 504 Exemption

Under Rule 504 of Regulation D, a security offering is exempt from registration with the SEC if the business raises no more than $5,000,000 over any 12-month period. The securities offered must be restricted, meaning that the purchasers may not sell them for six months or one year, depending on the circumstances. In lieu of registration, this exemption requires the issuer to file a Form D with the SEC. Form D lists the names and addresses of the issuer’s promoters, executive officers and directors, but it includes little other information.

Two Rule 506 Regulation D Exemptions

Rule 506 of Regulation D encompasses two exemptions from registration with the SEC. Unlike Rule 504 offerings, there is no limit to the amount of money that can be raised under Rule 506. Registrations exempt under Rule 506 also include the requirement of filing a Form D with the SEC.

Exemption Under Rule 506(b)

For private placement offerings, the Rule 506(b) exemption has several requirements for exemption under Regulation D. They are:

  • General solicitation or advertising of the securities is forbidden.
  • There is no limit on the number of “accredited investors” who may buy the securities. The term “accredited investor” is defined in Rule 501(a). There are many definitions. Generally speaking, accredited investors consist of certain institutions and wealthy or high-income individuals.
  • The issuer may sell to no more than thirty-five unaccredited investors, but they must be “sophisticated” investors, able to evaluate the proposed investment.
  • The business must not give investors false or misleading information about the investment or exclude any information the investors should know.

Exemption Under Rule 506(c)

Rule 506(c) exemption from registration under Regulation D applies only to accredited investors. It has a major advantage over Rule 506(b). General advertising of the investment is permitted. But that advantage comes with a disadvantage. When a business uses Rule 506(c) to raise money, the business has the burden of taking reasonable steps to make sure that the investors are, in fact, accredited investors. This may be done by reviewing financial documents such as W-2s, tax returns, bank and brokerage statements and credit reports.

Choices For Regulation D Exemption

Depending on how far along a startup is in its development, the entrepreneur is in the position of choosing which of Regulation D’s exemptions would be best to raise money for the startup. If less than $5,000,000 is needed over a 12-month period, and the investors do not object to their securities being restricted from sale for six months to one year, the Rule 504 exemption is superior. The other two exemptions allow raising unlimited amounts. But under Rule 506(b), which can include unaccredited investors, there can be no advertising and accountant-certified financials are required. Rule 506(c) allows advertising, but all the investors must be accredited. Accordingly, the Rule 506 exemptions from registration under Regulation D will be more expensive to use than the Rule 504 exemption. The entrepreneur should consult with experienced counsel to make, and properly implement, the best choice of exemption.

What Legal Considerations Are Vital When Raising Capital for My Business?

When soliciting investment money, depending on the amount you seek, you may need to comply with Securities and Exchange Commission (SEC) regulation as well as California’s securities laws. Unless exceptions apply, you will need to take extra steps to file information about your business, its management and properties, the securities involved, the risk factors, among other information.

How Can a Business Lawyer Assist in Structuring Successful Capital-Raising Efforts?

As an experienced business lawyer, I can help you explore your options for raising capital for your entity and ensure the requirements for proper execution are timely followed. I am Jerry Goldstein, and I have been helping my business clients successfully execute capital funding for more than four decades. I have a vast network of financial professionals who are readily available for assistance as well.

What Legal Steps Are Involved in Preparing for a Capital Raise, Such as an IPO or Private Placement?

The rules are complex for capital raises involving Initial Public Offering (IPO) and private placement securities offerings. Your first step should be to get knowledgeable legal counsel from an experienced business law attorney. State and federal laws do not require private placement securities to be registered with the SEC. Investors can purchase stocks or bonds without rigorous disclosures.

When you are offering shares of your corporation in an initial public offering (IPO), it is important to comply with the rigorous SEO requirements for holding an IPO. Setting a price, gauging demand and creating a marketing plan, will be essential to the success of the IPO.

How Can a Business Lawyer Ensure Compliance with Securities Laws During Capital Raising?

Raising capital privately or publicly is a big step for startups. A business lawyer will be familiar with the myriad laws and exceptions to be aware of for various types of business entities. At the Law Offices of Jerry J. Goldstein, I also have a solid community of financial advisers and professionals for additional guidance.

What Legal Challenges May Arise During the Capital-Raising Process, and How Can a Lawyer Address Them?

You may be unclear about your startup’s mission statement and how much capital you want to raise, investors may not be interested in supporting your business. A knowledgeable business lawyer can help you draft a vision statement and help you set a financial target.

If you not properly disclose the necessary information required by securities regulations, you could be in violation of the law. This will become a problem. Again, a knowledgeable business lawyer can guide you every step of the way so compliance does not become an obstacle. A lawyer can also assist you with drafting necessary operating agreements or subscription agreements.

Discover Your Options

Contact the Law Offices of Jerry J. Goldstein in Palm Desert by calling 760-359-2233 or sending on online inquiry using this form. I will return your call promptly.