Capital raising involves significant legal risks and complex securities law issues. All sorts of ownership interests sold in exchange for investments and payment rights constitute “securities” and their sale is subject to substantial state and federal regulation. This includes corporate stock, membership interests in LLCs, partnership interests, other investment contracts, and can even include promissory notes.[i]

Under federal law, the offer or sale of securities is unlawful unless the offering has been registered with the SEC or falls within an exemption from registration. Because of this broad general prohibition and the potentially severe consequences of violations, business owners and entrepreneurs must be mindful of securities laws when seeking investment capital. In most cases, they should not sell securities without the assistance of qualified counsel.

The Core Objectives of Securities Law

The U.S. Securities Act of 1933 (the “Securities Act”), similar state laws, and related administrative regulations—have two core objectives:

  1. To protect investors by ensuring they receive adequate information concerning securities, and
  2. To prohibit deceit, misrepresentations, and other fraud in the sale of securities.

Generally, information is adequate and accurate if it meaningfully enables the investor to evaluate the characteristics and qualities of an investment—including the associated risks.

The Registered Offering Requirement

One mechanism by which securities law achieves these objectives is the requirement that a prospective sale of securities (an “offering”) is registered with the SEC prior to any “public sale.” The interpretation of that term can be surprisingly broad. Unfortunately, however, registering an offering is a very expensive proposition. Additionally, registration subjects companies to onerous SEC reporting requirements. As a result, registered offerings are often not a viable option for many ventures.

On Exemptions from the Registration Requirement

Thankfully, federal law provides several exemptions from the requirement to register offerings. These exemptions seek to balance investors’ needs for protection with the needs of businesses by lowering the cost of offering securities. In doing so, the Congress and the SEC seek to foster access to capital for relatively smaller ventures. When it comes to smaller capital raises, these exceptions can be said to “swallow” the general rule prohibiting unregistered offerings: most capital in the United States is raised by way of exemptions. Notwithstanding, registration exemptions are not a “free for all.” Despite their wide availability, the complexity and associated burden of compliance is significant.

The various exemptions applicable to unregistered offerings contain different guidelines. Relative to one another, certain exemptions mandate enhanced disclosure, or other additional requirements, to satisfy a perceived need for greater investor protection. Typically, the larger the capital raise and the more available the offering is to persons who don’t qualify as accredited investors, the stronger the investor protections built into the applicable exemption’s guidelines.

Whether a capital raiser should use a specific exemption depends on several factors. These factors include:

  • the amount of investment sought;
  • how broadly the company wishes to promote the offering;
  • eligibility requirements, such as the stage of the development of the company or its business plan;
  • SEC filing requirements;
  • restrictions applicable to resale of the stock; and
  • whether the preemption of state securities laws is necessary or convenient.

Available Exemptions & Compliance with Disclosure Requirements

Exemptions from the federal registered offering requirement include the following:

  • Private Offerings (or Private Placements) under Section 4(a)(2) and Rule 506(b) of Regulation D.[ii]
  • General Solicitation Offerings under 506(c) of Regulation D.
  • Limited Offerings under Rule 504 of Regulation D.
  • Regulation Crowdfunding Offerings.
  • Intrastate Offerings under Section 3(a)(11) of the Securities Act, Rule 147, and Rule 147A.
  • Regulation A Offerings.

In every offering, issuers must comply with the anti-fraud provisions of the Securities Act in addition to complying with the guidelines of a registration exemption. Doing so means accurately disclosing all material information relevant to the investors’ decision to purchase securities.

Some exemptions expressly include disclosure requirements, but many do not. Securities practitioners have developed standard practices that aid in offering mechanics, including the tradition of creating a private placement memorandum or disclosure statement which address the material terms of an offering and other matters.

However, in certain industries when sophisticated investors conduct significant due diligence, issuers sometimes rely only on representations and warranties in stock purchase agreements to comply with anti-fraud provisions. In evaluating compliance with the anti-fraud requirements of the Securities Act, issuers should consider the basis objectives of securities laws. To prepare to meet the disclosure obligations associated with an offering, capital raisers can reference publicly available tools, such as the model disclosure form created by the North American Securities Administrators Association titled Form U-7 “SCOR” (Small Company Offering Registration).



[i] Note the breadth of the term “security” as defined in the Securities Act: 15 U.S. Code § 77b(1)

[ii] A prior blog by the author discussing these exemptions is available here: Fundraising for your Business through Private Placements & Rule 506(b) – Freeman Law

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