Securities Laws For Private Offerings

Securities Laws and Raising Capital Benjamin M. Hron bhron@mccarter.com 617.449.6584 @HronEsq 03.05.12

Agenda♦ What is a “Security”♦ Security Laws♦ Private Placements♦ Accredited Investors♦ Crowdfunding

What is a “Security”?Any note, stock, treasury stock, security future, bond, debenture,evidence of indebtedness, certificate of interest or participation in anyprofit-sharing agreement, collateral-trust certificate, preorganizationcertificate or subscription, transferable share, investment contract,voting-trust certificate, certificate of deposit for a security, fractionalundivided interest in oil, gas, or other mineral rights, any put, call,straddle, option, or privilege on any security, certificate of deposit, orgroup or index of securities (including any interest therein or based onthe value thereof), or any put, call, straddle, option, or privilege enteredinto on a national securities exchange relating to foreign currency, or, ingeneral, any interest or instrument commonly known as a "security", orany certificate of interest or participation in, temporary or interimcertificate for, receipt for, guarantee of, or warrant or right to subscribe toor purchase, any of the foregoing.

What is a “Security,” really?!Ownership interest in a common enterprisewhere the holder is led to expect profits solelyfrom the efforts of others.Examples – stocks, options, bonds ... – Interest in a citrus grove

What are Securities Laws?♦ Regulate issue and transfer of securities♦ Apply to public and private companies♦ Intended to protect “widows and orphans”♦ Generally require disclosure of information material to an investment decision – Public Offering  Prospectus – Private Offering  Private Placement Memo

What are Securities Laws?♦ Federal Laws – Securities Act of 1933 (“33 Act”) – Securities Exchange Act of 1934 (“34 Act”)♦ State “Blue Sky” Laws – Generally similar in nature to Federal laws – Federal preemption in limited circumstances

Why do Securities Laws Matter?♦ Companies use securities for: – Fundraising – Incentive Compensation♦ Failure to comply may result in: – Civil and criminal penalties – Right of investors to get their money back (“rescission”) – Chilling effect on future fundraising

Securities Law in a Nutshell♦ Prohibit offer or sale of securities unless – the securities are registered – an applicable exemption is available♦ Registration (ex. IPO)  $$$$♦ Exemptions – Exempt Securities – Exempt Transactions (ex. private placements) – State exemptions required unless federal exemption preempts state law

Private Placements♦ Section 4(2) of the 33 Act♦ Regulation D under 33 Act (Rules 501-508) – Rule 501: incl. def’n of “Accredited Investor” – Rule 502: incl. disclosure requirements – Rule 504 – Rule 505 Safe Harbors – Rule 506 – Rule 507 – disqualifying provisions – Rule 508 – insignificant deviations

Regulation D: Accredited Investors♦ Natural Person with – Net Worth (w/ or w/o spouse) >$1M (excl. home) – Income >$200K in past 2 years and current year – Joint income >$300K in past 2 years and current year♦ Director, executive officer or general partner of the company♦ Business in which all the equity owners are accredited investors♦ Entities with > $5M in assets

Regulation D: Safe Harbors♦ Rule 504: $1M max. in 12 months – No investor qualification requirements – Requires separate state exemption(s)♦ Rule 505: $5M max. in 12 months – Unlimited “accredited” investors – Up to 35 non-“accredited” – Requires separate state exemption(s)♦ Rule 506: No $$$ limit – Unlimited “accredited” investors – Up to 35 non-accredited, sophisticated investors – Preempts state law  only notice filing/fee required

Benefits of Selling to Accredited Investors♦ Premise: Wealthy can fend for themselves♦ No affirmative disclosure obligation♦ No limit on # of Accredited Investors♦ No limit on $$$ raised♦ Limited diligence required to confirm status – Questionnaire – Representations & Warranties♦ Bottom Line: Lower Transaction Costs

Accredited v. Non-Accredited Investors♦ Financing with Non-Accredited Investor(s) – Rely on 4(2) (but no “safe harbor”) – Rely on 504 or 505 (but need state exemptions and/or PPM) – If “sophisticated,” rely on 506 (but PPM req’d)♦ Accredited Investor Financing (Rule 506) – Confirm “accredited” status of investors – Provide information upon request – Notice filings due within 15 days of first sale

Crowdfunding♦ Investment of small amounts by many individuals (contra. Kickstarter)♦ 4(2) and Reg. D not available♦ Pending Legislation – H.R. 2930: Entrepreneur Access to Capital Act (passed by House 11/3/11) – S. 2190: Crowdfund Act (introduced 3/13/12; consolidates competing bills)

Crowdfunding♦ Proposed Requirements – Max. Raise: $1M-$2M/year – Max. Investments: $500-$10K/person/year (subject to income limitations) – 3rd party portal? Req’t TBD – Funds escrowed until closing – Basic disclosure obligations – Federal (and probably state) notice filings – Federal preemption?

Summary♦ “Security” is very broadly defined♦ Federal and State securities laws apply to sales of securities by private companies♦ Regulation D provides “safe harbor”♦ Rule 506 preempts state securities laws♦ Fewer restrictions on sales to Accredited Investors  lower costs♦ Crowdfunding would simplify seed financing

McCarter & English LLP Questions? Benjamin M. Hron bhron@mccarter.com 617.449.6584 @HronEsq

Securities Laws For Private Offerings

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