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Entity formation and securities law Evan Husney
1. Entity Formation and Securities
Laws
Evan Husney
Foster Graham Milstein & Calisher
LLP
February 17, 2016
2.
3. Choice of Entity
• Major Considerations
– Liability Protection
– Taxes
– Ease of Formation
– Familiarity of Form
– Ability to Access Investor Funds
– Record Keeping Requirements
4. Subchapter “S” Corporations
• Limited Liability
• Pass Through Taxation
• Simple to Form (note need for shareholders
agreement)
• Cannot go public (see limitations below)
• Limitations on Owners
– No more than 100 shareholders
– Only one class of stock
– Only U.S. citizens or resident aliens
– No entities except certain qualified trusts and tax exempt organizations
5. Subchapter “C” Corporations
• Same as “S” Corporations except:
– No Pass-through Taxation (double tax
structure)
– Can Go Public
– No Limitations on number or type of Owners
– More Than One Class of Stock Allowed
6. Limited Liability Companies
• Limited Liability
• Pass Through Taxation – same as S Corp.
• Can Be Difficult to Form
• Less Familiar Than Corporations
• No limitations on number or type of
members
• More flexible if needed
7. Helpful Hints - Preparing For
Investors
• Properly Complete Corporate Formalities
– Organizational Documents
– Employee Agreements
– Securities Issues
– Other Contracts
• Capitalization
– Think About The Future
– Don’t Sell Expensive Equity Early
– Keep it Simple
– Limit Number of Equity Holders if Possible
8. Helpful Hints - continued
• Surround yourself with the right advisors/board
• Intellectual Property
– Is it Protectable?
– If so, is it Protected?
• Understand Your Target
– Should You be Talking to Whom You are Talking?
– Don’t Waste Your Time
– First Impressions are Huge
– Find a Champion
9. Helpful Hints - continued
• Have Your Story Straight
– Executive Summary (no more than 2-3 pages)
– Detailed Business Plan
– Use Friends and Contacts to Review
– Should Take Many Iterations to Complete
• Have Patience!
10. Securities Laws
• Both Federal and State apply – must
comply with both – “Blue Sky” filings
• State based on domicile of investor
• Starting point is registration requirements
• Expensive and Time Consuming
• Regulation D Exempt Offerings (Federal
Rules 504-506)
11. Rule 504
• No more than $1,000,000 during 12 months
• Unlimited number of investors
• No specific disclosure requirements
• Anti-fraud and material info rules still apply
12. Rule 505
• No more than $5,000,000 during any 12
months
• No more than 35 unaccredited investors and
unlimited number of accredited investors
• No general solicitations or general
advertising
• Anti-fraud and material info rules still apply
13. Rule 506
• No dollar limitation
• No more than 35 unaccredited investors and
unlimited number of accredited investors
• accredited investors still need a certain level of
sophistication
• Unaccredited investors need to receive
information sufficient for full registration
• General solicitation or general advertising allowed
under certain circumstances
• Anti-fraud and material info rules still apply
14. New Rules
• Now can have up to 2,000 accredited
investors (up from 500) and still be a
private company
• General Solicitation allowed for Rule
506(c) offerings
– Must take additional steps to verify investor
status
15. Verification
• Safe Harbor
– Review documents showing sufficient income
– Review documents showing net worth
– Rely on written confirmation of a qualified
third party
– Rely on certification of investor that previously
invested in a private offering as accredited
16. Accredited Investor Definition
• Directors, officers, partners of issuer
• Net worth of $1 million (individually or
jointly with spouse but excluding residence)
• Income in excess of $200,000 (or $300,000
with spouse) in last 2 years and expectation
of same in current year
• Business entity treated as a single
individual unless formed for purpose of
investment, in which case each individual
17. Private Placement Memo
• Offering document provided to potential
investors
• Provides material disclosures required by
securities and anti-fraud rules
• Basically a business plan wrapped by legal
disclaimers and more information about the
company and securities being offered.
• Must contain any info that would be
material to investment decision
18. Offering Process
• Prepare PPM
• Hand out and track numbered copies
• Prepare subscription agreement that
investor will sign with investor reps and
warranties and amounts subcribed
• Accept payment and issue securities
• File Form D and any required state filings
19. Case Study
• 3 individuals wish to form a new business
to sell a revolutionary solar product
• Each will own 33% of the company
• They will need financing of $2 million
• The product is patentable technology
• What next?