One of the advantages of a small company is not having to make public disclosures under the securities laws - but there are some important things every small business should know about the securities laws.

Securities laws are important to small businesses.  Every time a small business raises funds, it needs to make sure it is doing so in compliance with the securities laws.  In addition, as small businesses grow and need more financing, raising funds from public offerings of registered securities under the securities laws becomes more important.  Actions taken by a small business early in its life can affect these later public offerings.  Once a small business has registered under the securities laws, there are additional disclosures and filings that are required of the small business.  As a result, a small business should have a basic understanding of the securities laws and should have an attorney who is familiar with these laws.

Important Tip Understanding a little bit about the securities laws now will make your small business that much more successful when it hits the big time and goes public

History of the Securities Laws
According the U.S. Securities and Exchange Commission, the history of the securities laws is as follows:  In the chaotic securities markets of the 1920s, companies often sold stocks and bonds on the basis of glittering promises of fantastic profits - without disclosing any meaningful information to investors. These conditions contributed to the disastrous Stock Market Crash of 1929. In response, the U.S. Congress enacted the federal securities laws and created the U.S. Securities and Exchange Commission (SEC) to administer them.

Application of the Securities Laws to Small Business
The federal securities laws require a small business to make certain disclosures and filings when selling securities, unless the sale is exempted from the securities laws.  A small business would do well to make sure it is in compliance with securities laws.  The government enforces the federal securities laws through criminal, civil and administrative proceedings. Some enforcement proceedings are brought through private law suits. Also, if all conditions of the exemptions are not met, purchasers may be able to obtain refunds of their purchase price.
There are two key tests for determining whether the securities laws apply to funds raised by a small business:

  1. Is the small business selling securities?
  2. Does the sale meet an exemption from the securities laws?


What is a Security?
Normally, whether a small business is selling securities is an easy answer.  Stocks and bonds are usually securities.  But, there are many more instruments that are classified as securities.  For example, one small business was selling tracts of land in Texas that the small business was going to drill for oil.  If oil was found, the proceeds from the oil would also go to the purchasers of the land.  The oil interest was deemed to be a security subject to the securities laws.  Another example is that a small business was selling orange groves to the public.  Along with the sale of the orange groves, the small business was also offering to cultivate the orange groves.  The offer was held to be the offering of a security subject to the securities laws.  There are also many exceptions to the definition of a security.  When in doubt, it is a good idea to consult with an attorney.

What are the Exemptions from the Securities Laws?

Even if a small business is offering securities, there are still several exemptions from the securities laws that could apply.  Most of the exemptions revolve around three things – the size of the offering, the number of investors and the type of investors.  A very brief summary of the most common exemptions is provided below:

A.  The Intrastate Offering Exemption. The "intrastate offering exemption" facilitates the financing of local small business operations. To qualify for the intrastate offering exemption, the small business must:

  • be incorporated in the state where it is offering the securities;
  • carry out a significant amount of its business in that state; and
  • make offers and sales only to residents of that state.

B.  Private Offering Exemption. Transactions by a small business not involving any public offering are exempted from registration. To qualify for this exemption, the purchasers of the securities must:

  • have enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (the "sophisticated investor"), or be able to bear the investment's economic risk;
  • have access to the type of information normally provided in a prospectus; and
  • agree not to resell or distribute the securities to the public.

In addition, the small business may not use any form of public solicitation or general advertising in connection with the offering.

C.  Regulation A. Regulation A is an exemption for public offerings not exceeding $5 million in any 12-month period. If a small business chooses to rely on this exemption, the small business must file an offering statement, consisting of a notification, offering circular, and exhibits, with the SEC for review.

D.  Regulation D. Regulation D establishes three exemptions from Securities Act registration:

  • Rule 504.  Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period.
  • Rule 505.  Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, a small business may sell to an unlimited number of "accredited investors" and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are "restricted." Consequently, the small business must inform investors that they may not sell for at least a year without registering the transaction. A small business may not use general solicitation or advertising to sell the securities.

An "accredited investor" is:
    * a bank, insurance company, registered investment company, business development company, or small business investment company;
    * an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
    * a charitable organization, corporation or partnership with assets exceeding $5 million;
    * a director, executive officer, or general partner of the company selling the securities;
    * a business in which all the equity owners are accredited investors;
    * a natural person with a net worth of at least $1 million;
    * a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
    * a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person.

  • Rule 506.  Rule 506 is a "safe harbor" for the private offering exemption discussed above. If the small business satisfies the following standards, it is within the exemption:

    * The small business can raise an unlimited amount of capital;
    * The small business cannot use general solicitation or advertising to market the securities;
    * The small business can sell securities to an unlimited number of accredited investors (the same group identified in the Rule 505 discussion) and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.

E.  Accredited Investor Exemption. Offers and sales of securities to accredited investors when the total offering price is less than $5 million are exempted from registration. The definition of accredited investors is the same as that used in Regulation D. Like the exemptions in Rule 505 and 506, this exemption does not permit any form of advertising or public solicitation. There are no document delivery requirements. Of course, all transactions are subject to the antifraud provisions of the securities laws.

F.  Exemption for Sales of Securities through Employee Benefit Plans. Sales of securities are exempted if made to compensate employees. A small business can sell at least $1,000,000 of securities under this exemption, no matter how small the business is. The small business can sell even more if it satisfies certain formulas based on the small business' assets or on the number of its outstanding securities. If the small business sells more than $5 million in securities in a 12-month period, it needs to provide limited disclosure documents to its employees. Employees receive "restricted securities" in these transactions and may not freely offer or sell them to the public.

Certain Rules that Still Apply When Selling Securities in a Exempted Offering
Even in exempt offerings, small businesses are still subject to the antifraud provisions of the federal securities laws. This means that you and your small business will be responsible for false or misleading statements, whether oral or written.

The Effect of State Securities Laws
The federal government and state governments each have their own securities laws and regulations. If the small business is selling securities, it must comply with federal and state securities laws. If a particular offering is exempt under the federal securities laws, that does not necessarily mean that it is exempt from any of the state laws.  Both must be checked.

Simplified Public Offerings for Small Businesses
Typical public offerings can easily cost $1 million or more due to all of the requirements that must be met.  For a small business, the SEC has made available certain simplified procedures that can have the effect of making the process less complicated, less expensive and faster.  Forms SB-1 and SB-2 are available to small businesses instead of the more demanding S-1 Registration Statement required in other public offerings.

Additional Information
Important Tip: 
Understanding a little bit about the securities laws now will make your small business that much more successful when it hits the big time and goes public
Marketing copy: 
Complying with the Securities Laws