Raising Capital for Your Business without Imprisonment

By Travis Townsend Jr.

There are no business fire drills like those caused by an emerging company with prospective investors chomping at the bit to pump money into the company. This is especially the case when the company is staring down the exhaustion of its cash on hand before the next payroll. It’s not uncommon for clients and prospects to call me with urgency to discuss an equity financing transaction that has to happen immediately. I am very much obliged to help them because, after all, that’s what I do. Just call me “the Fund-raiser,” because I get your company’s paper up.

While corporate finance must be done quickly sometimes, it is necessary to avoid running afoul of the Federal and State securities laws when doing so despite the haste. If you believe you can simply agree with someone to sell a certain percentage of your company for a set price, take a check for the agreed upon amount, and be okay to operate business with that cash and your new co-owners, you are risking your entire business and personal freedom to boot! Selling ownership in your company constitutes the issuance of securities, and Federal and state laws establish some very stringent requirements that must be adhered to lest you subject your company to repayment of all money received from such sale plus penalties. And if the prospect of paying back all the money raised, plus penalties isn’t trouble enough, you also run the risk of being imprisoned for up to five years if you violate certain securities law provisions. Yes, raising capital is serious business. Take it lightly and the consequences could be devastating.

I would be remiss if I told you how ghastly the improper issuance of securities can be without sharing some insight on how to do it right. The first thing required to offer shares of your company for sale is registration of the company and shares to be sold with the Securities and Exchange Commission (SEC). This registration process along with the required maintenance reporting is cost prohibitive to most emerging companies, but fortunately the SEC has established several exceptions to this requirement. The most commonly used exceptions to registration are based on the SEC’s “private offering” exemptions pursuant to Reg D of the securities laws.

There are three major exemptions under Reg D that serve emerging companies well when offering shares of their company for purchase to raise capital. They are commonly recognized as Rule 504, 505 and 506 exemptions. In summary, the requirements for an offering made under each respective rule are as follows:

Rule 504

  • The company can only sell up to one million dollars in securities over a 12-month.
  • The company cannot solicit or advertise the securities publicly.
  • The company must promptly file a Form D notice of sale with the SEC.

Rule 505

  • The company can only sell up to five million dollars in securities over a 12-month period.
  • The company cannot solicit or advertise the securities publicly.
  • The securities can only be sold to accredited investors and up to 35 non-accredited investors, and
  • The company must promptly file a Form D.

Rule 506

  • The company can sell an unlimited dollar amount of securities over a 12-month period.
  • The company cannot solicit or advertise the securities publicly.
  • The securities can only be sold to accredited investors and up to 35 non-accredited investors, but those non-accredited investors must be sophisticated and have sufficient knowledge and experience in financial matters to make them capable of assessing the investment your company is offering.
  • The company must give documents to the non-accredited investors thoroughly disclosing relevant information about the company.
  • Company representatives must be available to answer questions about the company from investors.
  • The company must promptly file a Form D.

In each of the aforementioned situations, the securities offered will be “restricted” and thus may not be freely re-sold without meeting the SEC’s resale exemption requirements. Another important requirement for any securities offering is that the information provided to prospective investors not be misleading. Mislead the investors and you put yourself in the zone of danger for the harshest punishments. But if you offer your securities pursuant to the requirements of Rule 504, 505 or 506, and do not mislead investors, you can get that much needed capital, avoid claims for repayment and stay out of prison. Remember, your push to build a world leading business will take a significant detour if you have to do a stint behind bars and give back all of your working capital.

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