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How Can Your Company
Sell Securities Without
Registering With The
Securities And Exchange Commission?

The Securities and Exchange Commission has the job of protecting the public when it buys securities from companies in the United States. Securities are equity (ownership) or debt (where the money has to be repaid) in a business, government or other organization. The SEC has set up rules that apply to register securities. These rules are designed to assure that investors will receive required information before they invest and are intended to prevent fraud and other financial misconduct.

The SEC is a government agency and these rules, while thorough, can be very expensive to meet. Unless your company is raising a large amount of money, the costs of registering can be a burden on your business or other organization. The SEC realizes this and has a number of ways in which securities can be sold without registration. Be careful to follow the rules, and check with a specialist in corporate finance, to make sure that you get it right. If you make a mistake, you may be subject to civil or criminal penalties, or you may be compelled to buy back the security in question from its purchasers at the offering price.

A. Intrastate Offering Exemption

Businesses can use SEC Rule 147, the "safe harbor" rule. It is intended to allow local business to raise needed funds locally. Following this rule ensures that the securities will qualify for the Intrastate Offering Exemption. It applies when the business:

• is being incorporated in the state where it is offering the securities;
• is carrying out a significant amount of its business in that state; and
• is making offers and sales only to residents (principal residence), or entities located, only in that state.

The SEC will look at the entire round of financing in considering whether it met rule 147. Factors include whether the securities were offered for generally the same purpose. Are they the same class or classes of securities? Were they offered at approximately the same time? Did they get the same type of payment, such as cash, in return for the securities that were sold? The issuer and/or sellers of the securities must prove that they have met all of the requirements of Rule 147 in order to use the Intrastate Exemption.

Under this exemption, you can sell any amount of securities to any number of purchasers, as long as they meet the requirements of the exemption. You must make sure that each purchaser has their legal residence in the state where the company is located. The seller must obtain this in writing from the purchaser. They cannot resell these securities to anyone out of state within 9 months of the original sale. You cannot make another sale of similar securities in the six months following the offering. The securities certificates must also state that they have not been registered and contain notification on the limitations on resale.

If your company has 20% or more of its assets or earnings outside the state, you may be unable to get this exemption. Additionally, at least 80% of the proceeds of the offering should be used within the "home" state.

In practice, it can cost a lot of money and take a lot of time to sell these securities because there is no real market for reselling them.

Although the SEC allows the intrastate exemption to avoid registering with the SEC, you should be aware that the state may have its own rules and requirements. In addition, the interstate exemption is not a defense for companies that commit securities fraud. You and your company will be responsible for written or oral statements that are false or misleading. You will also be responsible for any omissions of information that distort the investor's ability to make a judgment on the value of the investment opportunity.

A. Private Offering Exemption

The SEC will allow for a private offering of securities if the buyers:

• are experienced in finance and business so that they can evaluate the risks and opportunities in the investment or if they can afford the risk of loss.
• they must have a private placement memorandum that provides the type of information normally provided in a prospectus; and
• agree not to resell or distribute the securities to the public.

A private offering truly is private. You cannot advertise it to the general public. If you offer securities to anyone who does not meet the requirements, you may not qualify for any of the exemptions from filing with the SEC. You can follow Rule 506, another "safe harbor" rule, to meet the requirements of this exemption.

Other Options

"Regulation A"

Regulation A exempts small securities offerings not to exceed $5 million in any 12 months. The company has to file an offering statement containing notification, offering circular and exhibits with the SEC for their review. The offering circular allows you to choose from three formats, one of which is a simple question-and-answer document.

Under Regulation A, you can publicly offer the securities and they are not restricted in trade after the offering. This "mini registration" means that the company's financial statements can be simpler and no audit is required. The company will not have to report results publicly unless it has more than $10 million in assets and more than 500 shareholders. Shareholders can use Regulation A to sell less than $1.5 million in securities. Finally, the company can solicit interest in the securities before preparing the filing and selling the securities. This means you can advertise and use general solicitation to see if you can sell the issue before spending the money on the regulatory requirements. You can only make the offering and receive payment after SEC review of your documents.

Regulation D

Under Regulation D, there are three ways of getting an exemption from registration.

1. Rule 504 allows you to sell up to $1,000,000 worth of securities in a 12 month period. Unlike Regulation A, you may not sell the securities to the general public and purchasers can only sell their securities with registration or exemption.
2. You can make a public sale under Rule 504 if it's registered in the states, or in all states that require registration for the offering, and the purchasers are given "substantive" disclosure of the risks and material information.
3. You can make a general solicitation and advertising as long as you sell only to "accredited investors."

Rule 505

• Rule 505 allows you to sell up to $5 million in any 12 month period.
• You can sell to "accredited investors" and up to 35 other people.
• The purchasers must buy for investment and the securities are restricted from sale for at least a year.
• With Rule 505, you cannot tell the public about the offering.

What kind of financial statements do you need to give with a Rule 505 offering?

• Financial statements need to be certified by an independent public accountant;
• If a company finds it difficult or expensive to produce audited financial statements, only the company's balance sheet, dated within 120 days of the start of the offering, must be audited;
• Limited partnerships, facing difficulty and substantial expenses, may instead use audited financial statements prepared under the federal income tax laws.

Rule 506

Rule 506 is another "safe harbor" rule that allows you to raise capital within the Section 4(2) exemptions. The rules for this one are:

• You can raise an unlimited amount of capital;
• You cannot use general solicitation or advertising to market the securities;
• You can sell securities to an unlimited number of accredited investors (the same group we identified in the Rule 505 discussion) and up to 35 other purchasers. All non-accredited investors, either alone or with a purchaser representative, must be sophisticated so that their knowledge and experience allows them to evaluate the merits and the risks of the investments.
• The information that you provide to accredited investors must not violate the antifraud prohibitions. Non-accredited investors must receiver disclosure documents that generally are the same as those used in registered offerings. Any information given to the accredited investors must also be given to the non-accredited investors.
• You must be available to answer questions by prospective purchasers;
• Financial statement requirements are the same as for Rule 505; and
• Purchasers receive "restricted" securities. Purchasers may not freely trade the securities in the secondary market after the offering.

Section 4(6) Accredited Investor Exemption

• You are allowed to make direct sales, with no public solicitation or advertising, to accredited investors when you are offering less than $5 million in securities.
• There are no document delivery requirements but you still must make certain that you do not provide misleading or fraudulent information or leave out any important information that could affect an investor's decision.