If you own a private business, you may think that you do not need to worry about securities laws. After all, you do not sell shares on any of the stock markets, and you have not “gone public,” so maybe you think that national and state securities laws do not apply to you.
In fact, the sale of any ownership in a business (whether public or private) is highly regulated by state and federal securities laws. The penalties for ignoring or violating federal or state securities laws can be steep—and sometimes even criminal.
Ball & Barry Partner Michael Barry discusses the firm's experience.
Private equity is a popular way for businesses to raise needed capital. In many cases, the business will often couple an equity raise with some form of stock awards to help bring experienced management on board as partial owner of the business. Offering shares or ownership in your business can help the business obtain capital, person-power, and brainpower that you otherwise may not have the cash to afford.
Almost every sale of securities, even those sales that are made privately (for example, to a select or experienced group of people, such as lenders or those with specific experience who seek to invest in your business) must include investor disclosures. These disclosures describe the nature of your business, information about its owners, and additional details intended to allow the investors to make an educated decision about investing.
The company will customarily make these disclosures in a private placement memorandum (PPM), that is prepared to comply with the disclosures required under state and federal securities laws.
A well drafted PPMs protect both the investor and the business. For investors, the PPM provides transparency and understanding of the risks with which they may be getting involved. For businesses, a well drafted PPM can avoid investor claims of misrepresentation later on if something goes wrong or an investor is disgruntled.
Although some of the paperwork involved with selling private equity can seem onerous, detailed, and time consuming, it is far less so than for businesses making public offerings of stock to the general public. The “private exemption,” which avoids having to file the paperwork needed by companies offering shares to the general public, is often called “Regulation D.”
Yet, the regulation/exemption still requires detailed disclosures, notices that you are applying for the exemption, and disclosures of the risks that investors may be taking by investing.
Remember that even under an exemption such as Regulation D, federal securities antifraud laws still apply. While you may not mean to mislead anyone, innocent errors or omissions that are often contained in required filing paperwork, or in PPMs, can still lead to civil or criminal penalties if they are misleading or paint an inaccurate picture to investors.
Blue Sky Laws
Blue Sky laws are simply state securities laws. Every state has its own laws that govern the sales of shares that compliment or add to federal securities laws. Just because your offering is exempt from federal SEC disclosure or filing laws under Regulation D does not mean that it is exempt under state laws, although most states, like Colorado, have a number of exemptions that correspond to the federal ones.
Do not make the mistake of thinking your business is exempt from extensive filing just because you meet a federal exemption.
In addition to a PPM, businesses looking to raise money by attracting investors will also need to have each investor sign a subscription agreement. While a PPM is a general document disclosing information about the business and the investment to all possible investors, a subscription agreement is an agreement between the business, and a specific person or business seeking to purchase shares.
The subscription agreement sets forth the terms under which the business is willing to sell shares to a certain investor, and how the investor verifies that it is willing to purchase a business’ shares at a given price. The subscription agreement also contains warranties and representations made by both parties, which must be carefully drafted to make sure that your business is not overpromising or misleading and that the investor meets certain qualifications under Regulation D.
Even if your business is not selling shares to the public, complying with federal and state securities laws is vital. Even with exemptions available to private share offerings, paperwork, documents, contracts, agreements, and disclosures must be carefully drafted to protect all parties.
Contacting the Colorado securities and business attorneys at Ball & Barry Law early can help you save time and expense down the line, and can help make sure your securities transactions are as safe and compliant as possible.
MICHAEL P. BARRY