Securities laws and small businesses

Securities laws and small businesses

Securities Laws and Small Businesses

Small businesses may offer ownership to outside investors–namely, investors who will not play any management role in the company. When faced with this situation, the offering or sale of such ownership interests will put the business in the position of offering or selling “securities,” which is a defined term that is as heavily loaded as a nuclear arsenal.

This is because, if a business offers or sells securities, even if to just one person, the business will have to comply with extremely complex federal and state securities laws. Federal laws mandate that the business either 1) register the offer and sale with the SEC (what is commonly known as becoming a “public company”); or 2) conduct the offering and sale in accordance with one of the many registration exemptions available under federal securities laws. This second option is obviously much more common, as businesses do not regularly “go public” every time they wish to offer and sell securities to outside investors.

Therefore, for small businesses bringing on outside investors, the issue becomes how to conduct the offering and sale of securities in accordance with one of the exemptions. The SEC has a robust guide on its web site, entitled Small Business and the SEC. The guide explains in detail each of the exemptions. If a business owner wants to get a more in depth understanding of the exemptions, that guide is worth reviewing.

This article, meanwhile, covers some of the most common exemptions, and offers a brief explanation of each.

1) Section 4(a)(2) non-public offerings (aka “private placements”)

To qualify under this exemption, purchasers must be “sophisticated investors” (that is, able to evaluate the merits and risks of the investment, or able to bear the investment’s economic risk); have access to the type of information normally provided in a prospectus for a registered securities offering; and agree not to resell or distribute the securities to the public. In general, public advertising of the offering, and general solicitation of investors, is not permitted. Fortunately, the SEC set forth a specific set of objective standards that a business can rely on to meet the requirements of this exemption. These standards are set forth in Rule 506(b).

2) Rule 504 offerings (aka “seed capital exemption”)

Under this exemption, a business may offer and sell up to $1,000,000 of securities in a 12 month period. The business may use this exemption so long as it is not a blank check company and is not subject to certain reporting requirements. With some exceptions, general solicitation or advertising to market the securities is not permitted, and purchasers generally receive restricted securities. Purchasers of restricted securities may not sell them without SEC registration or using another exemption.

3) Rule 505 offerings

This exemption is for offers and sales of securities totaling up to $5 million in any 12 month period. A business may sell to an unlimited number of accredited investors and up to 35 persons who are not accredited investors. Investors must buy for investment purposes only, and not for the purpose of reselling the securities. The issued securities are, again, restricted, and the business may not use general solicitation or advertising to sell the securities.

4) Rule 506(c) offerings

This is the newest rule, which was adopted as a result of the JOBS Act. General solicitation of securities is permitted where all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers are accredited investors. Purchasers, again, receive restricted securities.

Filing requirements under rules 504, 505 and 506

The only filing requirement under each of rules 504, 505 and 506 is to file a notice on Form D with the SEC. The notice must be filed within 15 days after the first sale of securities in the offering. Many states also require the filing of a Form D notice. The main purpose of the filing is to notify federal and state authorities of the amount and nature of the offering being undertaken in reliance upon Regulation D (this is the regulation that contains rules 504, 505 and 506).

5) Regulation A

This is an exemption for public offerings not exceeding $5 million in any 12 month period. Regulation A offerings share many characteristics with registered offerings. For example, purchasers must be provided with an offering circular similar to a prospectus. The securities also can be offered publicly, using general solicitation and advertising, and purchasers do not receive “restricted securities.”

To comply with Regulation A, the business must file an offering statement with the SEC on Form 1-A, consisting of a notification, offering circular, and exhibits.

6) Accredited investor exemption (under Section 4(a)(5))

This section exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million. The definition of accredited investor 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 general solicitation or advertising. There also are no document delivery requirements.

7) Intrastate offering exemption (under Section 3(a)(11))

This exemption serves the financing of local businesses. To qualify, a business must be organized 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 (the business must determine the residence of each offeree and purchaser).

There is no limit on the size of the offering or the number of purchasers. However, if any of the securities are offered or sold to even one out-of-state person, the exemption may be lost. Also, if a purchaser resells any of the securities to a person who resides outside the state within a short period of time after the company’s offering is complete (the usual test is nine months), the entire transaction, including the original sales made within the required state, might violate the Securities Act. Rule 147, a “safe harbor” rule, can be followed to ensure meeting the requirements for this exemption.

Finally, if a business holds some of its assets outside its state, or derives a substantial portion of its revenues outside that state, it may also have difficulty qualifying for the exemption.


While there is not yet an exemption for crowdfunding, it is a very popular form of raising money, and is worth discussing. Securities crowdfunding will soon be regulated by the SEC, once it puts in place rules (as required by the JOBS Act) to create an exemption. 

Crowdfunding is essentially a way to raise money by attracting relatively small individual contributions from a large number of persons. Current popular crowdfunding web sites do not offer securities. Instead, the sites raise money in the form of donations, or in return for a product being made.

Once the SEC puts its crowdfunding exemption rules in place, businesses will be permitted to raise $1 million in any 12-month period. Businesses cannot crowdfund on their own, but will have to engage an intermediary that is registered with the SEC. These intermediaries will be subject to a number of requirements. Although it has not yet written the rules, the SEC has offered some initial guidance on crowdfunding intermediaries.

Businesses cannot use JOBS Act crowdfunding to raise funds from investors until the SEC adopts the new rules. See our guide on crowdfunding laws for more information.

State laws

Finally, it is important to keep in mind that both federal and state securities laws must be complied with when offering or selling securities. Typically, the law of the states where the offers and investors are based is the state law that applies. Each state’s securities laws have their own separate registration requirements and exemptions to registration requirements. To locate a state securities regulator and learn more about a particular state’s securities laws, visit the web site of the North American Securities Administrators Association.

If you would like to learn more about securities laws and small businesses or have an Oregon company that has securities laws issues, please contact us.

Author: Andrew Harris

Andrew Harris is an attorney in Portland, Oregon and he wrote this article on securities laws and small businesses.

Learn More About Securities Laws and Small Businesses

To continue reading more about the laws that might affect your business, please see the Articles page, or to simply see a list of helpful legal resources for Oregon startups and businesses, please see the Legal Resources page.

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