A business can be financed by selling interests in the business to investors. The interest sold is called a security, whether the business is a partnership, a limited liability company, a corporation, or some other entity. Partnership interests sold to an investor who is also an active partner in managing the business are often an exception.

The sale of securities is highly regulated by federal and state laws. The starting point is that a registration statement must be in effect for any offer or sale of a security unless an exemption can be found. If a registration statement is in effect securities can be sold to the general public.

Registration is very complex and very expensive. Few businesses qualify. There are exemptions, however, for certain limited offerings which are not public in nature. A company seeking to rely on these exceptions must do so in all respects or the buyers have rescission rights.

The requirements for the exemptions are set out in the relevant statutes and rules. Some of these rules contain specific requirements as to things which must be disclosed to investors and these requirements must be adhered to. Under some of the exemptions no specific disclosures are mandated, but still extensive disclosures must be made because of state and federal statutes that provide that any misstatement of a material fact or failure to disclose a material fact in connection with the offer or sale of a security is actionable.

This requirement means a detailed disclosure package must be prepared for any securities offering. For exempt offerings it is usually called a private offering circular or private placement memorandum. It resembles and contains much of the information a prospectus contains in the case of publicly offered securities. It is called private, because as a condition of most of the exemptions, these securities cannot be sold by solicitation of, or advertising to, the general public.

The common federal exemptions from registration (but not disclosure requirements) of securities are:

1. Intrastate. The company must be organized in and have its principal office in a state where it receives most of its revenues and the securities must be offered and sold only to residents of that state. There are no limits on the amount of the offering and no requirements that the purchasers be sophisticated. There are no federal limitations on public sale (however public sale within that state would have to be registered with the state).

2. Regulation D.

a) Rule 504. This allows public sales of securities up to $1,000,000 total in states where the offering is registered. In effect this allows small public offerings to be free of the federal registration requirement.

b) Rule 505. This allows the private sale of $5,000,000 of securities to up to 35 ordinary investors plus an unlimited number of accredited investors.

c) Rule 506. This allows the private sale of an unlimited amount of securities to up to 35 purchasers who alone or with an adviser are able to understand the merits and risks of the offering and also to an unlimited number of accredited investors.

d) Rules 504-506. The issuing company must disclose the non-financial information set forth in SEC Regulation A if it is eligible to use that form and if it is not, the information required by Part I of the registration statement it would be entitled to use if registering the securities. The financial information which must be disclosed varies with the size of the offering. Up to $2,000,000 Regulation S-B is applicable. Over that and up to $7,500,000 Form SB-2 is applicable. Over $7,500,000 the company must give the same financial information it would disclose in a registration statement. Accredited investors do not have to be counted when there are limits on the number of purchasers. They include certain banks, insurance companies and investment companies and individuals with high net worth ($1,000,000) or income ($200,000). Officers, directors and general partners of the issuer are also accredited persons. Except for certain securities sold under Rule 504 securities sold under Regulation D cannot be resold without registration or an exemption therefrom. The Regulation D rules for disclosure are slightly different for public companies or companies that are required to file periodic reports with the SEC. Form D must be filed with the SEC to report the offering and resale restrictions must be prominently communicated to buyers.

There are rules under the federal exemptions to prevent issuers from doing a series of offerings, one after the other. If offerings are close together in time or purpose and type they are integrated or considered parts of the same offering so the dollar and offeree number limits cannot be avoided.

State exemptions from registration vary widely from state to state. The common exemptions in Illinois are:

1. Offer or sale of pre-organization subscriptions to subscribers of an issuer provided a) if a commission is paid to sell them the sale is not public, or b) no commission is paid, and c) there are no more than 25 subscribers.

2. The private offer and sale of securities to no more than 35 residents of Illinois or private offer and sale of no more than $100,000,000 of securities in 12 months when no commission over 20% is paid. A form 4G must be filed with the Securities Department but that is not a condition of the exemption.

3. Sales to existing security holders if no commission is paid.

4. Sales to certain banks, insurance companies and investment companies.

5. Sales where up to 5 purchasers wind up owning 50% or more of the issuer where no more than 15% commission is paid.

6. Private sales to accredited investors - although the definition is slightly different from the federal definition.

7. Sales to someone who buys at least $150,000 where that does not exceed 20% of the purchaser's financial asset net worth.

8. Sales to directors, officers and general partners.

Under both federal and state law people who sell securities for compensation have to be registered as broker-dealers (the firms) and associated persons (the individuals). Generally there are exemptions from these registration requirements for employees of the issuer who are not paid any special compensation for selling the offering and who do not regularly engage in selling the issuer's securities.

Donald M. Thompson * 55 W. Monroe #3950; Chicago, IL 60603
Ph: 312-782-0844 * Fax: 312-201-1436 * Email: donthompsonlaw@sbcglobal.net