Information for the Small Businessperson Considering Selling Securities (as of August 15, 2018)

August 15, 2018

Author: John A. Eckstein and Gil B. Selinger


This information has been prepared by the law firm of Fairfield and Woods, P.C., Denver, Colorado, for the purpose of assisting a businessperson who wants to raise capital by selling securities to others. The information includes a discussion of federal and state securities laws and various practical matters. In order to keep legal costs to a minimum, we ask that, before your first conference with a lawyer in this firm, you do the following:

1.      Skim this material so that you will know generally what it contains.

2.      Thereafter read each section carefully and underline any parts concerning which you have questions or comments so that you can discuss them with the lawyer during your first conference.

3.      Complete the questionnaire and assemble the requested information. Once we are retained to represent you, you will then be able to return the questionnaire and information to the lawyer who is handling your matter prior to your first appointment.

This memorandum takes into account the enactment of the Jumpstart Our Business Start Ups Act, as signed by the President on April 5, 2012 (the “JOBS Act”), the SEC Rule 506(c) and “bad actor” rules of the SEC adopted on July 10, 2013, SEC Regulation “A+” effective June 19, 2015, Regulation Crowdfunding effective on May 16, 2016, changes to SEC Rules 504 and 147, effective May 22, 2017 and April 20, 2017, and the enactment of the Economic Growth Regulatory Relief, and Consumer Protection Act, effective May 24, 2018, respectively.

Separate Laws

The federal government, the several states and the Financial Industry Regulatory Authority (“FINRA”) (formerly known as the National Association of Securities Dealers, Inc. or the “NASD”) each have separate securities laws and regulations. Foreign countries often also have such laws. A person selling securities must comply with the securities laws and regulations of each separate securities authority. Compliance with the laws and rules of one securities authority does not constitute compliance with the laws and regulations of any other securities authorities. If securities are to be sold in every state, one must comply with the laws and regulations of approximately 52 separate securities authorities, i.e., the United States Securities and Exchange Commission (the “SEC”), the securities authority in each of the 50 states and FINRA (if the sales are to be made through a member of the investment industry). At a minimum a person offering securities must comply with at least two separate laws, i.e., the federal law and the law of the state in which the securities are to be sold (if sold in only one state). If one complies with federal law, compliance with the securities laws in many of the states is often relatively simple because many states permit what are known as “coordination filings” or because several federal “exemptions” from registration “preempt” the states (see below). However, several states have statutes which permit a state official to judge the merits of an offering. In these “merit states,” even though one complies with the registration or filing procedures, the state may still prohibit the offering because the particular state official does not consider the offering to be “fair, just and equitable” for purchase by residents of his particular state. Although the remainder of this material deals primarily with federal laws and regulations, one must remember to make sure that there also should be compliance with all applicable laws of the interested states and foreign countries.

Federal Law

Instead of permitting a government official to decide whether a particular securities offering is “good” or “bad,” the theory of the federal law is “full disclosure,” i.e., the seller must tell everything. Most people want to tell the truth. However, the difficulty with the federal law is the significant amount of work involved in trying to identify matters which should be disclosed to tell the whole story and then describing each matter in writing in such a way so that the matter will be understood by prospective investors. It sometimes is said, “In most commercial transactions the rule is that the buyer should beware. Under the federal securities law the rule is that the seller should beware.” This fundamental difference between securities transactions and other commercial transactions must be thoroughly understood and accepted and never forgotten. If an investor might reasonably consider a matter to be material, the matter must be disclosed to the investor in such a way that the disclosure can later be proven.


Most people think of stocks and bonds when thinking of securities. However, partnership interests, passive interests in oil and gas wells or programs, interests in some condominiums, promissory notes, mutual funds, insurance policies, or any arrangement which one commonly would consider to be an investment may involve a security.


It may be an oversimplification, but for purposes of this discussion, the federal securities laws will be divided into two parts: (i) the “anti-fraud” provisions requiring full disclosure as discussed above, and (ii) “registration” which is designed to establish procedures and guides for accomplishing full disclosure. There are no exemptions from the anti-fraud requirements.

The Securities Act of 1933 (“1933 Act”) technically provides in Section 5 that there must be an effective registration statement pertaining to the security every time a security is sold. However, the Act goes on to provide for several exemptions from the registration requirements. The principal exemption is Section 4(a)(1) [formerly known as Section “4(1)” before the enactment of the JOBS Act] which exempts transactions by all persons other than (i) issuers, (ii) underwriters, or (iii) dealers. In other words, the registration requirements only apply to sales by issuers, underwriters or dealers. Trading transactions, which constitute by far the greatest number of securities transactions, are exempt because of the Section 4(a)(1) exemption. Most small businesspeople do not need to be concerned about being a “dealer”, but a corporation or other entity in which securities are sold by a small businessperson usually is an issuer and often the small businessperson herself or himself will be responsible for sales of securities by the issuer because either he or she is classified as an “underwriter” or he or she is in “control” of the issuer. As a consequence, a small businessperson wanting to sell securities must either register the securities offering pursuant to the 1933 Act or sell the securities in reliance upon an exemption from registration other than the Section 4(a)(1) exemption.

Spectrum of Offerings

One of the first things which a small businessperson should do after deciding to sell securities is to tailor his or her securities offering to fit a particular (i) form of registration or (ii) procedure to bring the offering within an exemption from registration. The following categorization of offerings is arbitrary and each category may involve variations. Still, it is hoped that the following discussion of each of the different categories of offerings will help in tailoring a proposed securities offering. Some securities authorities may argue that one or more of the following types of offerings is not in technical compliance with the securities laws. Consequently, it is not always practical to obtain a legal opinion that a procedure is in compliance with all securities laws. Often a legal opinion cannot be obtained because the procedure involves future activities which cannot be the basis for a formal legal opinion. Therefore, the businessperson should understand that he or she will be assuming certain business risks in pursuing one or more of the following procedures. Further, a lawyer is not in a position to guarantee to anyone selling securities that he or she will not be accused of violating the law. The best a lawyer can do is to try to keep the opportunities for such accusations to a minimum.

Subject to the above, we suggest that a small businessperson wanting to raise capital by selling equity securities to others has the following alternatives:

1.      File an S-1 Registration Statement with the SEC in Washington, D.C.  Form S-1 provides for “scaled disclosure” requirements depending upon the size of a company’s revenues and public float.  “Emerging growth companies” (e.g. with annual revenues under $1 billion) as defined in the JOBS Act benefit from an additional measure of lightened procedures and disclosure requirements.

2.      File a notification pursuant to Regulation A with the SEC in Washington, D.C.  “Reg A” should be seriously considered for use by business persons.  For example, Reg A offerors may “test the waters” with a simple flyer or alternative media message soliciting interest in an offering prior to filing a preliminary “registration-type” statement with the SEC.  The JOBS Act directed the SEC to either amend Reg A or to promulgate a new additional regulatory exemption similar to Reg A; offerings under the JOBS Act’s changes could be for up to $50,000,000 and include periodic reporting and expanded financial disclosure (sometimes called “Reg A+”).  Effective on June 19, 2015, the SEC promulgated new final regulations which expand the “middle tier” of companies using Reg A; a relaxed “old” Reg A will continue as Reg A “tier 1” [offerings up to $20,000,000] and new Reg A+ will be Reg A “tier 2” [offerings up to $50,000,000].  We encourage a serious consideration of the use of Reg A by certain SME companies where after market liquidity is not an issue (see below). Effective May 24, 2018, the SEC is directed to effect regulations permitting the use of Regulation A by public reporting companies.

3.      Rely on the Section 4(a)(2) nonpublic offering exemption under the 1933 Act and SEC Rule 506(b) permitting an offering of restricted securities with no dollar limit to an unlimited number of “accredited investors” and, if desired, not more than 35 sophisticated unaccredited investors.  Effective on September 23, 2013, Rule 506 is broadened to remove restrictions against general solicitation and advertising on offerings under new additional Rule 506(c) as long as all sales are only to accredited investors and verified as such with standardized procedures.

4.      Rule 505 is eliminated effective May 22, 2017.

5.      Rely on Rule 147 which is an interpretation of the intrastate offering exemption under Section 3(a)(11) under the 1933 Act. This exemption should be used only for local offerings and offers and sales must be limited to residents of a single state. Usually there is no significant aftermarket opportunity to be developed for securities sold in these offerings.  Also, the Colorado legislature in 2015 enacted its own “crowdfunding” exemption based on Rule 147 and it then amended the “crowdfunding” exemption in 2016; however, Colorado requires that funds in such offerings be escrowed for a period of time and no Colorado depository institutions have indicated a willingness to serve as escrow agents to such offerings.  Rule 147A is adopted effective April 20, 2017 to permit interstate offers (but not sales in intrastate deals); however, Rule 147A does not derive from Section 3(a)(11), so there are extra risks when relying upon it exclusively for internet offerings.

6.      Rely on Rule 504 which permits offerings of securities totaling no more than, effective May 22, 2017, $5,000,000 during any 12 month period by non-public companies.

7.      Rely on Section 4(a)(6) and SEC Regulation Crowdfunding, effective May 16, 2016, for offerings aggregating less than $1,000,000 in a 12-month period, with significant limitations on the income and net worth of investors and upon their total investments.

8.      Arrange a true non-public transaction relying on Section 4(a)(2) above involving, for example, persons who are members of management or who negotiate the transaction.

9.      Conduct an offering to only employees of the company relying upon Rule 701.

10.    In the sale of securities exclusively to residents of foreign countries, rely upon the provisions of SEC Regulation S.

Full Registration

A full registration statement on SEC Form S-1 must be filed with the Securities and Exchange Commission in Washington, D.C. The attorney’s work for the issuing company involves:

1.      A review of the issuer’s structure.

2.      Often times making amendments to the articles of incorporation and bylaws and drafting corporate minutes.

3.      Collecting information pertinent to the issuer.

4.      Drafting and editing the registration statement including the prospectus.

5.      Negotiating the underwriting agreement with the underwriter, if any.

6.      Handling the filing of the registration statement with the SEC.

7.      Responding to comments from the SEC.

8.      Advising the issuer during the offering process.

9.      Handling the closing of the underwriting agreement.

There is no dollar limit on the amount which can be offered. Unless the securities are by their nature nontradable, they usually are traded in an aftermarket by members of the investment industry. Generally it takes from 60 to 90 days to prepare the filing for the SEC and another 30 to 60 days for the SEC to comment, the comments to be answered and the registration statement declared effective. Depending upon the type of underwriting, the funds may be received within a matter of a few days after effectiveness or not received until after an escrow amount is reached within a given period of time (which may vary but often is 60 to 90 days).

Although the time involved for a fully registered securities offering can be considerably shorter for an issuer which is already “public”, a first-time registrant should expect that it will take at least six months from the time work is started on the registration statement until funds are received. Often the time is considerably longer. The estimated legal costs for a full registration for a small business range between $250,000 and $400,000, and are usually higher. In addition, the registrant must pay accounting fees, printing costs, blue sky fees and often, if an underwriter is involved, an underwriter’s expense allowance. Consequently, the total cost of full registration (other than underwriting commissions) usually exceeds $300,000 and often totals $500,000 or more. Obviously this process involves a significant gamble by a small businessperson because, even though the registration statement is declared effective by the SEC and by various states, the small businessperson cannot be assured that the offering will be sold even if an underwriter is involved.

JOBS Act Creates “Emerging Growth Companies

Although the disclosure burden is lighter for a company with under $25 million in revenues, than for larger companies under the JOBS Act, a category of “emerging growth companies” (i.e., those with under $1 billion in gross revenues during its last fiscal year) (“EGR”) now exists; EGRs in initial public offerings on SEC Form S-1 are required to provide only two years of audited financial statements, are exempt from the annual audit attestation requirements of Sarbanes-Oxley about internal controls, are exempt from certain Dodd Frank provisions regarding disclosures about executive compensation, and have an ability to “test the market” (i.e., an exemption from the SEC “gunjumping” rules) and an ability to submit confidentially to the SEC their draft registration statement for confidential nonpublic review and comment.  According to some observers, over 90% of the registered IPOs in the United States from 2006 to 2012 were for companies which now meet the definition of an “emerging growth company”; EGR filings were a favored approach for IPOs in 2013, 2014, and 2015.

Regulation A Filings

Regulation A filings are made pursuant to the Section 3(b) exemption from registration under the 1933 Act. A notification including an offering circular (similar to a prospectus) is filed in the home office of the SEC for offerings of up to $5,000,000 (prior to June 19, 2015). If submitted to the SEC prior to the time of first use, Regulation A now allows an issuer to distribute a “freely written” document generally (so long as it does not make offers, the issuer does not accept money, and certain required information is provided) in order to “test the waters” for indications of interest in the formal offering to come. This information may be published in print or broadcast. After its use, however, certain time periods are delineated during which sales cannot be made (i.e. a “cooling off” period is prescribed).

Effective June 19, 2015, the new Regulation A puts smaller offerings on two possible tracks:  Tier 1 deals with offerings of up to $20 million in a 12-month period (no more than $6 million by selling security holders who are an issuer’s affiliates); Tier 2 deals with offerings of up to $50 million, also in a 12-month period, but this tier limits offers by selling security-holders who are issuer affiliates to no more than $15 million.  There are a number of additional material differences in filing and disclosure requirements between Tier 1 and Tier 2 offerings (e.g., Tier 1 offerings do require audited financials) and caution should be exercised when addressing the particulars of each.  Many issuers will be able to elect to go forward under either tier.  Issuers also can submit draft offering statements to the SEC under either tier for pre-filing, nonpublic staff review, much like the pre-filing review for EGRs under JOBS Act Title I.  Tier 2 offerings will be subject to additional requirements, including a provision that preempts state laws regarding qualified purchasers (i.e., any person to whom securities are offered or sold under Tier 2).  Generally, with a Tier 2 Regulation A filing the process involves the same type of legal work as is involved in an S-1 filing for a small business.  Regulation A permits the issuance of tradable stock and thus the existence of an aftermarket. The time and legal costs for a Tier 1 Reg. A offering would be much less than for an S-1 filing, e.g., a minimum of three months and $85,000 to $120,000. Also, there are accounting, printing and other costs so the total cost could be in the neighborhood of $150,000.  The time and legal costs for a Tier 2 Reg A offering will likely be roughly 50-60% of those for an EGR S-1 (see above).  Effective May 24, 2018, the SEC is directed to amend Reg A to permit its use by public reporting companies.

Limited Offerings

Rule 506

Rule 506 technically is a set of guidelines, which, if met, create a presumption or “safe harbor” that the nonpublic offering exemption in Section 4(a)(2) of the 1933 Act is available. Actually Rule 506 placements are private offerings of restricted securities to an unlimited number of accredited investors (see below) and, under Rule 506(b), not more than 35 non-accredited purchasers. Unfortunately, for many years neither the securities laws nor the SEC regulations provided any private offering procedures. As a result, pressure built up to expand the Section 4(a)(2) nonpublic offering exemption beyond its intended purpose. Because of this historical accident, Rule 506 technically is an interpretation of the nonpublic offering exemption and consequently is subject to many of the uncertainties which surround the use of the Section 4(a)(2) nonpublic offering exemption. A small businessperson using Rule 506 must realize that it entails risk, but the risk should usually be acceptable from a practical standpoint.

There is no dollar limit on the use of Rule 506, but the limit on the number of non-accredited investors is limited to 35 under Rule 506(b). If the issuer is not a reporting company under the 1934 Act, these 35 investors (i) must be provided information substantially equivalent to the information which they would receive if furnished an offering circular prepared pursuant to Reg A, (ii) must be sophisticated in commercial matters (e.g. they must be able to understand the information furnished to them), and (iii) usually must be wealthy. The offering may also be made to an unlimited number of “accredited” investors which are essentially institutions, including savings and loan associations and similar institutions such as credit unions, whether acting for their own accounts or as fiduciaries, and broker-dealers if registered under the 1934 Act and purchasing for their own accounts, any partnership, corporation, or business trust with total assets in excess of $5 million, trusts with at least $5 million in assets as long as the trust was not formed solely to make the investment, any directors, executive officers or general partners of the issuer, any person who has a net worth of $1,000,000 (exclusive of the person’s primary residence), and any person with an income in excess of $200,000, or has an annual income jointly with that person’s spouse of $300,000, for the last two (2) years and who reasonably expects an income in excess of $200,000/$300,000 for the current year.

Although the number of offerees (as distinguished from investors) is not limited under Rule 506, the offering cannot be advertised unless, pursuant to the final 506(c) regulations adopted by the SEC under the JOBS Act on July 10, 2013 and effective on September 23, 2013, the 506(c) offering is intended for and only sold to accredited investors by issuers under procedures reasonably intended to verify their “accredited” status.  The SEC actually considers Rule 506(c) to be a separate exemption created by Congress, rather than grounded in Section 4(a)(2); this creates higher risks for business persons who fail to comply with standardized 506(c) verification processes.

The work involved in doing a Rule 506 private placement includes the preparation of an offering memorandum which involves much the same work as drafting a prospectus for a registration statement. However, because the offering memorandum is not reviewed by the SEC or (in most states) by any securities authority, the time and money costs resulting from the review procedure are eliminated.  It should be noted that, if the offering is only to be sold to accredited investors under the Rule 506(c) exemptions, there are special provisions for the use in Rule 506(c) “accredited investor only” offerings of a “platform or mechanism” which permits the offering and sale of securities and general solicitations by issuers on and off independent websites where the website need not be not controlled by a registered broker dealer.

“Bad actor” provisions applicable to all Rule 506 offerings were also adopted by SEC regulations on July 10, 2013 and are effective on September 23, 2013.  The combination of the new Rule 506(c) regarding general advertising and the new Rule 506(d) “bad actor” provisions, together with additional SEC proposed disclosure and reporting rules which are quite controversial in the legal community, have fundamentally changed Rule 506.  All small businesspersons need to become familiar with the new and proposed rules before conducting any offering under Reg D.  There are many, many “traps for the unwary,” especially for those who want to advertise their securities offerings using Rule 506(c).

Rule 506(b) also may be used by public companies which can incorporate by reference the reports required under the “1934 Act”. Thus, costs and preparation time for public companies often are less than for a nonpublic company. For a nonpublic company, legal costs for a Rule 506(b) offering (as Rule 506 existed prior to July 10, 2013) should range between $7,500 and $17,500, depending upon the number of states involved and the quality of the company’s existing written business plan, if any. There may be some accounting costs but other costs should be minimal. Consequently the total cost for doing a typical Rule 506(b) private placement should be between $10,000 and $20,000. Although a Form D notice is filed with the SEC and certain states require other filings, Rule 506 filings normally are not reviewed by a securities authority and therefore the private placement normally can commence as soon as the offering memorandum has been completed. Usually it takes from 30 to 60 days to do the preliminary work (similar to that described under “Full Registration” above) and prepare the offering memorandum.

With regard to the new Rule 506(c) generally advertised offerings, the legal fees and total costs involved are approximately 5% higher than for Rule 506(b) due primarily to the formal accredited investor “verification” procedures involved.

For more information on Section 4(a)(2), Rule 506(b) and Rule 506(c), see our companion memorandum entitled “Private Placements:  Selected Exemption and Disclosure Issues after the JOBS Act.”

Rule 505

Rule 505 was adopted by the SEC pursuant to Section 3(b) of the 1933 Act and related to the sale of “restricted securities” in limited offerings.  Rule 505 is eliminated effective May 22, 2017.

Intrastate Offerings Pursuant to Rule 147

Section 3(a)(11) of the 1933 Act as interpreted by Rule 147 provides an exemption from the Section 5 registration requirements for an offering of securities sold to residents domiciled in only one state which also is the state in which the issuer is incorporated and conducts its principal business. Although no filing is made with the SEC, usually it is necessary to file a registration statement by qualification in the state in which the offering will be sold. In these offerings it is necessary for the state to assume review responsibility which in other offerings is assumed primarily by the SEC. The extent of such review depends upon the practice in each state. Consequently, until a particular state is designated, it is impractical to predict the time or costs involved in an intrastate offering. In some states the review essentially is the same as the review by the SEC of a full registration statement while in other states the review is limited and the issuer has almost the same flexibility as it would have in preparing a Rule 506 private placement memorandum.

The problem with relying upon the Section 3(a)(11) exemption is that historically this exemption was abused and used for large public offerings. The SEC enforcement division responded, a number of indictments were returned and as a result, such offerings have a poor reputation within the securities industry. Further, under Rule 147 (the “safe harbor” rule under Section 3(a)(11)), aftermarket trading must be limited to residents of the particular state for a period of six months following the offering and as a result, it is difficult to establish any aftermarket. In order to make offerings via the internet more accessible to residents of states in “intrastate” offerings, the SEC recently promulgated Rule 147A, effective April 20, 2017; Rule 147A permits offers (but not sales) to persons not resident in the state, but the Rule 147A “safe harbor” is not derived from the statutory 3(a)(11) exemption so exclusive reliance upon it is risky.  Because of all these difficulties, we discourage reliance upon any intrastate exemption except in small local offerings.  A Reg A offering circular, a Rule 506 private placement or a Rule 504 offering often is more appropriate.

Rule 504

Rule 504 permits the sale of up to $5 million (as of May 22, 2017) of securities in any 12 month period and is available to companies not subject to the reporting requirements of Sections 13 or 15(d) of the 1934 Act and companies that are not investment companies. The exemption, like Rule 505, is based upon Section 3(b) of the Securities Act and thus has the advantage of not being subject to some uncertainties associated with the Section 4(a)(2) nonpublic offering exemption. Within 15 days after the first sale is made pursuant to Rule 504, a Form D notice must be filed with the regional office of the SEC. Under Rule 504, the issuer still has a burden of full disclosure under the antifraud provisions of the Securities Act and state securities laws; therefore it is often necessary to prepare an extensive disclosure document similar to a private offering memorandum used in connection with Rule 506. As a practical matter, however, small offerings which come within the criteria of Rule 504 usually can be described in a simple disclosure document, often a thoughtfully composed letter. Although a lawyer normally would not give an opinion as to the availability of Rule 504, in the best of circumstances, the lawyer should be able to assist a small businessperson during a period of two or three days in drafting a document which tells the story of the small businessperson’s business. If each investor acknowledges in writing receipt of such a document, a Rule 504 notice is filed with the SEC and appropriate state filings are made, the business risks which must be assumed by the small businessperson in connection with such an offering should be acceptable. In this situation, legal costs should be significantly less than $7,500 and there should not be other significant costs. Since January 20, 2017, the “bad actor” rules of Rule 506 are also applied to “covered persons” involved with issuers using Rule 504.


SEC Regulation Crowdfunding (“CF”), effective May 16, 2016, provides the mechanism set forth by Congress in Title III of the JOBS Act (which enacted Section 4(a)(6)) by which equity monies may be crowd sourced.  Reg CF provides detailed rules for issuers and intermediaries and their controlling persons and also requires certain representations be made by investors.  The issuer has an exemption from the registration provisions of the 1933 Act if, among other things, (1) the issuer sells an aggregate of no more than $1 million under Section 4(a)(6) in a 12 month period, (2) the aggregate sale per investor in the offering does not exceed the greater of (i) $2,000 or 5% of the lesser of the net income or net worth of the investor if either is less than $100,000 (excluding the investor’s residence and the income of his or her spouse), or (ii) 10% of the lesser of the investor’s net income or net worth if both are at or over $100,000, and (3) the transaction is conducted exclusively through a platform of a complying intermediary.  The exemption is not available for non-U.S. issuers, for publicly reporting companies, for issuers with “bad actors” (see above under Rule 506), and for prior users of Reg CF who did not comply with its reporting requirements.  CF issuers are required to make certain specific initial disclosures to the SEC, prospective investors, and to its chosen intermediary on SEC Form C and to make certain continuing disclosures thereafter. However, some advertising of the ‘tombstone’ type is allowed to drive interest to the intermediary website. Reg CF intermediaries must be registered as broker-dealers or as funding portals and, in either case, must belong to FINRA. Only one intermediary may be used for each offering and that intermediary cannot have an interest in the issuer. The intermediary must make the disclosure information available to prospective investors and must receive, maintain and retransmit to the issuer the funds raised in the offering.  Each investor must represent that he, she or it has received the investment disclosure materials, that there is an understanding that the entire investment may be lost, and that he, she or it has a right to cancel the investment in the issuer up to 48 hours prior to the close of the offering.

There are many additional rules to be complied with and the use of an accounting firm is highly recommended.  It is difficult to estimate the availability of broker dealers or “platform providers.”  This exemption was intended for use by very small companies and is much more limited in value than many tech industry supporters originally believed. Due to the complexity of Reg CF and the ease with which the detailed rules can be inadvertently violated, our law firm discourages the use of Reg CF by its clients unless the client is willing to spend the significant amounts of time and energy necessary thoroughly to learn and comply with it.  For the few clients who are likely to engage in this process, however, we are willing to provide advice and counsel. However, we cannot estimate in advance the amount of legal costs involved.

Nonpublic Transactions

The Section 4(a)(2) nonpublic offering exemption was included in the 1933 Act to exempt the great majority of business investments which truly are private in the sense that only those participating in the business venture are permitted to invest. Usually, instead of being offered an investment on a “take-it-or-leave-it” basis, as is the situation in a public offering, private investors are in a position to negotiate the terms of the securities transaction. Such investors do not need to devote a significant amount of time (or even any time) to the business venture. However, a truly private investor is one who often has a real say-so in how the business venture is structured. Often a private investor negotiates the transaction by requiring that the business venture be structured in a particular way. “Venture capital” deals are often structured under this non-public exemption. Such transactions are exempt from registration under the non-public offering exemption found in Section 4(a)(2) of the 1933 Act.

The arrangements and relationships in a truly private transaction often are documented by carefully drafted consent minutes which are signed by each investor and each director. The use of consent minutes or making a person a director does not assure the availability of the Section 4(a)(2) non-public offering exemption. Further, if one is appointed as a director, that person must act as a director and not be a director in name only. Also, just because an investor signs consent minutes, if it otherwise can be established that such person had no voice as to the contents of the minutes or the structuring of the business venture, then the exemption might not be available. On the other hand, most small businesspersons who in good faith sell securities to persons who in fact negotiate a securities transaction or who are significantly involved in the management of the business venture, are willing to accept the business risk involved in relying upon the non-public offering exemption.

Regulation S

It should also be noted that the SEC permits an offering to non-residents of the United States through compliance with its Regulation S. The SEC does not review the documents used in such offerings, although the antifraud rules probably still apply. Such offerings are relatively inexpensive in terms of the legal fees involved in complying with federal law, although one must also explore the compliance issues involved with the law of the foreign jurisdiction. In the event that the small businessperson believes that he or she is capable of selling all the securities in the offering to non-residents, please do not hesitate to ask us about this option.

Employee Benefit Plans

For purposes of completeness, we note that under Rule 701, offers and sales of securities by issuers who are not yet “public” may be exempt from the securities registration requirements if made pursuant to a written compensatory benefit plan and interests in such a plan are pursuant to a written contract of compensation. Plans that qualify for the exemption are purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, pension, or similar plans. Only the issuer, its parent or majority owned subsidiary may establish the plan. Participants in the plan are limited to employees of the issuer, directors, general partners, trustees (if the issuer is a business trust) officers and its consultants or advisers if they are rendering bona-fide services.

It is important to note that the exemption does not apply if the primary purpose of the plan is to “raise capital.” Additionally, Rule 701 was adopted pursuant to Section 3(b) of the 1933 Act. The total amount of securities that may be offered in a twelve-month period under this exemption has been raised from $5 million to $10 million effective July 23, 2018.

Restricted Securities

Restricted securities are securities which cannot be sold freely into the public market. However, this does not mean that restricted securities may not be sold under any circumstances whatsoever. Restricted securities may be sold in what are commonly known as “negotiated transactions” to sophisticated investors who are willing to accept the securities as restricted securities. Although such transactions should be made only with the advice and assistance of a securities lawyer, negotiated transactions can usually be successfully accomplished.

Rule 144

Rule 144 is the “safe harbor” exemption for resales of restricted securities related to Section 4(a)(1) (see above).  Pursuant to Rule 144, if restricted securities have been held for six (6) months, if there is a public market in the securities, a person who is an “affiliate” of the issuer (see below) may sell up to 5,000 shares or $50,000, whichever is greater, of the outstanding shares of the issuer into the market in any three-month period by complying with the conditions of Rule 144. In addition to (i) 5000 shares or $50,000 requirement, and (ii) the three-month requirement, Rule 144 requires that there must be (iii) current information available concerning the issuer at the time of the sale, (iv) in most instances, a Form 144 must be filed with the SEC, (v) there can be no solicitation of the order to buy, and (vi) the transaction must be handled as a broker’s transaction or directly with a market maker. Thus, if a company goes public after securities are received in a Rule 506 transaction, a Rule 504 transaction or a nonpublic offering transaction, the securities which originally were restricted securities normally may be sold after six (6) months into the public market under Rule 144.

Pursuant to the provisions under paragraph (k) of Rule 144, a non-affiliate beneficial owner of restricted securities who has owned the securities of reporting issuers for a period of at least six (6) months prior to sale will be exempt from (i) the 5,000 shares or $50,000 volume limitation, (ii) the manner of sale requirement, and (iii) the Form 144 filing requirement. Furthermore, once the six (6) month period has passed, the non-affiliate owner of these securities may have the restrictive legend and stop transfer instructions deleted from the securities.

Under Rule 144, owners of shares of non reporting issuers who have held their shares for less than twelve (12) months may not resell their securities.  Thereafter non-affiliates are permitted unlimited resales, but affiliates must sell in compliance with the volume limitations of Rule 144.

An “affiliate” is a person that directly or indirectly controls or is controlled by the issuer or is under common control with the issuer.

There are additional exemptions for transfers of securities after they have been received from the issuer or from another owner; most securities lawyers can help effect a sale or transfer of restricted securities at any time if they are not held by an “affiliate”.


A small businessperson may sell securities himself or herself in a limited offering, a Rule 504 offering or in a nonpublic transaction, but usually it is necessary to engage an underwriter if securities are to be sold to the public under a registration statement. Essentially there are two types of underwriting agreements: (i) “firm” and (ii) “best efforts.” Firm underwriting agreements are preferable. In the past, many of the small offerings were done on a best efforts basis but recently even small offerings have been done on a firm basis.

The term “firm” is misleading because usually a firm underwriting agreement is not signed (thus there is no firm contract) until the registration statement is declared effective by the SEC. Consequently, the small businessperson in a firm underwriting bears the risk of incurring all of the structuring and registration expense on the basis of only a letter of intent. When the firm underwriting agreement is signed at the time the SEC declares the registration statement effective, the underwriters (usually there is a syndicate or group of forty or fifty underwriters) agree to buy all of the securities offered at a discount (usually less than ten percent (10%)) from the price at which the underwriters will sell the securities to the public.

What happens in a firm underwriting is that the group or syndicate of underwriters will have distributed preliminary “red herring” prospectuses to customers, both directly and through participating dealers, prior to the time the registration statement is declared effective and will have obtained “indications of interest” from customers. The “indications of interest” are tabulated by each underwriter who in turn gives the information to the managing underwriter who allocates the securities among the various members of the underwriting syndicate and who maintains the distribution list which commonly is known as the “book.” As a result, when the registration statement is declared effective by the SEC, confirmations are mailed with copies of the final or definitive prospectus to persons who have given “indications of interest.” Consequently, in a well-managed firm underwriting, the entire offering often is sold within a matter of minutes after the registration statement is declared effective. During the next several days, the money is collected from the customers by the underwriters. Typically, the underwriting agreement is closed and the proceeds paid to the company within a week to ten (10) days after the signing of the underwriting agreement.

A “best efforts” underwriting agreement is simply an agreement by an underwriter to use its best efforts to sell the securities. Although a “red herring” prospectus can be used to obtain indications of interest prior to the effective date of the registration statement, often the selling effort is postponed until the registration statement is declared effective and the selling is done on the basis of the final or definitive prospectus during the thirty- to sixty-day period following effectiveness. Usually an escrow agreement is entered into with a bank so that as funds are collected by the underwriter from the sale of securities, the funds are deposited in the bank until all (or at least a substantial percentage) of the offering amount is on deposit in the bank. When the escrow amount is reached, the funds are paid to the company less commissions which are paid to the underwriter. Best effort underwriting agreements usually are used by small underwriters who, because of limited capital, are unable to incur the liability which exists for a period of a few days under a firm underwriting agreement. Further, small underwriters often are unable to assemble a group or syndicate of underwriters to help sell the offering and thus are willing to contract to buy the securities even after the effective date as in a firm underwriting.

The underwriting agreement is simply a contract between the company and the underwriter and can have various provisions. Typically it sets the price, number of shares, registration procedure and indemnification arrangements. Usually in a firm underwriting agreement the underwriter obtains an overallotment option which permits the underwriters to buy an additional percentage of the offering so that securities are available for use in stabilizing the market price immediately following the offering. Smaller underwriters sometimes insist upon obtaining as additional compensation from the company an option permitting the underwriter to purchase five percent (5%) or ten percent (10%) of the amount of the offering for a period of up to five (5) years following the offering. Additionally, smaller underwriters often require the company to advance $20,000 or $35,000 to pay the underwriter’s costs during the registration process.

Satisfactory underwriting arrangements are essential to a successful public offering. Until a letter of intent is obtained from an underwriter, a small businessperson should not engage lawyers, accountants and other professionals to commence the registration process because if there is no arrangement for the sale of the securities, there is no purpose in incurring the significant expense of registration. For this reason, many small businesspersons conclude that they are at the mercy of underwriters and must agree to anything which the underwriter requests. However, one should remember that underwriters also compete for business. Thus, if the proposed offering is well conceived, the underwriting negotiations should be on a fair basis.


The legal costs mentioned above are rough estimates given solely for the purpose of alerting a small businessperson to the magnitude of the costs pertaining to the different alternatives. The actual charges for legal services will be based on the time devoted to the project by lawyers, paralegals and administrative assistants, the out-of-pocket expense incurred such as travel, photocopying and telephone charges and the result achieved. Usually, a retainer equal to the minimum estimate is paid before any work is commenced. Thereafter statements are rendered periodically. If the project is terminated or concluded, any previously paid retainer will be returned after submission and payment of a final statement.

In addition to legal fees and expenses, a small businessperson should obtain estimates of accounting fees, printing costs, SEC, FINRA and state filing fees, fees of other professionals such as engineers and underwriters expense allowances. One should make sure that satisfactory arrangements have been made to pay such “front-end costs” before engaging anyone to start work on a project.

Often times a small businessperson does not have sufficient money or credit through conventional sources to pay the “front-end costs.” Although risky to small businesspersons and often more expensive, if no funds can otherwise be obtained to pay the front-end costs, sometimes nontransferable, convertible, subordinated promissory notes personally guaranteed by the small businessperson are sold to a few sophisticated investors. The notes are (i) made nontransferable to avoid distribution problems under the securities laws, (ii) convertible so that the investor has an opportunity to profit from the venture, (iii) subordinated to avoid the possibility of precluding loans from banks and other financial institutions and (iv) personally guaranteed to provide by contract essentially the same liability against the issuer’s organizers as the payee could obtain by suit under Section 12 of the Securities Act based on a theory that the promissory notes were sold in violation of either the registration or anti-fraud provisions of the Act. Of course, every effort should be made to avoid violating any securities laws and regulations. If complete and accurate disclosure in a letter or other written document similar to the type of document used in connection with a Rule 504 offering is used and if the nontransferable convertible subordinated promissory notes are sold to only a few sophisticated (preferable “accredited”) investors who have complete and accurate information concerning the issuer, the sale of notes should not be held to be in violation of the securities laws.

Attorneys’ Stock

Small businesspersons often ask the attorneys to buy stock in their venture, thinking that (i) proceeds from the sale of the stock are available to pay part of the front end costs and (ii) the attorneys will have a proprietary interest in the business. Securities lawyers must remain objective and therefore, if asked to do so, lawyers in this firm will normally not buy stock.

Continuing Obligations

Once securities are sold to others, the company has a continuing obligation to keep those who own securities informed concerning the company’s affairs. This is especially important for companies which have securities which are actively traded in the market. Companies having more than 500 “unaccredited” shareholders (and, since the enactment of the JOBS Act, over 2,000 shareholders including accredited shareholders) and $10,000,000 in assets are required to register under Section 12 of the Securities Exchange Act of 1934. If we represent a company at the time it is required to so register, we typically provide to the company at that time a detailed written summary of its obligations under the 1934 Act. In general, such a registration is not difficult, but once registered a company has several continuing obligations including, but in no way limited to, the following:

1.         Reports. Generally, a company registered under the 1934 Act must file 10-K reports annually, 10-Q reports quarterly and 8-K reports following the happening of specified important events (a “small business” issuer, as defined above, will use simplified disclosure on these same forms). The 10-Q reports, containing primarily unaudited quarterly financial information, customarily are prepared in-house and merely reviewed by counsel. However, 10-K annual reports require audited financial information and the narrative parts customarily are prepared by counsel. If the company’s securities are quoted on NASDAQ, copies of the reports must be filed with FINRA. A filing fee must be paid to the Securities and Exchange Commission each year when the 10-K report is filed.

2.         Proxy Material. A company registered under the 1934 Act must file its proxy material with the Securities and Exchange Commission and as a practical matter receive clearance (or not receive comments within 10 days after the filing) before mailing the proxy material to its shareholders in advance of a shareholders meeting. There must be included within the proxy material a description of management’s remuneration, shareholdings and transactions with the company and other information which the SEC considers should be disclosed to shareholders on an annual basis. Proxy material customarily is prepared and filed with the SEC by the company’s attorneys. A filing fee must be paid to the SEC each year when proxy material is filed.

3.         Insider Trading. Officers, directors and ten percent (10%) shareholders of a company registered under the 1934 Act are prohibited from profiting by making short-term trades in the company’s stock. Section 16(b) requires any such person to pay any profits realized from trades within a six-month period to the company even though there was no intentional wrongdoing. So that there will be a record of such trades, officers, directors and ten percent shareholders are required to file Forms 3, 4, and 5 with the Securities and Exchange Commission following such trades. In addition, the anti-fraud provisions of the 1933 and 1934 Acts can create other insider trading liabilities.

4.         Tender Offers. A company registered under the 1934 Act is subject to the tender offer rules which are a mixed blessing. If a corporate raider is attempting to take over a company, the company must be notified under the tender offer rules. On the other hand, the SEC has adopted rules under Section 13(d) of the 1934 Act which require the filing of Schedules 13D or 13G by all persons owning more than five percent of the company’s outstanding stock. Further, such reports must be kept current by amendment. Although the reports appear simple, the preparation of such reports involves difficult questions and consequently the costs in both time and money are significant.

Time and money must be devoted to both (i) the foregoing specific requirements and (ii) the fundamental obligation of a company to keep its shareholders and the public informed. Thus, before deciding to “go public,” one should be prepared to accept a “fishbowl existence” and incur the annual cost for accountants and lawyers. Such costs for some very small companies have been as low as $20,000 per year but for most small businesses the cost, including the cost of the annual audit, will exceed $50,000 per year and may be considerably more.


In addition to the foregoing, the ability of the businessperson to successfully raise sufficient monies (in compliance with the federal and state securities laws) is measured by a myriad of additional legal and non-legal factors and concerns. Lawyers in this firm have participated in thousands of business financings. We can help identify and deal with many of these factors and concerns based upon our experience and that of your other advisors and we look forward to working with you.