In layman’s terms, a security is an interest in a business which can take the form of stock, LLC membership interest, investment contract or bond. This means that any company looking to raise capital for funding has to issue a security to its investors.
Securities regulations are the body of law around the issuance of securities. Both state and federal state laws regulate such issuances. The Securities Act of 1933 governs the federal law and requires that all securities be registered with the Securities and Exchange Commission (SEC) OR they must comply with one of the many exemptions under the Securities Act of 1933. All states also have state laws governing securities issuances. The objective of these laws is to protect investors. So any time you are bringing on an investor into your company, you will need to make sure you are in compliance with all applicable securities laws.
The process of registering a security with the SEC and applicable state laws is extremely burdensome. There are hefty legal costs, accounting costs and ongoing reporting requirements. The SEC has carved out exemptions, although less burdensome than registration, can still present challenges to small cap and microcap companies.
The main exemptions are under Regulation A+, Regulation D and Regulation CF. For a more in–depth comparison of these three exemptions, please refer to our article on Capital Raising for Small Cap and Microcap Companies.
Regulation A+ allows you to raise up to $50 million under its Tier 2 exemption. Regulation A+ is also known as the “mini-IPO” and allows the issuer a unique advantage in “testing the market” before issuing the security. Regulation A+ allows flexibility in raising from all investors. However, it also comes with ongoing reporting requirements.
Regulation D allows the issuer to raise an unlimited amount of money but it is primarily used to raise capital from accredited investors and there are very strict regulations on how the issuer can solicit investors.
Regulation CF is a newer exemption that is created specifically for small capital raises through crowdfunding. An issuer under this exemption can raise approximately $1m in any 12-month period through an approved crowdfunding portal. There is no restriction as to who the investors are and the filing requirements are less burdensome than Regulation A+ and Regulation D.
Exemptions still require some type of filing with the SEC and additionally require filings with every state in which there are investors.
Any time your company is looking to raise capital beyond the initial capital investment of its founders, you will need to consult with a securities attorney to ensure that you are in compliance with applicable securities laws. Most investors you go to will ask for your compliance documents such as your offering circular, private placement memorandum and other similar documents.
In addition to the appropriate filings, a securities attorney will also help you craft a corporate structure that best protects you and makes you an attractive choice for prospective investors.
The cost for securities compliance can be very high. Registering a public security or “going public,” is prohibitively expensive and only reserved for larger companies. Most smaller companies raising capital will raise capital under one of the exemptions mentioned above. The legal cost for the exemptions varies with most of them falling somewhere between $25,000-$50,000.
However, Ahmad & Hussan Law Group offers a flexible pricing packages that make it easier for small cap and microcap companies as well as small investment funds to get set up. Please contact info@sathlaw.com for more information.