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The sale of stock through a private placement can be an effective and practical capital raising tool for new businesses. Since these transactions are exempt from the registration requirements imposed by the Securities Act of 1933, 15 U.S.C. � 77a, et seq., they can be completed relatively quickly and inexpensively. Not all sales of securities to limited groups of investors will be entitled to the exemption, however. To confirm the exemption, such transactions must comply with the Securities and Exchange Commission’s “Regulation D.” THE ADVANTAGES New businesses confront special problems when seeking to raise the capital necessary to meet their objectives. Often, the venture’s business model is untested, its products are new to the marketplace, its management team is inexperienced and its only asset is an idea described in a business plan. Further, new ventures have no track record of generating revenues, much less earning a profit. These characteristics make conventional bank lending an unrealistic option for most new business ventures and entrepreneurs; banks typically require tangible collateral such as real estate, equipment or inventory and, very often, a history of profits before they will even consider lending money to a business. As a result, a new company must seek outside investors and sell them an ownership interest in the business, i.e., securities. The offer and sale of securities are subject to federal and state laws. Under the Securities Act of 1933, 15 U.S.C. � 77a, et seq., securities offered and sold must either be registered with the U.S. Securities and Exchange Commission or sold pursuant to an exemption. Each state has a similar law. Registering securities can be complex and expensive. For these reasons and a number of others not addressed here, it is not practical for a new business to raise capital by offering securities that must be registered. Sales of securities not involving any public offering are expressly exempt from the registration requirements under � 4(2) of the ’33 Act — a characteristic that makes such sales relatively quick and inexpensive. QUALIFYING FOR THE EXEMPTION When does a sale of securities not involve a public offering? The SEC promulgated Regulation D in 1982 in an effort to clarify the answer to that question. Regulation D exempts from registration three types of offerings described in SEC Rules 504, 505 and 506. 17 C.F.R. �� 230.504, 230.505 and 230.506. General terms affecting these offerings are set forth in SEC Rules 501, 502 and 503. 17 C.F.R. �� 230.501, 230.502 and 230.503. Several concepts affect the operation of each of the exemptions. An understanding of these concepts is essential to effectively planning and conducting an offering under Regulation D. Regulation D introduces the concept of the “accredited investor.” An accredited investor is either (i) a person who the issuer reasonably believes to have a net worth of at least $1 million (individually or jointly with a spouse), or an annual income in excess of $200,000 for the past two years (or $300,000 joint income with spouse) or (ii) any one of the following entities: a bank, broker-dealer, business development corporation, nonprofit organization or trust with assets in excess of $5 million or an entity whose owners are all accredited investors. Whether a company intends to sell its securities to accredited or non-accredited investors affects how the offering is documented and conducted. If an issuer sells its securities under either Rule 505 or 506 to a nonaccredited investor, although the issuer is exempt from the information disclosure requirements imposed on public offerings, it becomes obligated to provide to the nonaccredited investor with (i) certain non-financial information of the same kind as would be required in some registered offerings and (ii) audited financial statements. Assembling this information is time consuming and expensive. Therefore, making an offering under Rule 505 or 506 to a nonaccredited investor defeats the purpose of making a private placement: The opportunity to raise capital quickly and efficiently. To determine whether its offering under Rule 505 or 506 will be to nonaccredited investors, an issuer may find it helpful to develop a list of expected offerees and determine their financial status. Typically, an issuer will satisfy itself of an investor’s status by having the investor answer and sign a written questionnaire about the investor’s financial position. If the results of a questionnaire show that an offeree is, in fact, not an accredited investor, the issuer may withdraw its offer to sell and avoid becoming obligated to provide specific information including audited financial statements. To qualify as a private placement under Regulation D in the first place, an issuer’s offerings must come within certain parameters. The following chart sets forth the basic requirements that an offering must satisfy to qualify for Regulation D status. REGULATION D’S REQUIREMENTS Within 15 days after the first sale of securities under Regulation D, the issuer must file a Form D with the SEC. There is no filing fee. The issuer is obligated to provide copies of any materials used in connection with the offer and sale if the SEC requests them. Although offerings made under Regulation D may be exempt from the registration requirements of the ’33 Act, they still must comply with the act’s other provisions, including its anti-fraud provisions, which require that an issuer disclose to potential investors all the information that an investor would reasonably consider in deciding whether to invest in a venture. Thus, even though Regulation D does not require an issuer to disclosure specific items of information, it does require an issuer to supply information sufficient to allow a potential investor to make a decision based on a complete and accurate depiction of all material aspects of the venture’s business. In a private placement, issuers customarily make the required disclosures through a private placement memorandum (also referred to as an “offering circular” or a “book”). The offering circular also serves to protect the issuer from fraud claims asserted by disgruntled investors if the venture fails. At a minimum, this document contains each of the following: (1) Description of the offering: a complete description of the amount of securities offered (expressed as a number of shares and an aggregate dollar amount), the price of each security (on a per share basis) and other rights of each security, such as voting rights, dividends and any minimum purchase requirement. (2) Risk Factors: a list of all of the risks involved in investing in the venture, including a description of all of the potential impediments to the venture’s success, both internal and external. (3) Description of the Business: a detailed description of the issuer’s products and services, its market strategy, industry conditions, management team and compensation, and any other material aspect of the venture, including any material contracts and governmental regulations. (4) Use of Proceeds: a specific statement of how the issuer intends to use the capitalraised (for example, to acquire equipment, hire employees, develop its product). In addition to the ’33 Act’s requirements, issuers must comply with applicable state law. As noted previously, every state has its own regulations concerning the offering and sale of securities to its residents. Most states’ securities laws follow the basic framework of the ’33 Act: a registration process with certain exemptions. The state exemptions, however, often do not match the federal exemptions, so counsel must be careful to conform the offering to state requirements as well as to federal law. Securities issued pursuant to Rule 506 do not need to comply with state regulations concerning private placements except to the extent that such regulations require only a notice filing and payment of a fee because the National Securities Markets Improvement Act, which Congress enacted in 1996, establishes that states may not regulate transactions involving “covered securities” — those securities issued pursuant to an exemption under � 4(2) of the ’33 Act (i.e., Rule 506). However, the NSMIA does not pre-empt state securities laws relating to Rules 504 and 505 because these rules were promulgated under � 3(b) of the ’33 Act and, therefore, are not covered securities. To grow and survive, new ventures must pursue and obtain capital. Private placements are an effective means of doing so, but only if they are conducted and documented in a manner that conforms to federal and state securities laws and allows the issuer to take advantage of the registration exemptions provided by those laws. John W. Pauciulo is an associate and George J. Hartnett is a partner in the Philadelphia office of White & Williams LLP. Both practice in the firm’s business department and are members of the firm’s business and corporate group. E-mail: [email protected]

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