You have a great idea for a new business venture and want to provide your friends and family with the opportunity to invest in your concept. It sounds straightforward, but bear in mind that any corporation or other business entity considering an offering of stock must comply with the federal securities laws and applicable state “blue sky” laws. This is true even in the case of stock offerings limited to friends and family of the founder.

Under the Securities Act of 1933, a corporation intending to issue any stock to the public must first register the stock offering with the Securities and Exchange Commission, unless an exemption from registration under the Securities Act is available. The Florida Securities and Investor Protection Act also requires the registration of all stock offerings, unless the transaction is exempt from the registration requirements.

The securities registration process is time consuming and expensive. Fortunately for entrepreneurs, with a little advance planning, exemptions from the federal and Florida registration requirements are usually available. One routinely utilized exemption to the federal registration requirements is the “limited offering exemption,” often referred to as Regulation D.

Regulation D permits corporations and other issuers to sell an unlimited dollar amount of stock to “accredited investors” and up to 35 additional investors who do not meet the criteria of accredited investors. However, the corporation must reasonably believe that each purchaser who is not an accredited investor has sufficient knowledge of and experience in financial matters to be capable of evaluating the merits and risks of the prospective investment.

The principal categories of accredited investors are directors and executive officers of the corporation; investors whose net worth, either individually or with a spouse, equals or exceeds $1 million; investors who have had net income in excess of $200,000 in each of the two most recent years and who reasonably expect an income in excess of $200,000 in the current year (or $300,000 with spouse); and business entities with total assets in excess of $5,000,000 that were not formed for the specific purpose of acquiring the securities offered.

If the offering is made only to accredited investors, there are no specific disclosure requirements regarding the business and financial conditions of the corporation (although one would nonetheless want to disclose all material information about the company). If offers are made to purchasers who are not accredited investors, the corporation is required to provide detailed business and financial information, similar to that found in a prospectus filed for a corporation undertaking an initial public offering.

Other rules and restrictions related to the manner of conducting an offering and to limitations on the resale of stock are applicable to Regulation D offerings. Generally, entrepreneurs may only sell securities to investors with whom they have pre-existing relationships. Neither the corporation nor any person acting on its behalf may offer stock by any form of general solicitation or general advertising, which includes advertisements, articles, notices, or other communications published in a newspaper, magazine, or similar media, or broadcast over television or radio. The stock must also not be offered at any seminar or meeting whose attendees have been invited by general solicitation or general advertising.

Securities acquired in limited offering transactions are “restricted securities,” meaning they cannot be resold without registration under the Securities Act (unless there is an available exemption from registration). Issuers are required to ask purchasers if they have the necessary investment intent to ensure they are not acquiring the stock in order to make a distribution of the shares to the public. In addition, a restrictive legend is placed on the stock certificates stating that the shares have not been registered under the Securities Act and describing the resale restrictions.

Entrepreneurs must also be aware that satisfaction of the limited offering exemption tests do not limit or reduce the anti-fraud and civil liability protections of the federal and state securities laws. In other words, if you fail to disclose information material to an investor’s decision to buy stock, the investor can bring a legal action. In order to help protect against such legal actions, entrepreneurs should consider preparing a private placement memorandum (PPM). The PPM contains business and financial information about the corporation, including a risk factors section that highlights the specific business and financial risks associated with an investment in the offered stock. It also includes a section on uses of the proceeds from the offering, which explains how the corporation plans to use the money.

Compliance with Regulation D or any other federal exemption does not eliminate the need to comply with applicable “blue sky” registration requirements of each of the states in which stock will be offered. For issuers relying on Regulation D at the federal level, certain states require only a notice filing, usually the state’s version of the federal form, and a filing fee in order to claim the state exemption. In Florida, one commonly utilized exemption, the limited offering exemption, generally exempts offers and sales by issuers to no more than 35 purchasers (excluding accredited investors) in Florida. The Florida limited offering exemption is “self-executing,” i.e., utilization does not require any filing with the state to claim the exemption. However, if five or more sales are made to Florida residents in a stock offering, any sale is voidable by the purchaser within three days after payment is made or the right to void the transaction is communicated to the purchaser, whichever occurs later. Issuers of stock must be careful, therefore, to notify prospective Florida investors in writing of their right to void the purchase of securities.

Mr. Zipper concentrates his practice in corporate, securities, and contract law, advising public and privately held corporations in the areas of corporate governance and formation, private placements, initial public offerings, mergers and acquisitions, technology licensing, corporate finance, and Sarbanes-Oxley Act compliance. He is admitted to practice in Florida (1995) and Pennsylvania (1993). Contact Mr. Zipper at azipper@hodgsonruss.com.