Before you sell stock in your company, understand these 10 issues:
The Other SEC.Whatever you call it—stock, units, interests—outside investment in a business is a security.The sale of any security is regulated by Federal and state law.This doesn’t mean that you have to “go public” through an IPO just to sell your stock, but it does mean that you have to worry about securities regulations.Ignore them and you might face civil or criminal penalties.
Compliance Made Easy.The sale of stock does not require full-blown (read: costly) registration with the SEC if you comply with one of the private placement exemptions.These exemptions put limits on the total offering price, the offering duration, the number of investors, and/or the information required to be given to prospective investors.For each of the exemptions, no general solicitation or advertising is allowed.
The In Crowd.It’s always a good idea to limit the offering of stock to “accredited investors.”Accredited investors can presumably take care of themselves because of their net worth (at least $1 million for an individual) or their annual net income (at least $200,000).How do you know if someone is an accredited investor?You ask, usually by having prospective investors fill out a questionnaire.
Stick to the Script.At the heart of securities regulations is concern over what promises are made to potential investors.It’s important that your sales pitch is in writing, which is often called a private placement memorandum (PPM).The PPM includes all of the good and bad information about the stock being sold.
What’s the Plan?Your PPM should go into as much detail as possible about the company’s plans for using funds raised from the sale of its stock.This is important from a marketing standpoint (no one will give you money without a good plan), and it is also important for full disclosure. To provide some comfort for the initial investors, PPM’s will often state a minimum amount that must be sold, or else their investments will be returned.
Bespeak Caution. An important part of the PPM is the Statement of Risk Factors.This is everything that could go wrong with the investment.Since you’ll want your business plan to be as glowing as possible (you’re trying to make a sale remember), the Statement of Risk Factors is an essential dose of reality.If an investor later complains about the investment, you can point to the Statement of Risk Factors.
Widgets for Sale. Your stock is a product, and your goal is to sell it.You need to design that product with care.Is the stock voting or non-voting?What rights will the investor have to distributions?What rights will the investor have upon the sale or liquidation of the company?The design of the stock is in the Owners’ Agreement, which can include different designs for a number of classes of stock.
Me First.A common design element for stock offered for sale is a preferential return.Investors want to know that their dollars aren’t going straight into your pocket.One way to assure them is to promise that they get first dibs on the company’s profits, either from operations, the sale of the company, or both.Stock with these rights is often called preferred stock.Be careful:It’s a no-no for S corporations.
Me Too.Another concern of many investors is that soon after they buy their stock, the company will sell new, improved stock (with better preference rights, for instance) or sell the same stock cheaper.To deal with these concerns, you might include preemptive rights in the offered stock.Preemptive rights allow the stockholders first dibs on any new classes of stock the company sells in the future.
Pace Yourself.Don’t sell more stock than is absolutely necessary.Each time you sell new stock, you have to give away more of the company profits and/or control of the company.If you give away too much in the early rounds, you won’t have anything left when you need it.Venture capitalists, especially, demand a lot.
Primarily working with business owners and their families, Trevor advises clients on business structuring and sale transactions, regulatory compliance, third-party contracts, liability protection and general matters facing small business owners.