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.
If you’re looking for ways to raise capital for your company, you may consider crowdfunding. These ten facts will help you decide if crowdfunding is right for you. Come Together. Republicans and Democrats in Congress came together to pass the Jumpstart Our Business Startups (JOBS) Act of 2012, and President Obama signed it into law on April 5, 2012. The stated purpose of the JOBS Act is to ease the burden on smaller companies looking to obtain capital from public and private sources. The JOBS Act makes crowdfunding legal. Who Needs a Mil? The newly created crowdfunding exemption allows a small company to sell up to $1.07 million worth of the company’s stock or other ownership interests within a 12 month period. It Takes a Crowd. Crowdfunding investors are limited in how much they can invest in each company. For investors with annual income or net worth less than $107,000, the limit is $2,200, 5% of annual income, or 5% of net worth, whichever amount is greatest. For investors with annual income or net worth of $107,000 or more, the limit is $107,000. The numbers are set to adjust for inflation every five years. A Portal to Jump Through. Companies can’t tap into the crowd on their own. Crowdfunding offerings must be conducted through a registered broker or a registered funding portal. FINRA approved funding portals include SeedInvest, NextSeed, MicroVentures, and Wefunder. The broker of the funding portal is responsible for ensuring that crowdfunding investors are qualified and provided information about the company. Keep it Quiet. Companies cannot advertise their own crowdfunding offerings, except to direct potential investors to their designated broker or portal. Hold On Tight. Crowdfunding investors are required to hold onto their investment in the company for at least one year unless they sell to the company, an accredited investor, a family member, or as part of an IPO. Let the Sunshine In. Companies must file information with the SEC, including the names of directors, officers, and majority shareholders, a description of the company’s business, a description of the company’s financial condition (including other offerings), and financial information. The same information must be provided to each crowdfunding investor. Rights for All. Each crowdfunding investor will have rights in the company provided by state law and organizational documents. These rights might include the right to vote on the election of directors and certain actions, the right to review the company’s financials, and the right to demand a fair repurchase price. The SEC’s anti-fraud regulations also apply to crowdfunding offerings. So Long “S”. S corporation status generally requires that a company have no more than 100 shareholders and excludes most other companies as eligible investors. A company with these restrictions might have a hard time raising significant capital through crowdfunding. What Else You Got? Crowdfunding is not for every company. Fortunately, there are numerous ways for a growing company to raise need capital, including “friends and family” financing, commercial and private loans, intrastate offerings, and federally exempt private offerings. A company should review all of the alternatives before deciding on crowdfunding.