Small-business clients often assume their fund-raising activities are exempt from registration without understanding the legal constraints on their activities and the filing requirements in connection with exempt offerings.
Imagined securities law exemptions, such as the popular “friends and family exemption,” can lead to serious consequences if relied on without proper counsel as to the actual securities law exemptions available and the legal requirements for qualifying a sale of securities for the same.
Clients that are contemplating a sale of securities, whether they recognize their intended financing transaction as a sale of securities or not, should be counseled as to how to proceed within the confines of applicable law.
The future of an emerging company may be seriously compromised by failure to observe basic securities law requirements in its fund-raising efforts. Ideally, counsel will have an opportunity to work with her client on its fund-raising strategy before any offers are made, to help ensure that the necessary documentation and filings are completed to comply with applicable law.
In some states, such as New York, this may mean a pre-offering filing with the state securities regulatory agency, which is why it is important that counsel get involved early in the process.
The sample letters in this chapter are designed to help clients understand their legal obligations in connection with raising capital through the sale of securities and address the following issues:
This chapter also includes examples of letters forwarding draft offering documents to clients and discussing the terms and use of the same for fund-raising, filing securities law notices for exempt offerings, and a sample legal opinion for a financing transaction, among others.
Securities Law Compliance
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Securities Law Matters
Dear {Salutation}:
To confirm our recent conversation, if all members of COMPANY LLC are actively involved in the management of the company, and have the experience and ability necessary to manage the company, then the interests in the company will not constitute “securities” under California or federal law. However, if any of the members of COMPANY LLC are passive investors, then the offer and sale of an interest in the company to such investors would constitute the offer and sale of a “security,” and unless an exemption is available, the securities would require registration pursuant to federal and state securities laws.
Normally, such offers and sales can be structured to satisfy the requirements for exemption from registration under federal and state securities laws. Even if an exemption from registration is available for issuance of membership interests to the company’s founders, the sale by COMPANY LLC of additional interests to new investors (or additional contributions of capital by existing members) should be accompanied by the filing of a notice pursuant to California Corporations Code Section 25102(f) with the California Department of Corporations or, if investors are located in states other than California, a Form D Notice of Sale with the Securities and Exchange Commission and the state securities law administrator in each state in which a sale is made.
Please be sure to consult with us if you anticipate making an offering of securities.
Very truly,
FIRM NAME
Lawyer Name
Offering to Investors Outside the United States
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Securities Law Exemption for Sales to Non-U.S. Persons
Dear {Salutation}:
By way of background, the Securities Act of 1933, as amended, prohibits the offer or sale of any security unless it is registered with the Securities and Exchange Commission (SEC) or is exempt from registration requirements. State securities laws (Blue Sky Laws) apply in each state in which a purchaser resides.
Where the purchasers are all non-U.S. persons, as anticipated in connection with the proposed offer and sale of convertible notes by COMPANY, the offering is exempt from the registration requirements of the Securities Act pursuant to Rule 802 and Regulation S promulgated under the Securities Act, and no state laws will apply. Accordingly, Section 8.14 of the enclosed draft Convertible Note Purchase Agreement states that the securities being offered have not been “qualified” or registered, and that the agreement is conditioned upon the availability of an exemption from registration, which is determined based on the representations and warranties being given by the purchasers. Assuming the purchasers give the representations and warranties requested, and they are indeed non-U.S. persons, the transaction will be exempt from registration at both the federal and state levels in the United States.
I will endeavor to obtain the guidance of qualified foreign counsel on COMPANY’s behalf regarding any foreign securities law requirements once the subject jurisdictions have been identified. In the meantime, please don’t hesitate to call me with any questions or changes with regard to the enclosed or any other matter.
Very truly,
FIRM NAME
Lawyer Name
Enclosure
Avoiding Liability for Using Finders to Raise Funds
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Raising Money through Finders Not Advisable
Dear {Salutation}:
In response to your recent inquiry regarding laws recently enacted in California in 2004 that make it much riskier for issuers to use “finders” in connection with their securities offerings, here are the details:
In 2004, California Corporations Code Section 25501.5 was enacted to give rescission rights to investors who purchase securities through an unlicensed securities broker-dealer, or “finder,” whereby investors have up to five years to obtain the return of their entire investment—plus interest, attorneys’ fees, and costs.
The fact that the company may not be entitled to retain funds raised through a finder can have a negative impact on the financial condition of the company as well as on its ability to raise subsequent rounds of financing.
It is also worth noting that an unlicensed finder may be held liable to investors for treble damages, plus attorneys’ fees and costs, under California Code of Civil Procedure Section 1029.8, also adopted in 2004.
Please do not hesitate to call me with any questions with regard to the above or to schedule a meeting to plan your next financing transaction.
Very truly,
FIRM NAME
Lawyer Name
Enclosure
Accredited Investors
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Accredited Investors
Dear {Salutation}:
As you consider your fund-raising strategy for COMPANY, you are well-advised to make sure each of your investors is an “Accredited Investor” as defined in Rule 501 of Regulation D promulgated under the Securities Act. An Accredited Investor has individual income (exclusive of the income of his spouse) in excess of $200,000 for each of the two most recent years, or joint income with his spouse in excess of $300,000 in each of those years, and reasonably expects the same income level for the current year; or has (either individually or with his spouse) a net worth in excess of $1 million. Certain entities are also considered Accredited Investors under Rule 501. When the time comes, I would be happy to prepare a subscription agreement for your investors to complete that includes sufficient representations from them to establish their Accredited Investor status, access to information, and investment intent, among other things.
As we discussed briefly in my office, it is best to avoid allowing non-accredited investors to invest in COMPANY, as the implications can be severe if something goes wrong. Non-accredited investors often sue when things don’t go their way and are often able to get judgments in their favor based solely on insufficient written disclosures in connection with an offering. This is because issuers (i.e., companies raising money) are required to give non-accredited investors in a private placement the same level of information as would be disclosed in a registered (i.e., public) offering, and preparing a disclosure document that complies with this standard is very time-consuming and expensive. Another potential problem with allowing non-accredited investors (with or without a sufficient written disclosure document) to invest is that it might be more difficult to sell the company or complete an initial public offering in the future because acquiring companies and underwriters often do not want to deal with non-accredited investors.
Please do not hesitate to call me with any questions in regard to the above.
Very truly,
FIRM NAME
Lawyer Name
Disclosure Requirements for an Offering under Rule 506
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Disclosure Requirements for an Offering under Rule 506
Dear {Salutation}:
Pursuant to your request, this letter outlines the disclosure requirements for an offering in which up to 35% of the investors are not “Accredited Investors”—i.e., an offering under Rule 506 of Regulation D. Rule 506 of Regulation D is considered a “safe harbor” for the private offering exemption of Section 4(2) of the Securities Act. The required disclosures for an offering under Rule 506 are typically organized into a Private Placement Memorandum, or PPM.
The disclosure requirements for a PPM are essentially the same as would be required under Part II of Form 1-A for a Regulation A offering, which is available online at http://www.sec.gov/about/forms/form1-a.pdf. Part II of Form 1-A is set forth in a questionnaire/fill-in-the-blank format and can be used to help gather or identify the necessary information to be included in your PPM. I have attached a skeleton PPM (Part II of Form 1-A) that you (or I) could cut and paste into to construct a first draft.
The financial disclosure requirements for a Rule 506 offering depend on the amount being raised, with the minimum level (offerings up to $2 million) being the information required under Item 310 of Regulation S-B, with the exception that only your balance sheet must be audited (see the attached copy of Item 310). The full text of Regulation S-B (and lots of other tantalizing and relevant information) is also available on the SEC website.
It is a good idea to have each of the principals of the company complete a questionnaire to identify whether there are any other mandatory disclosure items. A standard Directors’ and Officers’ Questionnaire works for that purpose. If you decide to move forward with the offering, I’ll send you a questionnaire form.
Please do not hesitate to call me with any questions in regard to the above.
Very truly,
FIRM NAME
Lawyer Name
Enclosures
Keeping a Private Placement “Private”
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Keeping a Private Placement “Private”
Dear {Salutation}:
In connection with COMPANY’s upcoming private placement, please be mindful of the requirement that the company’s securities can only be offered privately or the offering will no longer qualify for an exemption from registration.
Specifically, the company’s offering would no longer be eligible for exemption if any general solicitation or advertising was used to market the securities, even if no sale of securities directly resulted from those activities. Some activities obviously constitute general solicitation or advertising, but others may not be as obvious and thus warrant discussion. For example, you should not post any information about the securities offering on the COMPANY website.
Please call me if you have any questions about whether any of your activities in connection with the offering could be construed as general solicitation or advertising to avoid a potential securities law violation.
Very truly,
FIRM NAME
Lawyer Name
Forwarding a Draft Convertible Note and Board Consent to Client
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Draft Convertible Note and Board Written Consent
Dear {Salutation}:
As we discussed, one of the advantages of moving forward with a convertible note offering at this time, rather than a stock offering, is the company’s ability to postpone the need to commit to a valuation for its stock until the next round of financing. Hopefully, by that time COMPANY will have achieved the next milestone in its business plan and be able to justify a higher valuation, thereby resulting in less dilution to the founders’ shares.
Enclosed please find a draft Series A Convertible Note and Directors’ Written Consent for your review and consideration in connection with the proposed convertible note offering. The note has the sample mandatory and optional conversion provisions you requested. You will also need a subscription agreement, which I will forward to you shortly. In the meantime, please let me know of any questions or changes with regard to the attached.
Very truly,
FIRM NAME
Lawyer Name
Enclosures
Forwarding Convertible Note and Subscription Agreement
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Convertible Note and Board Written Consent
Dear {Salutation}:
Enclosed please find a revised Series A Preferred Convertible Note and Subscription Agreement for COMPANY’s convertible note offering. I believe the enclosed incorporate all of the changes we discussed. Please review them carefully, and if there are additional changes, don’t hesitate to let me know. Also, please send me a copy of the fully executed Directors’ Written Consent authorizing the offer and sale of the convertible notes at your earliest convenience.
A couple of reminders: COMPANY needs to give all holders of its existing Series A Preferred Stock the opportunity to participate in this offering in recognition of their first-refusal rights. Please call me if you have any questions about the requirements of the first offer or for assistance in drafting a letter to the existing holders of preferred stock conveying the same. And this offering is limited to Accredited Investors, as set forth in the attached Subscription Agreement.
Finally, if you approve the attached and move forward with the offering, please remember to send me copies of the completed Subscription Agreements as soon as you receive them so that I can file timely securities law notices on the company’s behalf.
Thank you.
Very truly,
FIRM NAME
Lawyer Name
Enclosures
Forwarding a Draft Form D Notice of Sale to Client
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: Form D Notice of Sale of Securities
Dear {Salutation}:
Enclosed, please find a draft Form D Notice of Sale of Securities and Form U-2 Uniform Consent to Service of Process, which must be filed with the Securities and Exchange Commission and in each state where the company sells shares. The Form D will be filed with the SEC electronically, but some states require paper filings, so there are multiple signature pages and, in the case of the Form U-2, notarization is required.
If the Form D and Form U-2 meet with your approval, please sign and notarize them as indicated and return them to me at your earliest opportunity so I may have them filed on a timely basis.
Please do not hesitate to call me with any questions or changes in regard to the above.
Very truly,
FIRM NAME
Lawyer Name
Enclosure
Opinion in Connection with Stock Offering
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
|
RE: |
Sale of Series A Preferred Stock |
|
|
Pursuant to Preferred Stock Purchase Agreement |
Ladies and Gentlemen:
We have acted as counsel for COMPANY, a Delaware corporation (the Company), in connection with the preparation, execution and delivery of, and sale of stock under the Preferred Stock Purchase Agreement, dated as of [DATE], between you, the Company, and certain shareholders of the Company (the Purchase Agreement). This opinion letter is delivered to you pursuant to Section 5.6 of the Purchase Agreement. Capitalized terms used but not defined herein shall have the meanings ascribed thereto in the Purchase Agreement.
For purposes of this opinion letter, we have reviewed such documentation and made such other investigations as we have deemed appropriate. As to certain matters of fact material to the opinions expressed herein, we have relied on the representations made in the Purchase Agreement and certificates of public officials, officers of the Company, and others. We have not independently established the facts so relied on.
Based on the foregoing and subject to the other paragraphs hereof, we express the following opinions.
1. The Company is a corporation duly organized, validly existing under the laws of the State of Delaware.
2. The shares issued at closing have been duly authorized and validly issued and are fully paid and non-assessable.
3. The Company has the corporate power to execute, deliver, and perform the Purchase Agreement; has taken all necessary corporate action to authorize the execution, delivery, and performance of the Purchase Agreement; and has executed and delivered the Purchase Agreement.
4. The Purchase Agreement is a valid and binding obligation of the Company enforceable against the Company in accordance with its terms.
5. The execution and delivery by the Company of the Purchase Agreement do not, and the performance by the Company of its obligations thereunder will not, result in a violation of the Certificate of Incorporation or bylaws of the Company.
6. The execution and delivery by the Company of the Purchase Agreement do not, and the performance by the Company of its obligations thereunder will not, result in any violation of any law of the United States or the State of Delaware, or any rule or regulation thereunder, or require approval from or any filings with any governmental authority under any law of the United States or the State of Delaware, or any rule or regulation thereunder.
Our opinions above are subject to bankruptcy, insolvency, and other similar laws affecting the rights and remedies of creditors generally and general principles of equity.
The opinions expressed herein are limited to the federal law of the United States and the Delaware General Corporation Law.
This letter is being delivered to you in connection with the transaction described above and may not be relied on by or furnished to any other person without our prior written consent.
Very truly,
FIRM NAME
Forwarding Signed Funding Documents to an Investor
{Date}
{Name}
{Company Name}
{Address}
{City, State, Zip Code}
RE: COMPANY
Dear INVESTOR:
Enclosed please find an original Series A Preferred Stock Certificate No. 1 made out to you for ________ shares, and a complete set of copies of the executed COMPANY funding documents signed on DATE, as follows:
Stock Certificates;
Patent Assignments;
Amended and Restated Certificate of Incorporation;
Engagement Letter for Counsel for COMPANY;
Capitalization Table and Dilution Analysis;
Indemnification Agreements;
Stock Option Plan and Agreements;
Employment Agreements;
Shareholder Agreement;
Board of Directors’ Written Consent;
Shareholder Written Consent; and
Series A Preferred Stock Purchase Agreement.
Thank you for your time and attention at the closing. I look forwarding to continuing to work with you as COMPANY’s outside general counsel. Please do not hesitate to call me with any questions.
Very truly,
FIRM NAME
Lawyer Name
Enclosures