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Navigating Startup Capital Raising: A Guide to Federal and State Securities Laws
Starting a new business requires capital. For most early-stage startups, fundraising can determine success or failure. But before your startup can offer securities to raise funds, you must navigate complex federal and state securities laws. Violating these regulations carries serious consequences like rescission rights and SEC penalties.
This 10,000 ft view from Wheat Legal PLLC provides key insights on federal and state securities regulations for startups seeking capital. We’ll summarize critical fundraising exemptions, recent legal changes, and compliance steps to avoid legal pitfalls without bogging you down into too many boring technical details.
Overview of Securities Regulations
Two main federal laws regulate startup capital raising:
- The Securities Act of 1933 covers initial securities issuances and offerings. It prohibits sales of securities unless registered with the SEC or exempt.
- The Securities Exchange Act of 1934 regulates resales of securities. It generally doesn’t apply until a public stock offering.
The Securities and Exchange Commission (SEC) oversees compliance. States also have "blue sky" laws regulating securities sales.
Historically, registration was expensive for startups. Most rely on federal exemptions from SEC registration requirements.
Key Federal Registration Exemptions
Various Securities Act exemptions allow startups to avoid full SEC registration. Common options include:
Private Placements Under Section 4(a)(2)
Section 4(a)(2) exempts private offerings to a limited number of sophisticated investors able to “fend for themselves”. No set number determines a public sale. Limiting the offer, recording recipients, and securing investment reps help show it's non-public.
Regulation D Offerings
Regulation D provides multiple capital raising exemptions.
- Rule 504 allows up to $5 million in 12 months from accredited and non-accredited investors.
- Rule 506(b) permits offers to unlimited accredited investors and 35 non-accredited investors. Non-accredited purchasers require disclosure similar to a registration statement.
- Rule 506(c) allows general solicitation if all purchasers are accredited and steps are taken to verify accreditation.
Intrastate Offerings Under Rule 147
Section 3(a)(11) exempts intrastate offerings sold only to state residents if the startup does business in-state. Rule 147 provides a safe harbor for Section 3(a)(11) compliance.
Rule 701 for Compensatory Stock Issuances
Rule 701 exempts stock issuances to employees under written plans, subject to limits. It doesn't apply to capital raising rounds.
Regulation A+ Offerings
Regulation A+ allows certain startups to raise up to $50 million in a public min-IPO process. It reduces disclosure and qualification burdens versus full registration.
Other Federal Exemptions for Resales
Exemptions also exist for private resales of stock by insiders to raise capital:
- Section 4(a)(1-1/2) evolved through practice as a resale exemption similar to Section 4(a)(2). It is now codified under the new Section 4(a)(7).
- Rule 144 provides a safe harbor allowing affiliates and non-affiliates of a startup to resell restricted stock if conditions like holding periods are met.
SEC no-action letters may provide guidance on using these exemptions.
State Securities Regulations
In addition to federal requirements, startups making securities offers or sales must comply with state blue sky laws. Many exempt transactions similar to federal law, but state rules vary widely.
Major Federal Law Developments
Recent federal statutes like the JOBS Act ease capital raising for startups:
- Title I helps emerging growth companies IPO through relaxed requirements and confidential filings.
- Title II allows general solicitation under Rule 506(c) to accredited investors after taking verification steps.
- Title III legalizes equity crowdfunding from non-accredited investors via online platforms, subject to limits.
- Title IV expands the Regulation A registration exemption for smaller securities issues up to $50 million.
Some states also now allow equity crowdfunding, but with inconsistent standards.
Following Compliance Steps to Avoid Violations
With varied federal and state securities regulations, startups risk running afoul of the law. To raise capital safely:
- Consult experienced securities counsel on claiming exemptions properly.
- File Form D and any state notices timely when relying on Regulation D or other rules.
- Vet and verify all investors carefully to qualify for exemptions.
- Understand resale restrictions on securities and remove legends only when conditions are fully met.
- Ensure marketing materials comply with anti-fraud and solicitation limitations.
- Institute processes to comply fully with new crowdfunding rules if utilizing.
This 10,000 ft overview summarizes key capital raising regulations for startups. But the rules are complex, so consult our attorneys before any securities offering. We can help startups raise capital in compliance with all federal and state laws. Contact Wheat Legal PLLC via phone or email through our website to discuss your fundraising plans.