General Practice, Solo & Small Firm Division

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Practice Area Newsletter

American Bar Association - Defending Liberty, Pursuing Justice

Summer 2008

Vol. 4, No. 4

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Business Law


Raising Money for the Small Business

Which Laws Should a Small Business Be Aware of When Raising Money?

Editor's Note: Presently being marketed by the Division is an outstanding book on advising small businesses. The book contains not only suggestions and issues to consider in representing a small business but also contains many of the forms that will assist you in your daily representation of a company. Please read the portion that follows. If you like it, click the link below and purchase the book. Best wishes, Jim

Even when clients already have groups of friends and family lined up for a seed round of financing, they need to be aware of their securities law obligations because there are a number of legal issues and requirements to be concerned about. The applicable requirements will be determined in part by the number of investors, which state (or states) they are in, and whether they are all “accredited investors.”

Whenever a company raises funds by selling common stock, membership interests, limited partnerships, convertible debentures, or some other form of equity, it is selling securities and must comply with applicable securities laws. This basic rule applies regardless of the consideration received—services, cash, notes, or other property such as stock in another company. Generally, whenever an “issuer” (i.e., the company selling its equity) wishes to sell any securities, it must register those securities with the Securities and Exchange Commission (SEC) and appropriate state regulators, unless one of the many exemptions from registration applies to the proposed sale. For offerings that qualify for an exemption from registration, rules must be observed governing the way in which the offering is conducted, the filing of notices, payment of fees, consents to service, and in some cases submission of offering documents.

Companies often rely on the so-called private placement exemptions from the securities registration requirements. Typically, an issuer can sell stock to any number of accredited investors and to a limited number of investors who don’t meet the accredited investor standard in a private (i.e., nonpublic) offering. Reasonable disclosure about the business must always be made to prospective investors; and if the company is selling stock to investors who are not accredited, specific written information about the business must be provided. When a company relies on these exemptions, it will be required to make certain notice filings with the SEC and with state securities regulators in states in which offers or sales are made. Failure to comply with the securities laws can subject a company or its principals to investors’ claims for their money back (“rescission” claims) and other penalties.

Whenever a company is dealing with securities law issues, a lawyer should be consulted. Problems with early stage fund-raising may subject the company to rescission claims and could dissuade venture capitalists, institutional investors, and fund-raisers from working with the company later.

Rule 506 of Regulation D is a “safe harbor” for the private offering exemption, assuring issuers that they are within the section 4(2) exemption if they satisfy the standards within the rule. The criteria for reliance upon the Rule 506 exemption from registration are that the offering be made without any means of “general solicitation”; that the offering be made to no more than thirty-five persons who are not “accredited investors”; that each nonaccredited investor be financially sophisticated (that is, has such knowledge and experience in financial and business matters that he or she is capable of evaluating the merits and risks of the investment); and that if the offering is made to any nonaccredited investors, the same detailed disclosures required in comparable public offerings be made to them. Blue-sky compliance (meaning the securities law compliance in each state where the securities are offered or sold) for Rule 506 offerings was simplified by the National Securities Markets Improvement Act of 1996 (NSMIA), section 18(b)(4)(D) of the Securities Act of 1933, which preempts a state’s registration requirements with respect to securities being offered and sold under Rule 506 of Regulation D. States are permitted only to (i) require a notice filing from the issuer, (ii) impose a filing fee, and (iii) require the issuer to consent to service of process in the state. In accordance with NSMIA, each state generally requires an issuer that offers and sells securities in its state pursuant to Rule 506 to submit the following materials within fifteen days after the first sale of securities in that state in order to qualify for an exemption from registration: (a) an executed copy of Form D Notice of Sale of Securities, (b) an executed copy of Form U-2 Uniform Consent to Service of Process, and (c) a filing fee. A Form D must also be filed with the SEC.

The Securities Lawyer’s Deskbook, a website maintained by University of Cincinnati College of Law, is a great resource for accessing the federal securities laws (at The Securities and Exchange Commission website is also a great resource at

Is It Okay to Put Fund-Raising Information on a Website?

No general solicitation is permitted in connection with a private offering of securities, thus the designation of the offering as “private.” Don’t let your client put fund-raising information on its website, or it will likely be deemed to have made a general solicitation in connection with its sale of securities.

A problem that often arises in meeting the criteria of the Rule 506 safe harbor is that either the company’s officers and directors or the selling agent inadvertently engages in an act that is deemed to constitute a general solicitation, or at least cannot be affirmatively shown not to involve a general solicitation (the burden of proof being upon the person seeking to rely upon the exemption). Often the problem arises indirectly, and the company’s management or the soliciting agent are not aware of the issue until it is too late.

A typical action that raises a general solicitation issue is a mass mailing to potential investors, even if the mailing is confined to accredited investors. To preclude these issues from arising, the company’s management and the selling agent should review carefully in advance the strategies for solicitation of investors in the offering. Form letters, particularly to strangers, should be avoided, as should mailings with similar contents to a large number of persons. An appropriate procedure is to forward the offering materials or an executive summary to persons with whom management or the selling agent has an existing, established relationship (such as, for example, an existing securities customer of the selling agent) to determine if the recipient has any interest in the offering. The contact should be direct and personal, not general and to a number of persons, and particularly not to a number of strangers. A mass mailing by a selling agent in an attempt to solicit for itself, through advertising, newsletter, or otherwise, new accredited customers (especially strangers) can be deemed a general solicitation if the company’s offering is then in progress—unless steps are taken to preclude any person so solicited from becoming an investor in that pending offering.

One common occurrence that creates general solicitation issues is the appearance of a company’s management before a meeting of an investment forum consisting of potential investors, even if confined to accredited investors. The nature of these gatherings and how they are assembled will determine whether they are deemed to involve a general solicitation. Some of these groups have sought and obtained no-action letters from the SEC assuring that the Commission will not take any administrative action if their methods of operation are confined to certain stated circumstances. Companies that desire to appear before such groups should inquire before appearing as to whether the group has obtained such a no-action or interpretive letter and whether the circumstances recited in these letters are being observed. Otherwise, the ability to proceed with funding may be impaired or precluded.

Another common occurrence that creates general solicitation issues is media coverage at or near the time of the offering. If the company becomes the object of media reporting, even if not sought out by the company, a general solicitation may be deemed to be involved. Particularly problematic are news reports or articles that mention the company’s possible financial success or the fact that it is or may be seeking financing. Unless the company is then actually engaged in product or service marketing efforts, reports by the media should generally be avoided. If product or service marketing efforts are then actually in progress, media coverage should be confined to information concerning the company’s products or services, and then only to the extent that it might be of interest to potential customers.

It goes without saying that no solicitation of investors should be entered into directly or indirectly by any form of paid advertising, whether in newspapers or on radio or television. Such activity is usually inconsistent with the concept of a “private” offering and in any event is expressly prohibited by Regulation D.

The foregoing are examples of typical ways in which a “general solicitation” issue can arise. There are many other possibilities, of course. It is thus important for those persons involved in a private offering to be alert to the general solicitation prohibition and the ways that it may be violated, and to ask securities counsel for guidance when doubts arise before irreversible action has been taken.

Jean L. Batman founded Legal Venture Counsel, Inc., in 2004 to provide outside general counsel services to investors, entrepreneurs, and small businesses. As outside general counsel to a variety of companies and individuals, Ms. Batman provides business and financial legal services to privately held entities operating in a broad range of industries. Ms. Batman chaired the ABA Business Law Section’s Small Business Committee from 2001 to 2005.

Advising the Small Business: Forms and Advice for the Legal Practitioner

Did you find this article helpful? Do you think more information like this would help you? More information is available. Excerpted from Advising the Small Business: Forms and Advice for the Legal Practitioner, 2007, by Jean L. Batman, published by the American Bar Association General Practice, Solo and Small Firm Division. Copyright © 2008 by the American Bar Association. Reprinted with permission. GP/Solo members can purchase this book, which includes electronic forms, at a discount through the GP/Solo bookstore website: .

© Copyright 2008, American Bar Association.