In many cases, start-ups and other small businesses are selling company stock without registering with the Securities and Exchange Commission (SEC) or state regulatory authority. However, the key question is whether the offering qualifies for one of several exemptions from registration under the federal Securities Act of 1933 or state laws regulating the offering and sale of securities (often referred to as blue sky laws).
By way of example, you generally don’t need to file with securities regulators when forming your corporation and selling stock to yourself as well as co-founding shareholders. You also may not need to file with regulators when raising some initial capital from friends and family. However, it is imperative to thoroughly analyze what exemptions, if any, may apply to your particular stock sale, issuance or grant. Companies should also be mindful that federal and state laws do differ, so registration may be required by one regulator and not the other.
Rule 701 Exemption
Start-ups commonly take advantage of Rule 701 under the Securities Act when making equity awards to key members of the company. Rule 701 exempts certain compensatory equity awards issued to directors, officers, employees, trustees, service providers, etc. The key requirement is that the stock must be awarded pursuant to a written compensatory benefit plan or compensation contract. Accordingly, it may not be used for capital-raising transactions. Notably, Rule 701 is available to consultants and advisors, provided that they are natural persons who provide bona fide services to the issuer.
Regulation D Exemption
Start-ups also frequently rely on Rule 506(b) of Regulation D when awarding stock to directors and executive of officers. Regulation D is a “safe harbor,” meaning that if you comply with the rule you are considered to have engaged in an offering that is exempt from registration. Even if you fail to comply with Regulation D, that doesn’t mean that your corporation has conducted a public offering of securities that should have been registered. The issuance of shares to a founder, or even several founders, is almost always considered to be a transaction “by an issuer not involving any public offering,” which is an exempt securities offering under Section 4(a)(2) of the Securities Act. Accordingly, registration under the ’33 Act is not required for such sales. You don’t lose the 4(a)(2) exemption just because you did not file the Form D.
Restrictions on Reselling Shares
Don’t take exemptions as a license to then look for investors by offering the company stock or the stock that you received to others through the internet, a newspaper advertisement or other media without first registering that further offering. The important thing to keep in mind is that the ’33 Securities Act registers offerings and the ’34 Securities Exchange Act registers shares. It is a common occurrence today that an offering of shares that is exempt from registration under the ’33 Act does not mean that the offering, or the resale of those shares (which constitutes a different offering), is also exempt.
Failure to Register Securities
Securities transactions that are not exempt from registration and are not registered with the SEC violate Section 5 of the Securities Act. Violations may result in injunctive or other enforcement proceedings brought by the SEC, as well as private suits by securities purchasers seeking damages or rescission. In addition to costly SEC penalties, the company may also be required to make a rescission offer for all securities subject to the illegal transaction.
Registration and exemption issues are important to consider before making any offer to sell or commitment to issue company securities, therefore, if you are unsure how to approach the matter or have any questions, please contact me, Dan Brecher.
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What You Need to Consider When Selling Company Stock
Author: Dan Brecher
Filing Requirements When Selling Company Stock
In many cases, start-ups and other small businesses are selling company stock without registering with the Securities and Exchange Commission (SEC) or state regulatory authority. However, the key question is whether the offering qualifies for one of several exemptions from registration under the federal Securities Act of 1933 or state laws regulating the offering and sale of securities (often referred to as blue sky laws).
By way of example, you generally don’t need to file with securities regulators when forming your corporation and selling stock to yourself as well as co-founding shareholders. You also may not need to file with regulators when raising some initial capital from friends and family. However, it is imperative to thoroughly analyze what exemptions, if any, may apply to your particular stock sale, issuance or grant. Companies should also be mindful that federal and state laws do differ, so registration may be required by one regulator and not the other.
Rule 701 Exemption
Start-ups commonly take advantage of Rule 701 under the Securities Act when making equity awards to key members of the company. Rule 701 exempts certain compensatory equity awards issued to directors, officers, employees, trustees, service providers, etc. The key requirement is that the stock must be awarded pursuant to a written compensatory benefit plan or compensation contract. Accordingly, it may not be used for capital-raising transactions. Notably, Rule 701 is available to consultants and advisors, provided that they are natural persons who provide bona fide services to the issuer.
Regulation D Exemption
Start-ups also frequently rely on Rule 506(b) of Regulation D when awarding stock to directors and executive of officers. Regulation D is a “safe harbor,” meaning that if you comply with the rule you are considered to have engaged in an offering that is exempt from registration. Even if you fail to comply with Regulation D, that doesn’t mean that your corporation has conducted a public offering of securities that should have been registered. The issuance of shares to a founder, or even several founders, is almost always considered to be a transaction “by an issuer not involving any public offering,” which is an exempt securities offering under Section 4(a)(2) of the Securities Act. Accordingly, registration under the ’33 Act is not required for such sales. You don’t lose the 4(a)(2) exemption just because you did not file the Form D.
Restrictions on Reselling Shares
Don’t take exemptions as a license to then look for investors by offering the company stock or the stock that you received to others through the internet, a newspaper advertisement or other media without first registering that further offering. The important thing to keep in mind is that the ’33 Securities Act registers offerings and the ’34 Securities Exchange Act registers shares. It is a common occurrence today that an offering of shares that is exempt from registration under the ’33 Act does not mean that the offering, or the resale of those shares (which constitutes a different offering), is also exempt.
Failure to Register Securities
Securities transactions that are not exempt from registration and are not registered with the SEC violate Section 5 of the Securities Act. Violations may result in injunctive or other enforcement proceedings brought by the SEC, as well as private suits by securities purchasers seeking damages or rescission. In addition to costly SEC penalties, the company may also be required to make a rescission offer for all securities subject to the illegal transaction.
Registration and exemption issues are important to consider before making any offer to sell or commitment to issue company securities, therefore, if you are unsure how to approach the matter or have any questions, please contact me, Dan Brecher.
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