Small businesses: How to raise money without going public?

August 31, 2011 Robert Garson Yosef Shwedel
GS2LAW Business & Real Estate Business Law

Small businesses often face financial difficulties, due to a lack of capital. Developing a new project can indeed be costly, and banks can be reluctant to provide funding to small business owners.

A good alternative to raise capital is to sell shares or “securities” of the company to external investors. However, offering securities to the public usually falls under the Securities Act of 1933 (the “Act”) and its subsequent amendments, which imposes registration requirements with the Securities and Exchange Commission (SEC) upon companies.

Mindful of the difficulties that confront companies with limited resources when trying to raise capital, a number of exemptions from the registration requirements were created in the Act. The purpose of these exceptions is to facilitate funding solicitations for small companies.

Non-Registration with the SEC

These exceptions impose strict conditions on the amount of capital that can be raised and the possibility for an investor to resell the securities. Not only must the company offering the securities comply with certain rules, investors also must meet specified conditions.

Restrictions on the resale of the securities

SEC regulations often require the securities to be restricted. This means that investors may acquire the securities for investment purposes only, and are bound from reselling the securities, whether to the public or on secondary markets, without registering them with the SEC beforehand.

In other words, a company seeking to raise capital should specify that the investor would not be able to resell the securities unless he registers such securities with the SEC before resale.

No public promotion of the investment opportunity

Companies offering the securities must also satisfy certain conditions as to how they are offered for sale. For instance, companies are generally barred from promoting the investment opportunity by way of public solicitation or general advertising. Instead, companies should target investors that they already know, or resort to in-person marketing.

In addition, companies in development with no well-defined business project cannot be discharged of the registration requirement. This is the case for Blank Check Companies, which are companies currently at a development stage, with no specific business plan or purpose, or whose business plan is to engage in a merger/acquisition with an unidentified entity or person.

Sophisticated or Accredited Investors?

Some rules limit the number of investors that a company can target. Other regulations require that investors meet certain qualifications with respect to their knowledge or their wealth. The Act defines two categories of investors that are relevant here: sophisticated investors and accredited investors.

On the one hand, sophisticated investors are persons who have enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment; no specific wealth requirement is imposed on them.

On the other hand, accredited investors must meet specific wealth requirements, but no specific knowledge condition needs to be satisfied:



net worth of at least $1 million bank, insurance company, registered investment company, business development company, or small business investment company
Income exceeding $200,000 in each of the two most recent years and reasonable expectation of same income level in the current year charitable organization, corporation or partnership with assets exceeding $5 million
joint income with spouse exceeding $300,000 for those years and reasonable expectation of same income level in the current year director, executive officer, or general partner of the company offering the securities
business in which all the equity owners are accredited investors
trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person