Chart Comparing Common California and Federal Exemptions and Registration
When a California company wants to bring in investors through a private placement offering, it has to determine which securities exemption is the best one to use. The usual factors to consider are how much money needs to be raised, what forms of marketing are needed, how many investors are expected, what suitability standards will work for the expected potential investors, and whether the offering can be limited to California investors only or not. This chart lays out the pros and cons of each exemption with respect to these factors.
Note: Not all requirements are covered here, nor are variations for specific situations addressed; this is designed to give general guidance. Also, the securities law area is extremely complex; do not try to make an offering without advice from an attorney.
| California 25102(f) | California 25102(n) | California Qualification by Permit | Accredited Investor Exemptions (Most States but with Variations) | Federal Rule 504/scor in Other States | Federal Rule 506 | |
|---|---|---|---|---|---|---|
| Maximum Amount | unlimited | if a CA-only offering, no limit. Otherwise, up to $5 million. | unlimited, but less strict review if limited to < $5 million | unlimited | $1 million | unlimited |
| Advertising | only non-specific info and targeted offers1 | brief "tombstone" ad only (plus non-specific info and targeted offers1) | full public advertising if limited to CA only | brief "tombstone" ad only (plus non-specific info and targeted offers1) | only non-specific info and targeted offers1 unless registered in at least one state | only non-specific info and targeted offers1 |
| Maximum Number of Investors | 35 plus accredited investors2 | unlimited | unlimited | unlimited | unlimited | 35 plus accredited investors |
| Qualifications of Investors | pre-existing substantive relationship3 or sophisticated4 or accredited2 | for corporations, either "qualified"5or accredited2. For LLC's, accredited2only. | none, but no merit review if revenues < $25 million, offering is < $5 million and "minimum qualifications"6 used | accredited investors2only | usually none | sophisticated4or accredited2 |
| Foreign Investors – separate offering required? | Must be a separate offering, but 35-investor limit must count both offerings unless 6 months apart. Foreign investors must sign certificate7 | Can be part of single offer IF offer is $5 million or less. Foreign investors must sign certificate7 | Must be separate offering (or Rule 504, 505 or 506 must also be complied with). Foreign investors must sign certificate7 | May be single offering. Foreign investors must sign certificate7 | May be single offering, though $1 million limit applies to total. Foreign investors must sign certificate7 | May be single offering. Foreign investors must sign certificate7 |
| Combining California and Other Exemptions | limited to California only | can be combined with accredited investor2exemptions in other states | can be combined with a Rule 504/SCOR offering in other states – but may not be worth it | can be combined with a California 25102(n) | can be combined with a California qualification by permit | preempts state merit review, though brief filing required in each state with investors |
| Comments | easy for "friends and family" investors | entity may have only one class of securities unless accredited investors2only | extensive application is required that must be approved by the State in advance; the "minimum qualifications"6 are much less than required for accredited investors | must be combined with a CA 25102(n) offering of < $5 million to allow the tombstone ad; there are variations from state to state; brief filing is required in each state with investors | regional approval (five regions) must be obtained in advance | Form D must be filed with the SEC. A few states require issuer also register as broker. |
1. "Only non-specific info and targeted offers":
- The company can make a general announcement, meaning that on web sites, in advertisements and at seminars can discuss what the company does, its need for money and what that money will be used for, and in general the type of investments it has or will have available. Certain warnings must accompany this general announcement. What the company cannot do is mention any rate of return, price per share or unit or percentage of ownership, performance of prior offers, solicit offers from potential investors, etc. You must have an attorney review the general announcement before using it.
- Also, the company can contact individual potential investors by email, letter, etc. that it reasonably believes meet the investor suitability requirements for the investment and give them the specifics about the offering. (Although to actually invest the investor must usually be given an investor questionnaire, private placement memorandum or something similar, and a subscription agreement). Warning: Do NOT push the envelope on reasonable belief here; if unsure, send an appropriate investor questionnaire first.
- Further, the SEC has said (although it has received wide criticism for this), that when a federal exemption is being used and there is no prior relationship between the offeror and potential investor, the offeror must wait 30 to 45 days after receiving responses to the investor questionnaire before giving the potential investors any specifics about he offering.
2. "Accredited investors":
- For companies: Basically, either a) any organization not formed for the specific purpose of acquiring the securities offered with total assets in excess of $5,000,000, OR b) any organization where each owner is an accredited investor.
- For individuals:
- Any director, executive officer, or general partner of the company making the offering;
- Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his purchase exceeds $1,000,000;
- Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
"Pre-existing substantive relationship": A preexisting personal or business relationship with the company or one or more of its officers, directors or controlling persons of a nature and duration such as would enable a reasonably prudent purchaser to be aware of the character, business acumen and general business and financial circumstances of the person with whom such a relationship exists.
3. "Sophisticated": Having the capacity to protect own interests, meaning that by reason of substantial business or financial experience – or that of Investor's professional advisors (who are unaffiliated with and who are not compensated by the company or any affiliate or selling agent of the company, directly or indirectly) – the capacity to protect investor's interests in connection with the transaction.
4. "Qualified investors" (for a 25102(n)): Note that for this to apply the company must have only a single class of stock/units. A natural person who, either individually or jointly with the person's spouse, either:
- (i) has a minimum net worth of $250,000 and had, during the immediately preceding tax year, gross income greater than $100,000) and reasonably expects gross income greater than $100,000) during the current tax year OR
- (ii) has a minimum net worth of five hundred thousand dollars ($500,000).
5. "Net worth" must be determined exclusive of home, home furnishings, and automobiles. Also, the amount of the investment of each natural person cannot exceed 10 percent of their net worth.
6. "Minimum qualifications" (for a qualification by permit with no merit review): The investor (an individual, counting the husband and wife as one – and probably an entity) must meet one of the following requirements:
- Have a minimum net worth of at least $75,000 and had minimum gross income of $50,000 during the last tax year and will have (based on a good faith estimate) minimum gross income of $50,000 during the current tax year (with net worth determined exclusive of homes, home furnishings and automobiles AND the investment not exceeding 10 percent of that net worth); OR
- Have a minimum net worth of $150,000, provided that in either case the investment shall not exceed 10 percent of the net worth of the investor (with net worth determined exclusive of homes, home furnishings and automobiles AND the investment not exceeding 10 percent of that net worth); OR
- Investing less than $2,500 total in the company, including any investments made during the prior 12 months.
7. "Foreign investors certificate": Foreign investors must sign certificate stating that they will not re-sell or transfer the securities back into the U.S. unless U.S. securities laws are complied with.