Entity formation and securities law Evan Husney
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The document discusses various entity formation options and securities laws that must be considered when raising capital. It describes the key characteristics of S Corporations and C Corporations, as well as Limited Liability Companies. It then outlines Regulation D exempt offering rules under federal securities laws, including Rule 504, 505, and 506. It discusses accredited investor definitions and verification requirements. The document provides an overview of preparing a private placement memorandum and offering process when conducting a securities offering to raise funds. It concludes with a case study of three individuals wanting to form a solar company and raise $2 million.
Entity formation and securities law Evan Husney
- 1. Entity Formation and Securities Laws Evan Husney Foster Graham Milstein & Calisher LLP February 17, 2016
- 3. Choice of Entity • Major Considerations – Liability Protection – Taxes – Ease of Formation – Familiarity of Form – Ability to Access Investor Funds – Record Keeping Requirements
- 4. Subchapter “S” Corporations • Limited Liability • Pass Through Taxation • Simple to Form (note need for shareholders agreement) • Cannot go public (see limitations below) • Limitations on Owners – No more than 100 shareholders – Only one class of stock – Only U.S. citizens or resident aliens – No entities except certain qualified trusts and tax exempt organizations
- 5. Subchapter “C” Corporations • Same as “S” Corporations except: – No Pass-through Taxation (double tax structure) – Can Go Public – No Limitations on number or type of Owners – More Than One Class of Stock Allowed
- 6. Limited Liability Companies • Limited Liability • Pass Through Taxation – same as S Corp. • Can Be Difficult to Form • Less Familiar Than Corporations • No limitations on number or type of members • More flexible if needed
- 7. Helpful Hints - Preparing For Investors • Properly Complete Corporate Formalities – Organizational Documents – Employee Agreements – Securities Issues – Other Contracts • Capitalization – Think About The Future – Don’t Sell Expensive Equity Early – Keep it Simple – Limit Number of Equity Holders if Possible
- 8. Helpful Hints - continued • Surround yourself with the right advisors/board • Intellectual Property – Is it Protectable? – If so, is it Protected? • Understand Your Target – Should You be Talking to Whom You are Talking? – Don’t Waste Your Time – First Impressions are Huge – Find a Champion
- 9. Helpful Hints - continued • Have Your Story Straight – Executive Summary (no more than 2-3 pages) – Detailed Business Plan – Use Friends and Contacts to Review – Should Take Many Iterations to Complete • Have Patience!
- 10. Securities Laws • Both Federal and State apply – must comply with both – “Blue Sky” filings • State based on domicile of investor • Starting point is registration requirements • Expensive and Time Consuming • Regulation D Exempt Offerings (Federal Rules 504-506)
- 11. Rule 504 • No more than $1,000,000 during 12 months • Unlimited number of investors • No specific disclosure requirements • Anti-fraud and material info rules still apply
- 12. Rule 505 • No more than $5,000,000 during any 12 months • No more than 35 unaccredited investors and unlimited number of accredited investors • No general solicitations or general advertising • Anti-fraud and material info rules still apply
- 13. Rule 506 • No dollar limitation • No more than 35 unaccredited investors and unlimited number of accredited investors • accredited investors still need a certain level of sophistication • Unaccredited investors need to receive information sufficient for full registration • General solicitation or general advertising allowed under certain circumstances • Anti-fraud and material info rules still apply
- 14. New Rules • Now can have up to 2,000 accredited investors (up from 500) and still be a private company • General Solicitation allowed for Rule 506(c) offerings – Must take additional steps to verify investor status
- 15. Verification • Safe Harbor – Review documents showing sufficient income – Review documents showing net worth – Rely on written confirmation of a qualified third party – Rely on certification of investor that previously invested in a private offering as accredited
- 16. Accredited Investor Definition • Directors, officers, partners of issuer • Net worth of $1 million (individually or jointly with spouse but excluding residence) • Income in excess of $200,000 (or $300,000 with spouse) in last 2 years and expectation of same in current year • Business entity treated as a single individual unless formed for purpose of investment, in which case each individual
- 17. Private Placement Memo • Offering document provided to potential investors • Provides material disclosures required by securities and anti-fraud rules • Basically a business plan wrapped by legal disclaimers and more information about the company and securities being offered. • Must contain any info that would be material to investment decision
- 18. Offering Process • Prepare PPM • Hand out and track numbered copies • Prepare subscription agreement that investor will sign with investor reps and warranties and amounts subcribed • Accept payment and issue securities • File Form D and any required state filings
- 19. Case Study • 3 individuals wish to form a new business to sell a revolutionary solar product • Each will own 33% of the company • They will need financing of $2 million • The product is patentable technology • What next?