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Overview of Marketing, Promoting and Advertising Securities Offerings

California companies frequently ask how they can promote private investment offerings they would like to make without violating the securities laws. With care, general public communications about a company and its need for investment money can be made if no specifics regarding an offering are given. Individual, non-public communications giving specifics to potential investors believed to meet the suitability requirements for the offering are also allowed.

In addition, a California offering in compliance with 25102(n) can use a public "tombstone" advertisement that offers brief information on the specifics of the offering. Also, a California-only offering can use full public advertising if it is first qualified by permit by the Commissioner of Corporations.

Some Securities Laws Basics

By way of background, the vast majority of investments that companies want to offer constitute securities. This includes but is not limited to stock, LLC interests, options, promissory notes, investment contracts, etc. (See, e.g., California Corporations Code §25019,15 U.S.C. §77b(a).) There are certain exclusions – for example, some LLC’s where every member is actually actively involved in management (not merely having the right to participate in management), very carefully designed tenant-in-common arrangements, etc. –- but these have restrictions and do not work in most situations.

To offer securities in compliance with the law, either the securities must be registered with a government securities agency (which is more costly and time-consuming but is sometimes the right approach) or the offering must fit within one or more exemptions to the registration requirements.

If securities are being offered to residents of one state only, then only that state’s securities laws apply. (Actually, the entity also must be formed in that state, have its principal place of business there, and must have and expect it will have 80% of its assets, expenditures and sources of revenue in that state.) If securities are being offered to residents of more than one state (or if the offering does not meet those other requirements), not only will those states’ laws apply but federal law applies as well.

General Communications

The general rule is that exemptions (from registration of an offering) do not allow public advertising of a specific offer. On the other hand, a company can provide general information about what it does and its need for money and/or in general the type of investments it may make available. This may be able to be done on the company’s web site, at seminars, through flyers, etc. What a company can't do, with some limited exceptions, is either 1) solicit offers from potential investors or 2) mention any specifics of an offer: Stock price, rate of return, percentage of ownership that will be provided per dollar amount invested, performance of past offerings, etc. Also, the communication must state something along the lines of the following:

This is not an offer to sell or a solicitation of any offer to buy any securities. Offers are made only by prospectus or other offering materials. To obtain further information, you must complete our investor questionnaire and meet the suitability standards required by law.

Do not try this without consulting with an attorney, though: There are both civil and criminal penalties for violating the securities laws and it is relatively easy to violate them. An attorney can review the communication and make sure it does not constitute an offer. (Merely having a disclaimer like the one above is necessary but not sufficient.) Also, when the company does offer the securities, it still has to comply with the requirements of the securities exemption it is using – or register the offering.

Frequently the exemptions to registration of securities effectively require that the company making the offering have potential investors complete an investor questionnaire. If and only if it appears that the potential investor meets the investor suitability requirements for that offering, then the company can provide the offering specifics to the investor, almost always in the form of a disclosure document, which may be called a private placement memorandum, a prospectus, an offering circular, etc. Regardless of what it is called, the disclosure document (sometimes containing a business plan or having one attached as an exhibit) will describe the company and its plans, the offering, the management, suitability requirements for investors, risks and legal requirements, disclaimers, etc. (Obviously there needs to be legal review of the disclosure document before it is given to potential investors.)

As long as the company's web site does nothing that could be construed as an offering or a solicitation to invest, then the site can say something like "For more information regarding our company, click here." That link should then contain an appropriate investor questionnaire and a statement that it must be completed and returned before more information can be provided. Someone responsible must then review the questionnaire and determine if the person reasonably appears to be qualified. If and only if the person appears to be qualified, then offering materials may be sent and/or a password given to a special section of the site with offering materials.

It is also possible to have educational seminars where the company presents what it is doing and gathers information for an offering to qualified investors. The seminars, of course, cannot make or solicit any offer to invest. At some point -- in response to pre-seminar inquiries about the seminar, at the seminar and/or following up after the seminar -- the company needs to send investor questionnaires. As before, only those potential investors who reasonably appear to be qualified can be told of the existence of the offering and provided with offering materials. Obviously, to show that nothing in the presentation mentioned the offer, all seminar presentations should be put in tangible format -- whether paper (e.g., lecture notes and handouts ), electronic (e.g. PowerPoint slides), or tape (audio or visual) -- and kept permanently in a safe place.

Although widely criticized for its stance, the SEC has stated that, with offerings that must comply with federal law, if there is no pre-existing relationship between the offeror and the potential investor, the offeror should wait 30 to 45 days after receiving the questionnaire responses before providing any specifics about an offer.

Targeted Communications With Specifics

In some situations it is acceptable to send specifics regarding an offering directly to individual potential investors (by letter, email, etc.) that the offeror reasonably believes meet the investor suitability requirements for the securities exemption that will be used. This may occur via lists of investors previously determined by a securities broker to be accredited investors, or with certain potential investors –- often suppliers, customers, colleagues, friends and family –- who have a substantive pre-existing relationship with the company or one or more of its principals. The specific exemption being used determines who may be contacted and how.

If there is any doubt, though, about whether a particular investor meets the suitability standards, the investor-questionnaire approach must be used.

Publicly Advertising an Offering

If public advertising is needed, the options are basically the California 25102(n) offering (which allows a tombstone ad), a California qualification by permit (which allows full public advertising), and a Rule 504/SCOR offering, which also allows full public advertising.

A California 25102(n) offering may be used (with care) in states that have adopted the Model Accredited Investor Act. In that case the offering must be limited to $5 million or less, the company must be a California entity or do most of its business in California, and all the investors must be accredited.

The California qualification by permit method allows full public advertising, but the offering must be a California intrastate offering. (All investor must be located in California, the company must be a California entity with its principal place of business in California, and it must have and expect it will have 80% of its assets, expenditures and sources of revenue in California.)

Most states participate in regional approval for federal Rule 504/state SCOR offerings of up to $1 million. The states are grouped in five regions and approval by the designated state gives permission to make the offering to all participating states in the region. Full public advertising is allowed. One problem, though, is that California does not participate in the regional-review system, so the offering has to be separately submitted for review to the California Commissioner of Corporations.

Finders In California

While in theory it is possible to find licensed securities brokers to sell an offering, as a practical matter that can be difficult. Commissions often run from 7% to 20%. In addition, licensed securities brokers are generally reluctant to handle an offering unless the amount being raised is in excess of $5 million to $10 million and they are absolutely convinced they can sell the offering. (In addition, generally they want an attorney other than the attorney handling the offering to issue an opinion letter stating that the offering complies with all the securities laws.)

This raises the issue of using “finders”. Finders are people who are not licensed as securities brokers who are paid a commission (or other performance-based compensation) for locating investors. Federal law prohibits the use of finders. Finders may be used in California-only intrastate offerings if all the requirements are carefully followed.

Since roughly 2000, the SEC has effectively prohibited performance-based compensation for those who are not federally licensed securities brokers. On the federal level finders can only be paid a fee that is paid regardless of the success of the offering - and of course offerors do not want to do that.

An intrastate offering limited to California is different because California allows finders to be paid on a commission (or other performance-related) basis even if they don’t have a securities brokers license. The finders cannot be officers, directors, employees or independent contractors of the offering company (and probably cannot become so for at least six months after the offering ends). In addition, the finders may only introduce the parties and can play no role in negotiating the terms of the investment, advising either party, or touting the investment. This is discussed in more detail below.

Of course, to fall within the intrastate exemption, the offering company must be formed in California, have its principal place of business in California, and have and expect to have 80% of its assets, income and expenditures in California.

While directors and key officers (this is limited to the president, secretary and chief financial officer and to any other officer who has been expressly given the authority) of the offeror may sell the securities, they can only be paid their usual salary and cannot be paid any compensation based on the performance of the offering. Other officers and employees (and very probably independent contractors of the offeror) not only cannot sell the stock, they absolutely cannot be finders.

In terms of what a “finder” can say, basically a finder can say only that the company is seeking investors for a particular offering and communicate the price and terms, if any, already set by the offering company. The finder cannot even give advice to either party regarding the negotiations. Given this, the finder should have no role in giving advice on the price or terms even before making contact with the first potential buyer. Also, the finder cannot try to convince a potential buyer to make the investment, since this would constitute “selling”. Finally, once the finder introduces the buyer and seller, the finder should have the most minimal contact with the buyer that is possible until after that sale is closed (and ideally until the entire offering is closed). It is strongly recommended that the offeror have any finders sign a finders agreement stating exactly what they can and cannot do.

Conclusion

While many of the offering exemptions prohibit public advertising (communications giving any specifics about an offering), between 1) general communications that invite potential investors to submit an investor questionnaire that can be used to qualify the investor, and 2) targeted communications to those who are reasonably believed to meet the investor suitability requirements, many companies are able to make investment offerings without using public advertising.