How to Raise Unlimited Amounts of Money as a Startup
August 18, 2018
When you raise money from investors, federal securities laws requires you to either register your security or find an exemption to registration. Startups commonly rely on Rule 506 of the Securities Act of 1933 (“Securities Act”) to raise an unlimited amount of capital from accredited investors, such as VCs and angel investors. Rule 506 is a federal exemption from registration, which allows companies to raise an unlimited amount of money throughout the United States without registering their offering of securities.
Raising unlimited amounts of money with federal securities exemptions
Rule 506(b) allows startups to raise money from an unlimited number of accredited investors and up to 35 non-accredited investors that meet sophistication requirements.
A company can choose the type of information that they give to the investors as long as the information is not fraudulent or misleading. If the company also raises money from non-accredited investors, it must provide disclosures that are similar to those in a Regulation A or registered offering and give non-accredited investors any information given to accredited investors.
Under Rule 506(b), a company cannot generally solicit or advertise its offering and can rely on an investor’s self-attestation to verify accredited investor status.
Unlike Rule 506(b), Rule 506(c) allows a company to advertise its offering. However, unlike Rule 506(b), non-accredited investors cannot buy securities offered under Rule 506(c). Additionally, a company must take “reasonable steps” to verify an investor’s accreditation status under Rule 506(c) and cannot simply rely on an investor’s attestation. The verification process may include reviewing personal information such as bank statements, credit reports, and W-2s or having an attorney or CPA attest to their accredited investor status.
When companies rely on accredited investors for capital, they sometimes find themselves being forced into decisions that favor the investors. For example, professional investors prefer investing in Delaware C-Corps and founders structure their companies accordingly. Founders with companies based in California would be well-served to be familiar with California’s securities exemptions, which may place power back into the hands of founders, while allowing them to raise unlimited amounts of capital.
Raising unlimited amounts of money with California securities exemptions
25102(f) — The Friends and Family Exemption
Section 25102(f) can be thought of as California’s friends and family exemption. Under section 25102(f), a company can raise unlimited amounts of money from unlimited numbers of accredited investors and up to 35 non-accredited investors that are either sophisticated or have a substantial pre-existing relationship with a principal of the company.
Unlike Rule 506(b), which only allows non-accredited investors that are “sophisticated” to invest, the 25102(f) exemption allows friends and family that neither meet the accredited or sophisticated investor standards to invest.
Companies raising money under 25102(f) can communicate about their business generally and that they are seeking capital, even soliciting potential investors to fill out questionnaires to determine their suitability to invest. If company reasonably believes that a potential investor meet suitability requirements, the company can send specifics of the offering to that investor.
25102(n) — The Exemption that Allows Limited Advertising
Section 25102(n) allows California-based businesses to raise an unlimited amount of money from an unlimited number of “qualified purchasers” in California and even allows these companies to advertise their offering.
If a company wishes to use the 25102(n) exemption and raise money from residents outside of California, it is limited to raising $5 million and must comply with the securities exemptions of other states, but are exempt from federal registration. The advertising is limited and may only include the issuer’s name, the type of securities being offered, the price, and suitability requirements.
Prospective investors must complete an investor questionnaire to determine their status as “qualified purchasers.” After reviewing these questionnaires, a company may send an offering memorandum and other advertising materials to investors that it reasonably believes are qualified.
California Qualification by Permit — The Exemption that Allows Full Advertising
Companies in California can apply for permit that would allow them to advertise an offering and raise an unlimited amount of money from both accredited and non-accredited investors in California. The permit takes 30–60 days, if not more, to process and all advertisements must be filed with the California Commissioner of Corporations at least 3 days before use.
Small companies with revenues less than $12.5 million and conducting an offering for $5 million or less and selling securities to investors that meet certain suitability standards are subject to a more relaxed review. An investor meets such suitability standards if the investor (including their spouse) have (1) a minimum net worth of $75,000 and a minimum gross income of $50,000 during the current and last tax years or (2) a minimum net worth of $150,000 and invested no more than $2,500 of the issuer’s securities within the last 12 months. The investment cannot exceed 10% of the investor’s net worth and the investors homes, home furnishings, and cars are excluded from the calculation of net worth.