Securities Law 101

Securities Law 101If you are the founder of a startup, unless you plan to self-fund and never grant stock options or other types of compensatory equity awards, you will need to familiarize yourself with both federal and state securities laws.

The reason?  Because if you don’t comply with the securities laws you may significantly harm the value of your company (not to mention exposing you and your company to potential civil and criminal liability).

If you can’t find an exemption, or you don’t have the time or money to file all the applicable forms and pay the required fees, do not issue the securities.

I know, I know, you’d prefer to spend your time on matters more directly related to the immediate success of your business, like typing out your next line of code.  But here is the key for you to remember:  Any time your company issues stock or any time your company grants stock options or compensatory equity awards of any kind (stock bonuses, for example), your company either must comply with the registration requirements of federal and applicable state securities laws (which, for the most part, are overly complex, burdensome and expensive to comply with at the startup stage of a company’s existence) or will have to identify an applicable exemption from the registration requirements.

The table below lists securities exemptions private companies commonly use.  The table does not contain a complete list, but it might be helpful to you in understanding the most likely choices applicable to the typical emerging business.  You should always consult with a legal counsel before issuing securities.

Section 4(a)(2) The Securities Act of 1933, as amended, provides an exemption for “transactions by an issuer not involving any public offering.”  This is the exemption relied upon when founders come together to form a company in which they are each going to be actively involved.  See SEC Release No. 33-4552. (  If you issue securities based on Section 4(a)(2), you will also have to find a state law securities exemption.  This can require the filing of forms with various states, and the payment of fees.  See, e.g., California Form 25102(f).
Rule 506 of Regulation D

Rule 506 allows companies to raise an unlimited amount of money from “accredited investors.”  Effective September 23, 2013, there are now two types of offerings under Rule 506.  A non-generally solicited type of offering – referred to as a 506(b) offering, and a generally solicited offering – referred to as a Rule 506 (c) offering.  (“Accredited investors” generally are investors with either (i) a $1M net worth excluding primary residence (but taking into account debt on such residence in excess of the fair market value), or (ii) $200,000 of income for the last two years with the expectation of the same in the current year, or $300,000 with spouse.)  Generally solicited 506(c) offerings involve complications not present in non-generally solicited Rule 506(b) offerings.

One great thing about Rule 506 is that a security sold under Rule 506 is considered a federal “covered security,” meaning that state securities regulators cannot condition or merit review the issuance of the security. They can require the payment of a fee incident to the filing of the Form D, but they cannot otherwise impose limitations or conditions on the issuance. See

Rule 701 Rule 701 is a federal securities law exemption for compensatory equity issuances.  For example, if you want to grant an employee or an independent contractor a stock option, you would typically rely on Rule 701 as your exemption.  Rule 701 has a number of qualifications, conditions and limitations.  See this blog post, What is Rule 701 and Do I Need to Worry About It?
Washington Equity Compensation Exemption RCW 21.20.310(10) provides a Washington securities law exemption for, among other things, compensatory equity awards (i) issued pursuant to a plan that provides for the issuance of ISOs and NQOs and (ii) similar plans if the director of the DFI is notified in writing with a copy of the plan 30 days before offering the plan to employees.
California Equity Compensation Exemption See California Corporation Code 25102(o). See also this blog post: California Compensatory Equity Issuances.
Equity Crowdfunding Under Title III of the JOBS Act (Section 4(a)(6) offerings) Equity crowdfunding under the JOBS Act is not yet available.  The SEC has issued the proposed rules, but those rules won’t be final for some time.

I am sometimes told by a company that they issued securities under the “friends and family” offering. There is no such thing as a “friends and family” exemption.

If you are looking for a more comprehensive exemption table, albeit one with many exemptions inapplicable to startups, see the Exemption Table.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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