In this post we discuss the first of the Regulation D safe harbors, Rule 504, which permits an issuer to raise up to $1 million and does not require that investors must meet any net worth or sophistication requirements (“Rule 504”). This post is not intended as legal advice. A company considering raising capital through the sale of securities must contact an attorney to seek guidance. The federal and state securities laws can create enormous liability for improperly conducted offerings, even in the absence of any fraudulent intent on the part of the offeror. The applicable laws and regulations are complicated and often seem arbitrary, so the guidance and assistance of a professional is extremely important.

Who may use Rule 504? Rule 504 is available to any company except one which either has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies. The SEC does not want so-called “blank check companies” to use Rule 504.

What conditions must be met in relying on Rule 504? Offerings under Rule 504 generally are subject to very few federally-imposed conditions. The conditions applicable to an offer mainly turn on whether the offer is registered under the laws of the states in which the offering is made. As described below, State registration may give issuers additional freedom or could impose additional restrictions in conducting the offering, depending upon the law of the state(s) at issue. Again, a company must consult with an attorney prior to attempting to conduct an offering to ensure the company is not unduly hampered in its capital raising and to ensure it is complying with applicable law.

State Registered Offerings. If the offering is conducted only in states in which the offering is registered (as discussed below), then there are virtually no federal conditions imposed on the offer. If an offering is registered under state law, however, the permitted offerees and manner of conducting the capital raising activities could be subject to certain substantive limitations and filing requirements that will vary by state. In addition, state law may impose limitations on an investor’s ability to sell or pledge its shares or interests in the company. These state requirements, depending upon the state at issue, could be more onerous or less onerous than the conditions imposed under federal law by non-state registered offerings.

Non-State Registered Offerings. Most states permit a company relying on Rule 504 to conduct its offering largely exempt from state law, subject to certain notice filing requirements. If a company elects to conduct its offering without state registration, the offering of securities cannot be made in that state through any “general solicitation” or “general advertising.” This means that a company cannot seek investors in that state through newspaper or magazine advertisements, television or radio advertisements or other public communications. The best way to avoid general solicitation is to solicit investors with whom the company or its personnel have pre-existing relationships, such as personal or prior business relationships.

How often may a company raise money using Rule 504? A company is not limited to one Rule 504 offering. It can conduct many Rule 504 offerings, or can rely on Rule 504 in one instance and later rely on another Regulation D safe harbor. The general rule is that after a Rule 504 offering is complete, a company cannot begin another round of fundraising in reliance on Rule 504 for six months. A company should consult an attorney, however, to ensure that its offerings are not integrated and treated as one offering, which could cause the company to exceed the $1 million limit imposed on a single Rule 504 offering.

Can investors sell the securities purchased pursuant to a Rule 504 offering? Generally, securities purchased in a private placement are subject to restrictions or limitations on resale. If the offering is registered with one or more states, state law determines how, when and if securities purchased in a Rule 504 offering can be resold. If the offering is not state-registered, the securities are treated as “restricted” securities under the 1933 Act. Resale provisions are available for investors to sell their shares, but such resales are subject to numerous conditions. A company should restrict the ability of investors to resell its securities without the consent of the company in the documents governing the securities’ terms, given that improper resales can cause the company to lose the ability to rely on Rule 504 (or any private offering exemption) and create significant liability for the company.

Our next post will deal with Rule 505 under Regulation D, pursuant to which a company may raise up to $5 million in a single offering.

****Always consult with an attorney before attempting to raise capital.

A business can obtain capital through borrowing, such as a bank loan, or it can issue securities. These securities could be equity securities, which provide an interest in the gains and losses of the business or debt securities, which provide a fixed or variable rate of interest upon a principal amount for a fixed term, or they could be instruments that combine features of debt and equity, such as preferred stock or convertible securities.

Most small businesses raise capital through what are called private offerings. Private offerings are exempt from the registration and complex disclosure requirements of public offerings. The regulations governing private offerings, however, place various restrictions on the offer and sale, which can include limitations on the amount that can be raised, restrictions on advertising or public solicitations and/or net worth and financial sophistication requirements prospective purchasers must meet. In the coming weeks we will focus on the following exemptions, and may address related topics in the future:

• Part 1: Small offerings of up to $1 million; these offerings are exempt from most federal regulation, but are subject to state regulations on required filings and manner of conducting the offer and sale.
• Part 2: Offerings up to $5 million made to no more than 35 investors; these offerings are subject to restrictions on the manner in which the offering can be advertised but are exempt from most state regulation.
• Part 3: Offerings with no maximum amount made to “accredited investors” (meaning investors meeting certain sophistication and net worth requirements) and no more than 35 unaccredited investors; these offerings are subject to restrictions on the manner in which the offering can be advertised but are exempt from nearly all state requirements.

Although fund raising is an integral part of growing a business, it is heavily regulated by both state securities agencies and federal agencies such as the Securities and Exchange Commission (SEC). The discussion in the coming posts addressing offerings of securities are not intended as legal advice, and a business owner considering raising capital should consult with an attorney. The penalties for failing to comply with state and federal regulations in offering and selling securities can be severe. An offering that does not comply with applicable regulations can lead to a right of rescission on the part of the buyer (meaning a return of the invested amount) as well as monetary penalties for the offeror. In addition, any material false or misleading statements or omissions made in offering securities can give rise to liability for fraud under state and federal law, with penalties ranging from civil monetary penalties to imprisonment.

So, before you go looking for angels, find out everything you can about the devils.

Current economic conditions, however, have brought venture capital investments to the lowest level in years.  The small, high-growth firms which benefit most from venture capital are particularly susceptible to downturns in the broader market, making what are already perceived as high-risk investments in such companies even riskier.  As a result, new venture capital fundraising is down significantly to just a fraction of funds raised in previous years.
In addition, the two traditional means of achieving returns on venture capital investments (an IPO or a sale to a larger company) are largely unavailable.  The IPO market has come to a near standstill, although some are forecasting marginally increased activity later in 2009.  The market for mergers and acquisitions has similarly declined.  As a result, venture capital investors are unable to exit their current investments, and, if an exit is possible, it will likely represent a substantial or total loss, further chilling the market for new venture capital investments.

A new group of secondary investors is emerging to pick at the carcass of current venture capital investments.  These investors purchase the interests of current venture capital investors at a substantial discount, hoping for later gains when the IPO and mergers and acquisitions markets thaw.  This secondary market at least provides some liquidity to those currently stuck in venture capital positions.

Despite this dour news, there is some reason for optimism.  There is evidence that corporate acquirers are taking tentative steps to reenter the market for start-up operations, albeit on conservative terms.  Some larger companies are using these difficult times to make strategic purchases of start-up companies, as evidenced by Google’s recent creation of a $100 million venture capital fund.  Click on the link below for information about the Google venture capital fund http://blog.delawareinc.com/2009/04/google-launches-a-venture-capital-fund/.  In addition, well-positioned emerging companies are increasingly taking advantage of the distressed balance sheets of public companies, acquiring technologies and operations from these companies at a relatively depressed price. This practice was virtually unheard of before the current downturn.

In short, while the current state of financing for start-up companies is glum, the market for innovation and high-growth companies will return.  The entrepreneurial spirit has and always will survive difficult markets, and investment assets invariably seek out the brilliant new cutting-edge companies and innovations that will shape the future.

After much speculation Google has officially announced their new venture capital fund. They expect to invest up to $100 million dollars in it’s first year; this is fantastic news for all of you entrepreneurs with great ideas looking for capital. Your idea may very well be “the next big thing” that Google is looking for.

Below is the announcement on the Official Google Blog:

Today we’re excited to announce Google Ventures, Google’s new venture capital fund. This is Google’s effort to take advantage of our resources to support innovation and encourage promising new technology companies. By borrowing the best practices of top-tier, financially focused venture capital firms and bringing to bear Google’s unique technical expertise and brand, we think we can find young companies with truly awesome potential and encourage their development into successful businesses.

At its core, Google Ventures is charged with finding and helping to develop exceptional start-ups. We’ll be focusing on early stage investments across a diverse range of industries, including consumer Internet, software, clean-tech, bio-tech, health care and, no doubt, other areas we haven’t thought of yet. Central to our effort will be our fellow Googlers, whom we view as a critically important resource to help educate us about potential investments areas and evaluate specific companies.

Economically, times are tough, but great ideas come when they will. If anything, we think the current downturn is an ideal time to invest in nascent companies that have the chance to be the “next big thing,” and we’ll be working hard to find them. If you think you have the next big idea, or if you just want to to learn more, please see our website at www.google.com/ventures.

Money has never been easy to raise when you’re selling a dream… presented confidently as a vision — for the first time. If it were easy everyone would be doing it. The key to understanding and surviving this process is to realize that, “It isn’t SUPPOSED to be EASY!”

The lessons learned from REJECTION reveal the logic that eventually leads to long term SUCCESS. Others have described this as “having to learn to crawl before you can learn to walk”, but it’s not that elementary. It’s a simple reduction process, which allows only the most clever and detail-oriented to survive. The innovative, the committed, the determined and the clever each find that they must, in fact, be ALL of the foregoing to survive. Any single qualification would not be enough. The term “competition” provides inspiration as well as deep seeded fear. One learns that they must deliver competitively and that with every presentation excellence is expected.

In order to get money from an investor, you MUST ask them for the money and you need a presentation to ask an investor for money. The first presentation you give will be your last if you fail to impress. You must answer the usual investor questions up front, but primarily you should set your “vision” in the mind of the investor. Where are you going? Is the first question the investor wants to know after he understands what it is you want to do and how you plan to get it done.

Once you’re successful, you can reminisce with joy about the lucky breaks you got that lead to your success, and minimize the effort it took you to become successful — others will love you for it. But to BECOME successful, you need to work at it like the best professional athletes work out. Work is taken for granted. Amazing feats are taken for granted. Scoring continually is taken for granted. Even winning is taken for granted. The only effort that counts is EXTRA effort. If you can LOVE that, you’ll be successful during these tough times.