Financial strategies Featured

7:04am EDT August 29, 2006
Small business owners often find themselves needing to raise capital for anything from growing a business to expanding production capacity or buying real estate. Securing a bank loan is one way to raise capital. But a myriad of other options are available, including “going public” or utilizing the many exemptions for selling securities without registering with the Securities and Exchange Commission (SEC), according to Jeffrey Hatchew, an associate at Gambrell & Stolz.

“Many businesses think raising capital without a bank requires listing company securities with a stock exchange (‘going public’). This, however, requires a business to be absolutely sure it has the time and money to go through the grueling process of a public offering,” Hatchew says. “The good news is that there are other ways for a small business to raise capital.”

Smart Business spoke with Hatchew about some alternative ways for small businesses to raise capital, besides asking banks, friends or family members for money.

How can small businesses raise capital?
A creative and successful business owner can sell securities from the business to achieve his capital needs. Of course, taking a business public is always an option, but this can be impractical for many small businesses. Going public requires compliance with numerous regulations, not to mention the information that must be provided regularly to the SEC and shareholders. To avoid these provisions, business owners can offer their securities under an exemption to the registration requirements, including intrastate offerings, Regulation D, and selling to accredited investors. Companies must still comply with the anti-fraud rules of the SEC when using any exemption from the registration requirements.

How does a business raise capital through an intrastate offering?
Businesses that want to sell unregistered stock within a single state can utilize the exemption in Section 3(a)(11) of the Securities Act of 1933. This type of offering is treated as a local matter and regulation is left to the state. As with any exemption, companies just need to determine if the state restricts such offerings.

To qualify for this exemption, a business must be incorporated in the state where it plans to offer the securities, it must carry out a significant amount of its business in the state where the offering is made, and it can only offer and sell securities to residents of that state. Additionally, the SEC requires purchasers of securities, under this exemption, to hold the stock for at least nine months.

This exemption is fairly simple and straight-forward and allows a business to raise unlimited capital while eliminating much of the costs associated with complying with the federal regulations and oversights.

How can a small business raise capital if it cannot limit its offering to a single state?
One of the more common exemptions is known as Regulation D, which is composed of Rules 504, 505 and 506. Companies using Regulation D do not have to register with SEC; however, they must file a ‘Form D’ after they sell their stock for the first time.

Rule 504 allows a company to raise up to $1 million in a 12-month period without registration and with no disclosure requirements. This exemption, however, prohibits advertising or publicly soliciting the sale of securities. Additionally, purchasers receive ‘restricted’ securities that cannot be freely traded.

Rule 505 permits an offering up to $5 million in any 12-month period, and the company can sell its securities to an unlimited number of accredited investors as defined by the SEC. An accredited investor is essentially a person or entity with a high net worth. No more than 35 nonaccredited investors may purchase the securities. Rule 505 also requires certain company financial statements be certified by an independent certified accountant.

Rule 506 allows a company to raise an unlimited amount of capital. This exemption, like Rule 505, limits the total number of nonaccredited investors to 35, and these nonaccredited investors must be sophisticated. A sophisticated investor must have the knowledge and skills necessary to understand the risks and advantages of the investment. Like Rules 504 and 505, no general solicitation or public announcement of the offering is allowed.

Can a business offer company stock only to accredited investors, and is there a separate exemption?
Yes, to both questions. Under Section 4(6) of the Securities Act, companies offering stock only to one or more accredited investors are exempt from the registration requirements. The total offering, however, is limited to $5 million or less, and a company is not permitted to make any public solicitation or advertisements about the offering. Like the Regulation D exemption, the company is required to file a ‘Form D’ after the initial sale of the stock.

JEFFREY HATCHEW is an associate with Gambrell & Stolz. Reach him at (440) 223-2206 or