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What is an accredited investor?

April 3, 2009

Under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. In addition, the company must also comply with securities laws in each state where securities are offered.

The Act provides companies with a number of exemptions from federal registration requirements. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as “accredited investors” defined in rule 501 of Regulation D.  Offerings to accredited investors are exempt from the registration requirements on the theory that accredited investors are sophisticated enough to protect their own interests.

The following types of individuals are accredited investors:

  • a director, executive officer, or general partner of the company selling the securities;
  • a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase; or
  • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

Net worth includes the value of houses and automobiles.  Thus, many homeowners are accredited investors due to the value of their houses.  The $1 million net worth and $200,000 income standards were established in 1982 and have not increased with inflation.

The following types of entities are accredited investors:

  • a bank, insurance company, registered investment company, business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation, or partnership with assets exceeding $5 million;
  • a business in which all the equity owners are accredited investors; or
  • a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

Written by Yokum · Filed Under General | View Comments 

What are securities laws?

November 28, 2008

The SEC publishes a guide titled: Q&A: Small Business and the SEC that provides a simple answer.

In the chaotic securities markets of the 1920s, companies often sold stocks and bonds on the basis of glittering promises of fantastic profits – without disclosing any meaningful information to investors. These conditions contributed to the disastrous Stock Market Crash of 1929. In response, the U.S. Congress enacted the federal securities laws and created the Securities and Exchange Commission (SEC) to administer them.

Companies selling common stock, preferred stock or issuing options or warrants are issuing “securities.”  The Securities Act of 1933 generally requires companies selling securities to give investors full disclosure of all material facts that investors would find important in making an investment decision. The Act also requires companies to file a registration statement (i.e. see the Google IPO registration statement) with the SEC that includes information for investors, unless the security or the type of transaction is exempt from registration.

However, registering a securities offering with the SEC is a very expensive (typically costing over $1,000,000) and time-consuming process.  Therefore, sales of securities by companies to private investors or venture capitalists are usually structured to be exempt from the registration requirements of the Act.  These exemptions (post to come) are fairly technical and companies need advice from competent securities attorneys to ensure compliance.

Even if a securities offering is exempt from federal registration requirements, the company must also comply with securities laws in each state where securities are offered.  States may impose their own registration or qualification requirements that must be complied with unless an exemption is available.

Failure to comply with securities laws allows a purchaser to rescind or undo the purchase of securities and get his or her money back or recover damages.  These rescission rights create potential exposure to the company if its stockholders demand their money back.

Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the date of the violation upon which the action to enforce liability is based.  State remedies and statutes of limitations vary and depend upon the state in which the shares were purchased.  For example, the California statute of limitations for noncompliance with the requirement to register or qualify securities under the California Corporate Securities Law is the earlier of two years after the noncompliance occurred, or one year after discovery of the facts constituting such noncompliance.

In extreme cases, a company may make a rescission offer (i.e. offer to repurchase the securities plus interest) to stockholders that were sold securities in noncompliance with securities laws in an attempt to eliminate the exposure from rescission rights.  The rescission offer itself must comply with all relevant securities laws.  For example, Google’s noncompliance with securities laws in connection with option grants required it to file a registration statement with the SEC to make the rescission offer at the time of its IPO and resulted in a cease and desist order by the SEC.

Written by Yokum · Filed Under General | View Comments 

What is important in a confidentiality agreement or non-disclosure agreement (NDA)?

April 27, 2008

There are various factors to consider when reviewing or drafting a confidentiality or non-disclosure agreement (NDA). Obviously, your perspective on the agreement depends on whether you are primarily disclosing or receiving confidential information. The following points should be kept in mind:

  • Need for an agreement. Entering into an NDA increases the risk that the recipient may face charges of trade secret misappropriation if it develops similar information in the future or inadvertently discloses or uses the information. This is the primary reason that VCs will not enter into NDAs.
  • Mutual versus one-way. Some agreements only cover disclosure of confidential information by one party. Other agreements are mutual and cover disclosures by both parties. Generally speaking, mutual agreements are less likely to have provisions that are one-sided.
  • Non-disclosure and non-use. There are two important restrictions in an NDA. The non-disclosure provision prevents the recipient from disclosing the confidential information to third parties. The non-use provision prevents the recipient from using the information other than for a specified purpose. Occasionally, an NDA may not have a non-use provision. This would allow the receiving party to use the information for its own purposes as long as it did not disclose the information
  • Definition of confidential information. The discloser will want a broad definition of confidential information and may also want third party confidential information to be deemed confidential. The receiver will want to narrow the definition of confidential information in order to avoid being “tainted” by the information. The definition can be narrowed by (i) limiting it to information disclosed in writing (or oral disclosures reduced to writing within a certain time frame), (ii) specifically marking the information confidential, (iii) specifying the information that is deemed confidential or (iv) specifying the dates of disclosure. The discloser will want to avoid some of the limitations because of the possibility or inadvertent disclosure or over-marking information as confidential, which may impair the ability to enforce the agreement with respect to genuine trade secrets.
  • Exceptions to confidential information. The recipient will want broad exceptions to the definition of confidential information. Typical exceptions to the definition of confidential information include (i) information publicly known or in the public domain prior to the time of disclosure, (ii) information publicly known and made generally available after disclosure through no action or inaction of the recipient, (ii) information already in the possession of recipient, without confidentiality restrictions, (iv) information obtained by the receiver from a third party without a breach of confidentiality, and (v) information independently developed by the recipient. The discloser will try to limit the exceptions or add qualifiers such as the discloser must prove the exception with contemporaneous written records. Please note that the typical exception for information required to be disclosed by law should be an exception to the duty to not disclose, as opposed to an exception from the definition of confidential information (which would allow the recipient to disclose the information to anyone).
  • Residual information. The recipient will want to include a clause that allows the recipient to use the discloser’s information that is retained in its employees’ memory. The recipient will want to avoid being “tainted” by receiving the information. This is often strongly rejected by the discloser. In the event the residuals clause is included, the discloser may try to limit it to (i) use of general skills and knowledge, (ii) information retained in the unaided memory of employees after a certain amount of time after access to the confidential information, and (iii) explicitly noting that the discloser is not granting any license to the recipient.
  • Permitted disclosures. The discloser will want to limit disclosures to employees and contractors on a need to know basis with similar non-disclosure obligations. In addition, if disclosure is required by law, the discloser will want the recipient to notify the discloser in advance and provide the opportunity to obtain a protective order or otherwise maintain the confidentiality of the information.
  • Term. NDAs commonly have terms of three to five years. The period of time depends the strategic value of the information to the discloser and how quickly the information may become obsolete.

Written by Yokum · Filed Under General | View Comments