LAW ALLOWS CALIFORNIA COMPANIES TO RAISE CAPITAL FASTER AND CHEAPER

California companies have a powerful weapon in their arsenal to raise capital. Under a law, companies can raise capital by advertising to the general public while maintaining the status of a private offering. This was accomplished with the passage of Section 25102(n) of the California Corporate Securities Law and a coordinated federal exemption, Rule 1001 under the Regulation CE (the “CE” exemption). The exemptions seem to offer companies the best of all worlds. They can advertise like an Initial Public Offering (“IPO”) but without all the restrictions.

The Securities and Exchange Commission (“SEC”) Regulation CE works in conjunction with Section 25102(n) to allow California companies (or those with certain minimum contacts or activities in California) to raise up to $5,000,000 through a public solicitation. Under these coordinated exemptions, companies do not have to go through the expensive and lengthy process of registering the securities with the SEC or under the California “blue sky” laws. As a result, California companies are poised to raise capital faster and at less expense.

Even in today’s IPO marketplace, the investment banking community is taking a close look at the CE/Section 25102(n) exemptions. Yon Friedmann, an investment banker turned entrepreneur, believes the exemptions may provide more flexibility than most private placement offerings because they allow a company to advertise. “Under this exemption, a company may pre-sell an offering.” This pre-selling allows a company to appraise the market place and raise money faster than traditional private placements. Friedmann added that the real advantage is these exemptions substantially go beyond selling only to “friends, family and business contacts” allowed under most private placements.

Under the coordinated exemptions, companies with a nexus to California may solicit to California residents through an announcement, similar to a tombstone ad. The ability to advertise the offering allows a broker to “test the waters” and determine the possible success of an offering, says Friedmann.

Many brokers that specialize in raising private capital or bridge financing are interested in utilizing the new exemptions to raise financing for their small and middle market business clients, states Joe Cerbone, executive vice president of Federated Broker Dealer Service Corporation, which has more than 15 broker-dealer members in California, Colorado, Arizona, Texas and Massachusetts.

Financial consultants have also joined the CE/Section 25102(n) bandwagon. Greg MacGanders, a financial consultant for 25 years, says his clients have already raised capital using the exemptions. MacGanders anticipates that in the future more California companies will opt for
these exemptions over traditional private placements, as it provides companies with the benefit of rasing capital directly from the marketplace through advertising. These benefits should translate into raising capital faster and at a lower cost to companies.

The following are highlights of the coordinated federal CE and California Section 25102(n) exemptions:

• Offering Limit: Businesses may raise up to $5,000,000, with some restrictions.
• Number of Investors: Companies may solicit and sell securities to an unlimited number of investors.
• Type of Investor: Investors must be “Qualified Purchasers,” as defined as high net worth individuals, certain institutional investors, pension funds, non-profits, directors, officers and promoters, as well as other qualified entities.
• Disclosure Requirements: Companies must provide a disclosure document to certain investors.
• Coordination with Other Exemptions: A company relying on the CE/Section 25102(n) exemptions for offers and sales of securities in California may also offer and sell securities in other states in reliance of a Regulation D exemption, providing the business complies with that state’s securities laws.
• Resale Limitations: Securities issued under the CE/Section 25102(n) exemptions have restrictions imposed on their resale.
• Filing Requirements: A company must file certain notices of transaction with the California Corporations Commissioner. Failure to file results in a loss of the Section 25102(n) exemption.
• Availability: The CE/Section 25102(n) exemptions are not available for offers or sales of securities in any roll-up transaction, blind pool or an investment company subject to the Investment Company Act of 1940.

The SEC, in a May 1, 1996 release, stated it anticipates the new rule will facilitate companies’ capital raising ability and result in compliance cost savings.

Jeff Osheroff, President of California Economizer, an Orange County technology firm concurs with the federal government’s assessment. He is presently contemplating raising additional capital for a new product line through a CE/Section 25102(n) offering. Osheroff believes the exemptions offer an alternative method for businesses to raise capital. “The exemptions enable a company to raise funds in the public arena without incurring the substantial cost of an IPO.”

Technology is also increasing the speed with which securities may be sold by companies. With more broker networks and companies offering their securities over the Internet, it is anticipated by many in the investment banking community that these exemptions, with their less stringent rules against public solicitation, will be used to effectively advertise securities to California residents.

As with all securities transactions, companies contemplating raising capital in reliance on the CE/Section 25102(n) should seek legal counsel for information concerning their specific situation.

By Elizabeth Brandon-Brown, Esq.
Reprinted from the Los Angeles Business Journal