Washington State Department of Financial Institutions

Raising Capital

Raising Small Business Capital Through a Securities Offering

INTRODUCTION

Chances are, you’re reading this because you’ve exhausted all sources of funds for your small business. Your bank lines of credit, friends and family, and other sources of small business capital have extended all the funds they can to your company. However, your company needs more funds for growth, expansion or other objectives. Raising capital through a securities offering, the subject of this document, is an alternative worth considering.

Securities Regulation

Before proceeding, you should know that all companies conducting a securities offering must comply with both federal and state securities laws. These laws are intended to protect investors while providing a mechanism for capital formation and economic growth.

Every offering of securities must either be registered or exempt from registration under both federal and state securities laws. Most securities offerings conducted by small businesses are exempt from registering federally with the Securities and Exchange Commission (SEC). In addition, many securities offerings conducted by small businesses in the State of Washington also qualify for exemptions from registration with the Securities Division. However, if an offering is unable to meet the requirements for one of the exemptions, several registration options exist for small businesses raising capital in the State of Washington.

Regardless of whether an offering is registered or exempt from registration, an application or notification is usually required to be filed with the SEC, and with the securities division of every state in which the offering will be made. In addition, regulations frequently specify the content of offering circulars and contain restrictions on the way in which the securities can be sold or transferred.

Furthermore, before conducting a securities offering, you should be aware that securities laws in the State of Washington impose civil liability on companies and their principals for offers and sales of securities made in violation of the law. Generally, this means investors, who purchased securities from a company while the offer or sale of the securities was in violation of the Securities Act of Washington, can sue the company and its principals for the full amount of their investment plus interest at 8% per annum from the date of investment.

Our brochure entitled “Offering Options” provides summaries of the basic exemption and registration provisions available for small businesses conducting a securities offering in the State of Washington. Hard copies of the brochure are also available upon request from the Division. If you wish to sell in other states, you should contact the SEC and the securities divisions of the states in which you wish to conduct your offering.

Types of Securities

There are two basic types of securities: equity and debt.

Equity securities are usually common stock and convey a portion of the ownership interest in the company to the holder of the security. Stockholders are usually entitled to receive dividends when and if declared, vote on corporate matters, and receive information about the company, including financial statements. A company must be incorporated under state law in order to issue common stock, which requires the company to file its articles of incorporation with the state in which it wishes to incorporate. The articles of incorporation specify the amount and type of stock the company is authorized to issue. To incorporate in the State of Washington, the company must file with the Corporations Division of the Secretary of State. Please see the Further Information section of this document for information on how to contact the Corporations Division.

Debt securities usually consist of bonds and represent debt obligations of the company. They have a specified interest rate, maturity date and repayment amount. In a registered securities offering, a company can only offer debt securities if it can demonstrate that it has the ability to repay the debt based on its past performance. Since it is usually difficult, if not impossible, for small companies to demonstrate this ability, offering debt securities in a registered offering is usually not an option available to small companies in need of capital.

CONDUCTING A SECURITIES OFFERING

With few exceptions, any company can offer securities. However, it may not make sense for your company to conduct a securities offering at this point in its development. Before you undertake a securities offering, you must consider the steps involved.

Preparing for an Offering

If you’re considering a securities offering, it is a good idea to prepare a business plan, if you haven’t already, to assist you in determining whether a securities offering makes sense at this point in your company’s development. This plan should describe in detail the product or service the company sells, the market for its products or services, its competition, management and financial condition. Documents that should accompany the business plan include resumes, financial statements, credit reports, letters of reference, job descriptions, leases, contracts and other legal documents. A good business plan acts as a guidepost as to when a securities offering is appropriate. In addition, the information in the plan will become the core material for any disclosure document prepared by the company in connection with a securities offering, which will be provided to prospective investors.

 

There are many issues to take into consideration before deciding a securities offering makes sense for your company. You will have to devote a significant amount of time to putting the offering together and ensuring compliance with the securities laws.

The selling process will take even more time. You should consider whether potential investors feel an “affinity” with your company. Investors in small offerings are frequently attracted to the offering because they have an interest in the product or service that the company provides. For instance, people that are interested in wine may be interested in investing in a winery.

If you conduct an equity offering, you will have given up a portion of your business and you must answer to your investors. These investors will expect periodic reports on the company’s progress, and they may want to talk to management, attend board meetings, or visit the company facilities on a regular basis.

Investors look for liquidity and though investments in small business should be viewed as long term, even long term investors need to see some light at the end of the tunnel. Consider whether your company will ever be large enough that a public trading market could develop, whether it may be a possible merger candidate or able to be sold one day, as well as your plans for distributing profits.

Finally, securities laws place heavy constraints on all aspects of the securities selling process in order to protect you and your investors. The process is complicated, and you are wise to consult an experienced securities attorney early on even if you later decide to do some or all of the preparation yourself. Never attempt to hide anything about your business from your attorney, securities officials, or potential investors.

Anyone who thinks a securities offering is a one-size-fits-all proposition is wrong. The best offerings are tailor-made to specific financial needs and goals.

Selecting the Type of Offering

Once you’ve made the decision to conduct a securities offering, you must determine the type of offering that suits the company’s needs best. You will need to determine the offering exemption or registration that is most appropriate. In addition, you will need to determine the type of security to be offered. Depending on the type of offering chosen, you may issue common stock, preferred stock, debt, limited partnership interests, or interests in a limited liability company.

These decisions will be based on the following considerations, among others:

The company should be realistic in its plans to raise capital through a securities offering. You should concentrate on the amount of funds needed to accomplish short-term business goals (6-12 months). If the company reaches that goal successfully, it may be able to offer additional securities to finance the company to reach its next objective. Be cautious of trying to do too much. Investors often base their investment decisions on their impressions of management. A person may be more likely to invest in a company where the management is perceived as having a clear idea of the step-by-step development of its business. In addition, the most likely persons to purchase securities in your company will be friends, relatives, company suppliers, local merchants, customers and other individuals familiar with the company.

Preparing the Offering Materials

In order to provide adequate and complete disclosure of all material information about the company to prospective investors, a requirement under the securities laws, you will need to prepare a disclosure document. The disclosure document and exhibits are the basic offering materials you will need to provide to prospective investors.

Piecing together a well-prepared offering package requires a lot of time and expertise in many areas. Consulting with an experienced securities attorney and a qualified accountant early in the decision making process is strongly recommended. Even if you decide to prepare the bulk of the package yourself, attorneys and accountants can offer invaluable assistance with many general business planning issues and with determining what type of offering to pursue. It is also a good idea to contact the Securities Division to obtain the rules, as well as any forms required to be filed, in connection with the offering exemption or registration provision upon which the offering will rely. Much of this information is also available in the Small Business Assistance section of our website.

Take time to read the applicable rules, requirements and instructions. Make sure you will be able to fully comply. Seek a determination from the Securities Division as soon as possible if you are unsure of the requirements or if you foresee a problem with complying with a particular requirement.

When preparing the disclosure document, you must clearly disclose the following:

If you make any earnings or cost projections, you must carefully explain and justify the assumptions underlying those projections. Unjustified or otherwise inappropriate assumptions are a frequent problem, so you should consult the Securities Division before including any projections in your document. Financial projections are rarely, if ever, justifiable for publicly offered start-up or development stage companies.

You should double check figures and proofread all documents to avoid errors, omissions and discrepancies.

Complex offerings, start-up companies, and companies in a unique business often have special disclosure problems that complicate the drafting process. If you are unfamiliar with securities, or are having trouble drafting the disclosure document, you should consider hiring a securities attorney or other professional.

The Division has published a brochure entitled “Role of Disclosure” which provides more information about this important legal obligation. Hard copies of this brochure are available from the Division upon request.

If you will be seeking registration in the State of Washington, you may also wish to consider scheduling an appointment with the small business section of the Securities Division to learn about the application process and get an idea of potential problems before you begin. You can also obtain disclosure documents from prior offerings that were approved by the Securities Division, so that you can become familiar with the kind of information you will be required to disclose in your own offering document.

Developing the prospectus can be demanding. However, you must remember that you will be asking investors to part with money that could be placed in a financial institution and insured against loss. Investing in small businesses is inherently risky, and the securities laws seek to ensure that investors have enough information to make an informed investment decision.

Obtaining Clearance from the Securities Division

Most small business securities offerings in Washington are subject to a filing requirement with the Securities Division, even if the offering is exempt from registration. You may also be required to make a filing with the SEC.

Exempt Offerings

Most exempt offerings only require a notice filing and are subject to a cursory review by the Securities Division. Typically, in order to claim an exemption from registration, the company is required to file a form notifying the Division of the offering, a consent to service of process (Form U-2) and a nominal filing fee. The offering materials are not typically required to be filed, however, the Division reserves the right to request them in connection with certain exemptions. The review period varies between 1 and 10 business days depending on our filing volume. Once the notice filing has been reviewed, the Division will send you either an Acknowledgement of Receipt allowing the offering to commence or a letter containing any comments generated from our review that must be resolved prior to any sales.

Registered Offerings

Offerings that may be sold to the general public through advertising or general solicitation must be registered and are subject to an extensive review by the Division. The review seeks to ensure that adequate information is contained in the disclosure document to be provided to prospective investors, and that the issuer has complied with limits imposed in such areas as offering amount, selling expenses, affiliated transactions and promotional shares.

The initial review focuses on identifying major content issues that must be dealt with first. Further reviews are then made to identify and correct smaller content and disclosure problems. Several reviews may be required before the offering is ready to be cleared.

The initial review usually takes place within two weeks of the receipt of your application. This initial review will normally center on “deal killers” – substantive problem areas that, unless resolved, will kill an offering regardless of the quality of the disclosure. Typical “deal killers” include: For the most part, these “deal killers” are derived from policies adopted by the Division that were created by the North American Securities Administrators Association (NASAA). Hard copies of these policies are available from the Division upon request.

Our staff will maintain regular contact with you during the review process so you will always be aware of the status of your application. We will also provide comment letters to explain the changes you must make to the disclosure document.

The length of the review period varies with the number of comments issued and how quickly you respond. Naturally, the more complete and thoughtfully prepared your offering is, the shorter the review time. If your file is particularly complex, or has some unusual problems, it will usually take longer for the Division to review and longer for you to make necessary changes prior to clearance. Few offerings are cleared in less than six weeks and it can take several months. You should therefore begin preparing for the offering well before the money is needed.

Once all issues have been resolved, the Division will issue a printed permit and the offering can begin.

Selling the Offering

Preparing the offering documents is a difficult task, but your greatest challenge will probably be finding investors. Small offerings tend to be high risk, and investors are often wary. Furthermore, most securities broker-dealers do not handle small offerings because they cannot make enough in commissions to cover their marketing costs. In addition, some offering alternatives, particularly those exempt from registration, do not allow you to advertise the securities offering. For the most part, you will be relying on family, friends, and business acquaintances to invest in your offering.

If changes are to be made at any time to the offering that are material to the investors, the Securities Division has to be notified and your disclosure document has to be amended to reflect these changes.

In addition, if you are conducting a registered offering, a copy of every advertisement for your offering has to be reviewed and cleared by the Division before you can use it. Remember that exempt offerings generally can’t engage in “general solicitation,” including advertising.

Fulfilling any Reporting Requirements

Some securities offerings, particularly registered offerings, require that you make periodic reports to the Securities Division regarding the status of the offering. In addition, you may also be required to report the final sales results to the Division when the offering is completed.

If you do not raise the minimum offering amount specified in the disclosure document, all funds collected from investors must be returned.

Furthermore, after completion of the offering, the company may be required to provide periodic financial reports to investors.

FINAL WORD OF CAUTION

Undertaking a securities offering is a serious matter. It can be costly and will take time away from running your business.

Ask yourself some basic questions. Do you have a clear sense of where your business is going and why you need the funds? Have you prepared a business plan? Are you willing to provide written documentation to investors describing your company, the offering, and the risks associated with investing in your enterprise? Are you willing to comply with all applicable requirements of the securities laws?

The consequences for not making a filing when required or exceeding certain numerical limitations can be costly and embarrassing. Contacting the Division BEFORE you offer or sell securities is an inexpensive and easy way to obtain accurate information about your specific circumstances.

Finally, the purpose of this document is to acquaint the small business person with the possibility of raising capital through a securities offering. It SHOULD NOT be relied upon to actually make a securities offering. There are many additional important issues, of which a person making a securities offering should be aware. This document summarizes only some of these issues.

FURTHER INFORMATION

For more information, please contact the Securities Division. Several informational brochures are available from the Division, which are also available in the Small Business Assistance section of our our website. The staff in the small business section can answer your specific questions or provide guidance on how to obtain the information you need.

For more information on federal securities laws, contact the Office of Small Business Policy of the Securities and Exchange Commission (SEC):

Office of Small Business Policy

Division of Corporation Finance

Securities and Exchange Commission

450 Fifth Street, N.W.

Washington, D.C. 29549

(202)-942-2950

Website: http://www.sec.gov

 

The State of Washington maintains a home page on the Internet providing access to sources of information concerning the operation of businesses in the State of Washington. The website is located at http://access.wa.gov.

Information on how to prepare a business plan may be available through Small Business Development Centers which are located throughout the state. The Small Business Administration hosts a website for these centers at http://www.sba.gov/content/small-business-development-centers-sbdcs.

A nonprofit organization of retired business persons called SCORE often operates programs to assist entrepreneurs. Location of chapters around the state usually can be found in the white pages of the telephone directory. The organization also maintains a website at http://www.score.org.

The U.S. Small Business Administration may also be able to provide assistance to the entrepreneur. Regional offices are located in Seattle and Spokane. The organization maintains a website at http://www.sba.gov.

KEY TERMS

The following definitions are included to help clarify some of the terms used throughout this document. These are working definitions only; for specific details related to these terms, please see the Washington securities laws and rules. Some terms are not defined, but have generally accepted usage.

Accredited investor: Any investor whose income, net worth, or business purpose meet certain requirements defined by the SEC. Banks, registered broker-dealers, insurance companies, investment and business development companies, certain employee benefit plans, and charitable organizations with assets over $5 million are considered accredited investors.

Accredited investors also include: directors, executive officers, and general partners of the issuer; persons with income greater than $200,000 in each of the two most recent years (or joint income greater than $300,000), and a reasonable expectation of the same income in the current year; and persons whose individual or joint net worth exceeds $1 million.

Common stock: An ownership interest in a corporation.

Consent to service of process: A form submitted by the issuer that allows the Securities Division to be served with legal papers on the issuer's behalf. This form must be filed for each financing option.

Debt security: A security in which the seller must repay the investor's original investment amount plus interest. A company can offer debt securities only when it can demonstrate that it has the ability to repay the debt based on current earnings.

Disclosure document: The disclosure document distributed to potential investors is the primary source of information about your company. This document is also referred to as a prospectus or offering circular.

Limited Liability Company: An unincorporated entity that combines the limited liability features of a corporation with the pass through taxation and structural flexibility of a general partnership.

Non-accredited investor: Any investor not included in the definition of an accredited investor.

Preferred stock: Stock that has priority over common stock as to dividend payments and/or the distribution of the assets of the company. Preferred stock can have the characteristics of either common stock or debt securities.

Promotional shares: Equity securities that were issued within the last three years, or that are to be issued, to certain founders or organizers of the issuer for less than 85 percent of the public offering price.

Selling expenses: Selling expenses include those costs that are directly related to issuing and selling the securities, such as underwriting and brokerage discounts and commissions, printing costs, and filing fees paid to the SEC and/or state securities divisions. Fees paid to attorneys and shares made available to underwriters are also counted as selling expenses.

Sophistication: The investor and/or his/her representative have sufficient business knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of an investment opportunity.