In Part 1 of this series, we explained how securities laws impact small businesses that are trying to raise money. Before asking someone to invest in your business, you must comply with both federal and state laws, and you must either register (at both the federal and state levels) or be exempt from registration. Not surprisingly, most small businesses try to fit within an exemption from registration to avoid unnecessary filing fees and regulatory complexity.
So what are the common exemptions Ohio small businesses rely upon at the state level? (Remember, we’re discussing investors who are located in Ohio. If your potential investors are located in another state, you would have to look to that state’s securities laws to determine whether there are any exemptions from registration in that state.)
Ten or Fewer Investors The most common situation is a small business raising money from 10 or fewer investors who are purchasing for investment (i.e., who are not looking to simply resell their investment to a third party). There is no limit on the dollar amount that you can raise this way, but the law does prohibit general advertising of your investment opportunity. Because nothing is filed with the Ohio Division of Securities (“ODS”), you should be careful to document your reliance on this exemption in your business records and the investment agreement. Related to this is an exemption for promissory notes that are “sold” to 10 or fewer people in a 12-month period.
In Part 1, we used the example of friends from college who are interested in investing in your business. As long as we’re dealing with 10 or fewer of these friends who are all located here in Ohio, then this would be an appropriate exemption to rely on. We could structure the transaction as a typical investment where the friends can earn a return on their investment in the form of profits earned by the business. Or we could set it up as a promissory note where you promise to pay your friends back at a later date with interest. (We’ll leave it to you to decide how this might impact your friendship.) In the next part of this series, we’ll discuss how to exempt this transaction from federal securities registration.
Again, they must be purchasing for investment and not merely to re-sell to a third party. Because of this, the law generally restricts the ability of investors to resell their investment within the first 12 months. And while a very limited type of general announcement is permissible, general advertising is still prohibited. This exemption does require a notice filing with ODS within 15 days of announcing the investment.
This type of exemption would apply if our hypothetical college friends were relatively wealthy.
Private Placements When raising money from more than 10 investors or investors from multiple states, small businesses often rely on private placements. Ohio law provides two types of private placement exemptions from registration. As the name implies, both exemptions apply to transactions that are not offered to the general public, but instead are private transactions. The first is known as the 3(Q) exemption. It involves reliance on the analogous federal exemption and a notice filing with ODS within 60 days of the first sale in Ohio. The second private placement exemption is the 3(X) exemption. It too involves reliance on an analogous federal exemption and what is known as a Form D filing with both the federal Securities and Exchange Commission (“SEC”) and ODS within 15 days of the first sale. The key differences between these two private placement exemptions are in the nuances of federal securities law, which we’ll cover in Part 3. For now, let’s just say that 3(X) is more commonly used because the law provides more guidance for meeting the related federal requirements than it does for the 3(Q) exemption.
So if some of our hypothetical college friends lived out of state, we might look to the private placement exemptions both at the federal level and in the states where our friends lived. We would also rely on these exemptions if not all of our friends were wealthy accredited investors. And although these exemptions require some filings at the federal and/or state levels, these are notice filings, meaning you aren’t waiting for government approval to raise money for your business.
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