Legal Question in Investment Law in California

Re: start-up company investment

Sometimes, but not always.

It is said that there are three kinds of stock offerings: registered, exempt, and illegal. Since the offering you're discussing obviously isn't a registered public offering, i.e. an IPO, in order for it to be legal, it must fit into an exemption from registration. Further, the exemption must satisfy both federal and state securities-registration laws.

There are probably ten or a dozen separate and distinct registration-exemption laws or rules; they have names like Regulation D, Rule 504, etc. There is also an exemption for issuance of stock to insiders, such as co-promoters, company founders, etc.

Some of these exemptions require that the investors meet suitability standards, either before you can sell to them at all, or with respect to the number of persons to whom you can offer or sell the stock. Others don't.

Now, here's the hard part. There are also at least three recognized levels of investor suitability measurement. The test can be based on net worth or income, or on sophistication, or on whether the proposed purchaser is a financial instritution or just an average guy.

So, I'd say if a company is issuing stock to its promoters, founders, etc., anyone who is enough of an insider to know all about what's going on and what the risks are, just read and observe Corporations Code section 25102 and file the proper form after the stock is all issued.

On the other hand, if stock is being issued to, and money taken from, anyone who is not a fully-informed insider (even if the person is a relative or a sophisticated, wealthy investor), the issuing company and its principals can be in a peck of trouble if they don't study the exemptions available and the limitations of each, and choose and follow the exemption scheme that fits their needs most nearly. The issuer will also have to make disclosures in a private-placement memorandum.

The limitations of a particular exemption may include investor suitability, amount of money that can be raised, whether audited financial statements must be furnished, whether the offering can be advertised, maximum number of persons who can be solicited or sold to, and others.