Special Solari Report: Legal Pathways for Entrepreneurs to Raise Capital Using Securities: Does Crowdfunding Ease the Way?

Carolyn Betts, Esq., September 16, 2013

“Crowdfunding is the collective effort of individuals who network and pool their money, usually via the Internet, to support efforts initiated by other people or organizations. Crowdfunding is used in support of a wide variety of activities, including disaster relief, citizen journalism, support of artists by fans, political campaigns, startup company funding, motion picture promotion, free software development, inventions development, scientific research, and civic projects.”

“Crowdfunding can also refer to the funding of a company by selling small amounts of equity to many investors. This form of crowdfunding has recently received attention from policymakers in the United States with direct mention in the JOBS Act; legislation that allows for a wider pool of small investors with fewer restrictions.”

— From the Wikipedia definition

How Does an Entrepreneur Raise Capital for a New Business?

You are an entrepreneur desiring to raise capital for a new business, which is in the development stage. You are not a trust fund baby and your savings are limited. You and your partners in the venture are eking it out with a combination of part-time 1099 gigs, spousal support, 401K liquidations, severance packages, second mortgage loans, state-supported loan modifications and parental support. You have come to the point where, for the business to move forward, sweat equity will not cut it because you have to hire third parties for technological, accounting, patent and trademark, general legal, technical, marketing study, prototype-building and other support. In order for the business to grow you need to invest in computer hardware and software, equipment and a real office or manufacturing space. And sooner rather than later, members of the founding group will have to drop out if they are not able to start earning income from the business. So what are your alternatives in terms of potential funding sources?

While there is such a thing as a small-business commercial loan for start-ups, debt-based funding, particularly with bank loans, is difficult, if not nearly impossible, for many businesses to qualify for. For those who qualify, there are drawbacks. A bank loan for a new business usually requires personal guarantees. Highly-leveraged new businesses are at a disadvantage out of the gate because of the debt service nut they have to crack before spending money on founder salaries, inventory and supplies, rent, marketing expenses and research and development. Many bank lenders impose conditions on the business that reduce operational flexibility. Working capital lines of credit can be called or cut back by the bank based on deteriorating general economic conditions, even if the business has not defaulted. Debt service on adjustable-rate loans can skyrocket when market interest rates increase.

After facing these facts and concluding that significant bank financing is either unavailable or too risky, the typical small business entrepreneur may seek to raise capital informally on a handshake and a promise. Initially, the potential capital-raising group consists of a relatively small number of family members and close friends of the founders who appear to have both enthusiasm for the business and readily-available resources in the form of cash or marketable securities. Frequently, the amount of funding that can be squeezed from this group is more limited than the founders initially thought, and it dawns on the entrepreneurs that more extensive outreach campaigns and more formal lending or investment arrangements will be necessary. Raising capital from a wider group of people often necessitates issuing economic or financial interests that are legally considered to be securities.

This is the point at which the securities laws come in to ruin all the fun. This is the point at which the entrepreneur is well advised to seek counsel of a securities attorney, because it is highly unlikely that a novice at securities law can navigate the applicable filing, disclosure, investor qualification, commission limitation and other requirements of a successful securities offering ⁱ. Even if the company is wildly successful and initial investors are fully satisfied, the founders may not avoid the sanctions from having failed to jump through all the regulatory hoops. Sanctions for failure to respect securities law requirements can and do occur even if a company operates on a fully-transparent basis from the beginning relative to the founders and keeps meticulous accounting, investor communication and other records.

A cautionary tale comes to us from the Cincinnati Enquirer, which reported in August 2013 that the founder of a local debt-based crowdfunding startup named Somolend Holdings LLC had been singled out for investigation by the Ohio Division of Securities for alleged violation of the Ohio antifraud regulations. The company was accused of making overly optimistic projections and of engaging in general solicitation and general advertising in the sale of company securities, which activities are prohibited by state and federal laws. The investigation reportedly was not begun following any investor complaints (which is the usual source of regulatory investigations and appears not to exist in this case) but rather spontaneously as the result press coverage of the founder and her prominent role in lobbying regarding impending regulatory rulemaking that would define the requirements for the registration of crowdfunding portals.

What is a Security and Why Does It Matter?

A security is best thought of as a financial instrument or transaction whereby someone who owns something of value (usually, but not always, money) seeks a return on that asset by investing it in a transaction whereby the return on the investment is dependent upon the efforts of others. ⁱⁱ Most of us know that listed and over-the-counter stocks and bonds are securities. Some who have previous investment experience recognize the reality that virtually any ownership interest in a business enterprise, whether it is a limited partnership, a general partnership, a limited liability company, a corporation or a business trust, is a security, even if the business enterprise is a private company. Many even experienced and sophisticated business people, however, fail to realize that, strictly legally speaking, many funding arrangements involve the sale of a security, even though it may appear to an outside observer that the “issuers” of the securities and the sellers of the securities have not recognized them as such. Here are some arrangements that may involve securities, particularly if they are undertaken in a non-commercial context (i.e., involving an investor or funding source that is not a financial institution or other enterprise in the business of lending money or providing financing):

Unsecured notes
Equipment leases
Fractional interests in mineral [and probably other types of] leases
Options to purchase securities in the future
Participations (i.e., percentage interests, as opposed to full ownership) in securities that are otherwise “exempt” securities
Loan participations
Interests in tangible equipment or other real or personal property accompanied by contracts that guarantee or otherwise provide for income based upon the use of the property by third parties
Timeshares

By law in the US, at both the state and federal levels, the sale of securities ⁱⁱⁱ is heavily regulated through the requirement that any sale of a security, unless the security itself or the transaction in which it is sold is exempt, requires that both the security and the person or institution who sells it be registered at the state and/or federal level. Historically, at least since the 1930s, registration of securities has been expensive, because it involves:

Retaining an attorney with one of the highest-paid specialties to navigate the risk-fraught and time-consuming registration process, including the rendering of legal opinions on various matters – easily generating fees in the hundreds of thousands of dollars;
Retaining a public accounting firm to prepare audited financial statements;
Producing printed prospectuses to offer the securities; and
Paying hefty underwriting fees to investment bankers (who are themselves expensive due to their level of expertise and the costs of maintaining their own registrations) for advice about the terms of the securities, for generating market interest in the securities and, once registration is final, for selling the securities to customers (usually, through yet another layer of middlemen who employ the ultimate salesmen and take a fee that is split with such salesmen).

Legal Pathways for Startups to Issue Securities in the US

In 2012, Congress enacted the Jumpstart Our Business Startups (“JOBS”) Act, part of which was intended to make it easier for startups to raise capital. A review of the “Special Solari Report: Jumpstart Our Business Startups Act of 2012” will assist the entrepreneur in understanding that a sea change is taking place in the securities world with the advent of internet-assisted crowdfunding platforms contemplated by the JOBS Act. As of this writing, however, crowdfunding under the JOBS Act is not legal, because, even though the Act is effective, the Securities and Exchange Commission (“SEC”) has announced that crowdfunding offerings under the JOBS Act are not legal until regulations with operational details of the requirements are issued. Such regulations are expected to be issued toward the end of 2013. In the absence of regulations, it’s largely business as usual in the private securities markets.

Pre- the JOBS Act, for the most part, startups offer their securities by means of federal and/or state exemptions from registration requirements or, less often, registrations designed for small companies. Perfecting such registrations or exemptions is a relatively tedious process involving careful disclosure of the founders’ best guesstimate of the potential financial rewards, risks, tax consequences to the investor, relevant market for products or services offered and other relevant information that an investor needs to know in order to evaluate whether and how much to invest. Even where no specific mandatory disclosure is required by statute or regulation, state and federal antifraud rules militate against selling securities unless these disclosures are made (usually by means of a term sheet or offering memorandum) and the issuer has determined that the potential investor is sophisticated enough to understand the risks of the investment and financially able to bear the loss of the entire investment (usually by means of an investor qualification questionnaire and subscription agreement in which the investor answers questions and makes various representations as to financial wherewithal, previous investing experience and intent to invest and not resell the security).

There are at least five very unfortunate aspects of most small-issuer registration and exemption alternatives, at least pre-JOBS Act:

(1) Offerings of securities cannot legally be made by means of general solicitations (which means that public offering over the internet or through email blasts to large mailing lists is prohibited);
(2) Payment of compensation to third parties for selling the securities is severely limited (which means that, generally, the founders will have to sell the securities directly to investors and not pay any commission-based compensation for the sale even to company employees);
(3) The issuer needs to focus, or limit, the securities offering efforts at the “accredited investor” ^iv market unless the offering is very small;
(4) The period during which sales of securities can take place is limited to the period when all material information, including financial information, in the offering memorandum is accurate (which means both that the startup is weighed down by constant disclosure update obligations and that valuation of the securities from one investor to the other becomes problematic); and
(5) The investors’ ability to resell the securities is limited (unless the issuer buys them back, in which case valuation is an issue).

Those who are experts in securities laws may protest that there are exceptions to each of these generalizations, and that is true. But the startup founders are well-advised to assume that these limitations exist unless an expert can provide well-documented and well-reasoned justification for ignoring them, ideally in writing.

With these caveats in mind, the following are some, though not all, of the ways that startup issuers may sell securities pre-JOBS Act (and thereafter, since the JOBS Act does not retract any existing laws, but rather provides new pathways for those who choose to engage in crowdfunded offerings).

Pathway #1: Exempted Securities

Certain securities, by definition (in the securities laws) are exempt from registration requirements. An exempt security may be sold without registration under state and federal securities laws. There are lots of types of securities that are exempt securities ^v, but what is important for the entrepreneur to know is that unless his or her business funding originates with a financial institution or government (as with a bank or SBA loan), equipment manufacturer (as with an equipment lease), or an outright gift, award or grant (as may be the case with Kickstarter, e.g.), it is highly unlikely that the securities offering by a startup company does not require either registration or perfection of an exemption from registration.

Pathway #2: Exempt Transactions: Regulation D – Sales by Issuer Not Involving a Public Offering

There are many statutory provisions dealing with exempt transactions, but the most frequently-used federal transactional exemption from securities registration requirements used by startups is the one for offerings by the issuer not involving a public offering. The safe harbor rules for qualifying such an offering are found in Regulation D under the Securities Act of 1933. There are three subcategories of offerings under Regulation D, those under Rule 504, Rule 505 and Rule 506. In the case of each of such offerings, the issuer is required to file a Form D with the SEC and, usually, with state securities regulators.

Rule 504:

The offering is limited to $1 million within any one-year period.
The company cannot be a “blank check company” i.e., one with no specific business plan).
No specific offering memorandum is required, but due to antifraud rules, one is advisable.

Rule 505:

The offering is limited to $5 million within any one-year period.
Sales are limited to an unlimited number of accredited investors and 35 non-accredited investors.
An offering memorandum must be provided to investors. The offering memorandum must include disclosure information of the type (though not in the same amount of detail) as would be required for a registered offering. Financial statements need to be certified by an independent public accountant. If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company’s balance sheet (dated within 120 days of the start of the offering) must be audited. Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.

Rule 506:

The offering amount is unlimited, but sales are limited to 35 non-accredited investors.
All non-accredited investors must be “sophisticated.” ^vi
General solicitations are prohibited.
An offering memorandum must be provided to investors. The offering memorandum must include disclosure information of the type (though not in the same amount of detail) as would be required for a registered offering. The financial statement requirements are the same as for offerings under Rule 505.

In the case of all Regulation D offerings, the securities are “restricted“, requiring a legend that says they are not transferable (with certain limitations) within a year unless the securities are registered. Any later resales of the securities must themselves qualify for exemption from registration requirements.

“Integration” rules under Regulation D prevent the issuer from conducting multiple offerings for more or less the same purpose in order to avoid the offering size limits. They also mean that the issuer must wait for at least a year to conduct a later securities offering.

As of September 23, 2013, regulations promulgated under the JOBS Act loosen the general solicitation prohibitions of Regulation D, making it a more attractive means for offering securities.

Pathway #3: Exempt Transactions: Conditional Small Issues Exemption under Regulation A

Regulation A is technically an exemption from public registration requirements for “small” issuers of securities seeking to raise less than $5 million over one year. In fact, it is an abbreviated registration with the SEC (which includes an SEC review and comments) using a shorter form than is used for a full-blown registration statement and prospectus. For various reasons, including the simpler disclosure requirements and absence of SEC review, an entrepreneur seeking to raise capital in a first offering for a startup probably would choose to offer its securities under Regulation D rather than Regulation A and, therefore, the author will not go into the detailed requirements for a Regulation A offering. The primary benefits of a Regulation A offering over an exempt offering under Regulation D are two: there is no general solicitation ban and the securities are not restricted (and therefore can be resold without a legend soon after the original purchase).

For those interested in reading further about Regulation A, the SEC website has a good description.

Pathway #4: Exempt Transactions: Intrastate Offerings under Rule 147

The issuer may avoid the federal law requirements for the offering of securities, and rely solely on state securities registration (or exemption ^vii) requirements, by making an “intrastate” offering, which is an offering solely within a single state. Whether an intrastate offering is less onerous than one in reliance upon federal law depends upon which state and what type of security offering is involved. While it may be possible for an entrepreneur to obtain assistance from state regulatory personnel in satisfying the securities offering registration or exemption requirements of a given state, this course of action is not without risk and it is possible to mis-step and become subject to federal laws. Further, it is safe to assume that every state has securities anti-fraud laws that must be respected in order to minimize the risk that a business failure or financially rocky period could result in investor actions claiming fraudulent misrepresentation in the sale of a security. The defense of such a lawsuit, even if successful, probably is as expensive as, or more expensive than, retaining securities counsel from the outset to ensure that all regulatory requirements have been satisfied.

Under federal law, a securities offering qualifies for an intrastate offering exemption (under Section 3(a)(11) of the Securities Act of 1933, which is further codified in the form of a safe harbor Rule 147 from federal registration requirements in a given state if:

(a) The issuer of the security is formed under the laws of the state and has its principal office is located within the state.
(b) All offerees and purchasers of the securities are residents and domiciled in the state (which, for an entity, means it is formed under the laws of the state and its main office is located within the state).
(c) The issuer carries on a substantial amount of its business within the state (at least 80% of its revenues are generated within the state and 80% of its assets are located within the state) and the issuer intends that at least 80% of the net proceeds of the offering will be used for business within the state.

An example of a fairly complex state exempt transaction provision is the one found in § 25102 of the California Corporations Code. California is known as one of the most-regulated states, and this provision reflects this fact.

Links to state securities regulatory agencies can be found on the North American Securities Association website. Usually, a copy of the applicable state securities statute and administrative rules can be found from a legislative link on the home page or on the site map. If not, a search engine search for “[state] securities registration” may lead to a general description by the regulatory agency that may cite the statute and regulations. Caution: make sure you are on the state’s website and not a third-party business website providing questionable advice and services for a fee. Do not rely on third party websites for definitive interpretation of the laws. The SEC and many state securities regulators provide user-friendly descriptions that can be helpful in gaining a general understanding of state requirements. Do not expect state securities regulators to provide legal advice or interpretations, however, and do not consider securities registration a do-it-yourself process.

Pathway #5: Exempt Transaction: Offshore Offering to Non-US Investors – Regulation S Safe Harbor

Regulation S under the Securities Act of 1933 provides for an exemption from securities registration requirements for offers and sales of securities outside the United States. At the outset, it is important for the issuer to understand that the regulation expressly provides that it does not apply to a technically compliant offering conducted offshore as part of a plan or scheme to evade the registration provisions of securities under US law. Regulation S, like Regulation D, is a non-exclusive safe harbor, meaning that the offering may also qualify for other exemptions and does not require any exclusive election. Making a valid Regulation S sale does not taint a subsequent sale during the same distribution period that is in compliance with another exemption or registration provision. Securities sold in the US, even if originally purchased abroad, must be registered or sold under another exemption from registration.

The requirements that would apply to a startup issuer making a Regulation S offering are:

(1) The sale of the security must physically take place outside the US or the purchaser is a non-US person ^viii;
(2) The issuer must not make any “directed selling efforts;” inside the US (i.e., efforts that condition the market in the US for that security) ^ix;
(3) Each purchaser must certify that he or she is not a “US person” and will resell the security only in compliance with Regulation S or another exemption (or after registration of the security);
(4) The securities must bear a Regulation S legend indicating they are restricted and can be sold only in an exempt transaction or following registration;
(5) The issuer agrees not to transfer Regulation S restricted securities unless they qualify for exemption or are registered;

Offerings made to designated groups of US citizens living abroad (e.g., US military personnel) do not qualify.

A New Pathway: Crowdfunding under the JOBS Act

There are two parts of the JOBS Act that ease the limitations on general solicitations for startup offerings, those dealing with Regulation D offerings only (Title II) and those that provide for Internet offerings on registered securities portals (Title III). The SEC has issued an announcement that no offerings may be made in reliance upon the JOBS Act until regulations are issued. The JOBS Act requires the SEC to issue (or “promulgate”) such regulations within 270 days of the effective date of the JOBS Act (i.e., by early January, 2013). The SEC failed to issue such regulations by its deadline and, as of this writing, still has not issued regulations covering Internet offerings on registered securities portals. It is therefore still illegal to conduct “crowdfunding” offerings (i.e., those conducted on an Internet portal) as described in the Solari Report.

Final Rules for New Rule 506(c).

On July 10, 2013, the SEC issued regulations, effective 60 days after publication in the Federal Register (September 23, 2013), with respect to Regulation D offerings on the Internet, through the creation of a new Rule 506(c). Under Rule 506(c), the ban on general solicitations and general advertising is lifted (and therefore offers may be made on the Internet) for offerings that would satisfy the existing requirements of Rule 506 but are open exclusively to accredited investors. The issuer is required to take steps to insure that all investors are, in fact, accredited investors. The standard applied to determine whether the steps taken are reasonable is an objective one, but the SEC provides guidance, or examples, of what such reasonable steps might be (and in that sense has issued a type of safe harbor rule). Thus, the issuer presumably will be found to have taken reasonable steps to determine that an investor is accredited if it has:

(1) As to the investor’s income, reviewed copies of any IRS form that reports the income of the purchaser (specifically, Forms 1099, W-2, K-1 and 1040) and obtained a written representation that the purchaser will likely continue to earn the necessary income in the current year; or
(2) As to the investor’s net worth, reviewed one or more of the following types of documents:
- a. As to assets: bank statements, brokerage statements and other statements as to securities holdings, certificates of deposit, third-party appraisal reports and tax assessments ; and
- b. As to liabilities, copies of a consumer credit report from one of the nationwide credit reporting agencies;
(3) Received a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser’s accredited investor status.

Author’s prediction: these poorly-written, non-mandatory suggestions by the SEC as to what steps are presumptively “reasonable” in confirming an investor’s accredited investor status are sure to be converted into intrusive mandatory requirements and instill controversy within the legal, investment advisory and accounting professions.

Proposed Rules for New Rule 506 (c) Offerings

In addition to the final rules for Rule 506(c) offerings, separately-proposed rules would require the following for Rule 506(c) offerings:

(1) That the issuer file its initial Form D before any general solicitation takes place (instead of after the first sale of securities as is the current requirement);
(2) That the issuer file a final updated Form D once when the offering is terminated;
(3) That the issuer use legends:
- a. Saying the offering is limited to accredited investors;
- b. Warning that the SEC has not passed on the securities, the securities are not registered, an investment in the securities is risky and that resales of the securities are limited; and
(4) That the issuer file written general solicitation materials with the SEC for at least the next two years.

Regulations Governing Internet Portals and Internet Offerings to Non-Accredited Investors

As described in our previous Solari Report article on the JOBS Act legislation (see the first column of the attached PDF table), the major and groundbreaking aspect of the JOBS Act that makes possible what most of us think of when we hear the term “crowdfunding” is in Title III of the legislation, as to which the required implementing provisions have not been issued. In July 31, 2013 Congressional testimony, the new SEC Commissioner, Mary Jo White, is quoted as predicting that the regulations would be issued by “this fall“. More recent speculation is that the regulations can be expected to come out towards the end of 2013, but we have heard promises as to issue-date timing before. The SEC has solicited industry comments (which are available on the JOBS Act portion of the SEC website) since soon after enactment in April 2012.

If the final rules for Internet solicitations of accredited investors under Regulation D are any indication, the as-yet-unissued regulation requirements for Internet portal registration, mandatory disclosure and qualification of investors will be extensive and detailed and require some level of intrusiveness into private information. Time will tell whether the Internet portal registration requirements will be so onerous as to effectively exclude all but major existing, deeply funded industry members from playing a role in Internet crowdfunding.

The following are some of the issues we can expect the SEC to address in these regulations:

How will an issuer determine whether an investor’s net worth is more than or less than $100,000 (which determination will itself determine the amount of the maximum permitted investment)?
Will there be any sanctions for fraudulent or negligent “underwriting” of investors?
Will there be a national database or other method by which the investors’ information is communicated from one offering and Internet portal/intermediary to another?
How feasible will it be for issuers to conduct Internet offerings without the use of an Internet portal? For such offerings, will the issuer be permitted to “subcontract” some of the functions (like investor underwriting) to third parties?
Will the requirement that Internet portals be either registered brokers or members of a national securities association prevent or limit the role that lawyers, accountants, and other professionals, particularly those that are not associated with major firms, can play?
What role will banks, brokerage firms, investment advisors and other regulated financial institutions play in Internet offerings?
Will there be a mechanism for audits of Internet portals and other intermediaries?
What, if any, limits will there be on fees and other sales-related and non-sales-related charges in connection with Internet securities offerings?
Will there be privacy protections for investor financial information, identities of site users, etc.? Will investors have password-protected “accounts” to hold information about securities purchased, communications and private financial information?
Will there be public Q&A facilities for investors to post questions and for issuers and/or Internet portals/intermediaries to post answers?
Will investors be able to purchase securities through PayPal?
Will the requirement that the SEC and state securities divisions receive investor communications mean that the regulatory agencies will have private access to Internet portals?
Will Form Ds be made available on Internet portal sites?
How will issuers and Internet portals capture Internet information posted at various times in order to prove that they have complied with disclosure requirements?

The resolution of these and other issues will determine whether Internet crowdfunding will allow new companies to raise capital in a cost-effective, less-risky and reasonably expeditious manner and afford middle-class investors access to an exciting market where the risks of investment have been reduced to reasonable levels that they can understand. Probably, in the early stages of building the market, learning the new rules and setting up new systems will be timely and expensive, at least for intermediaries, and this fact will make raising capital through crowdfunding expensive enough that it is not economically feasible for small offerings, at least initially.

Time will tell whether Internet crowdfunding opens up a whole new entrepreneurial world that we can only dream of today or provides an opportunity for institutionalized robbery of the public. Pending issuance of the regulations and an opportunity for the market to absorb the ramifications and create new compliance and registration systems, startup issuers must depend upon existing pathways to raise capital.

Footnotes

ⁱ In this context, securities “offering” refers to the sale of a security to a single non-insider investor.

ⁱⁱ Strictly speaking, this definition is a description of what the securities laws refer to as an “investment contract,” which is the catch-all term used for a security that does not fall under any other category in the list of instruments or transactions that are securities. On close examination, however, one probably will conclude that all of the named instruments in the statutory definition(s) of securities fall within this description. The definition of a security under the Securities Act of 1933 is:

ⁱⁱⁱ … any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

^iv An individual accredited investor is one who is either an insider of the company or someone who:

(a) Has an 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 or
(b) Has a net worth that exceeds $1 million, or joint net worth with the his or her spouse that exceeds $1 million, at the time of the purchase, excluding the value of his or her primary residence.

For a full list of all types of accredited investors, click here.

^v An exempted security is defined in Section 3(a) under the Securities Act of 1933 as:

Any security issued or guaranteed by the United States or any territory thereof, or by the District of Columbia, or by any State of the United States, or by any political subdivision of a State or territory, or by any public instrumentality of one or more States or territories, or by any person controlled or supervised by and acting as an instrumentality of the Government of the United States pursuant to authority granted by the Congress of the United States; or any certificate of deposit for any of the foregoing; or any security issued or guaranteed by any bank; or any security issued by or representing an interest in or a direct obligation of a Federal Reserve bank; or any interest or participation in any common trust fund or similar fund that is excluded from the definition of the term “investment company” under section 3(c)(3) of the Investment Company Act of 1940 [15 U.S.C. 80a–3 (c)(3)] ; or any security which is an industrial development bond (as defined in section 103 (c)(2) [1] of title 26) the interest on which is excludable from gross income under section 103 (a)(1) [1] of title 26 if, by reason of the application of paragraph (4) or (6) of section 103 (c) [1] of title 26 (determined as if paragraphs (4)(A), (5), and (7) were not included in such section 103 (c)), [1] paragraph (1) of such section 103 (c) [1] does not apply to such security; or any interest or participation in a single trust fund, or in a collective trust fund maintained by a bank, or any security arising out of a contract issued by an insurance company, which interest, participation, or security is issued in connection with
(A) a stock bonus, pension, or profit-sharing plan which meets the requirements for qualification under section 401 of title 26,
(B) an annuity plan which meets the requirements for the deduction of the employer’s contributions under section 404 (a)(2) of title 26,
(C) a governmental plan as defined in section 414 (d) of title 26 which has been established by an employer for the exclusive benefit of its employees or their beneficiaries for the purpose of distributing to such employees or their beneficiaries the corpus and income of the funds accumulated under such plan, if under such plan it is impossible, prior to the satisfaction of all liabilities with respect to such employees and their beneficiaries, for any part of the corpus or income to be used for, or diverted to, purposes other than the exclusive benefit of such employees or their beneficiaries, or
(D) a church plan, company, or account that is excluded from the definition of an investment company under section 3(c)(14) of the Investment Company Act of 1940 [15 U.S.C. 80a–3 (c)(14)] , other than any plan described in subparagraph (A), (B), (C), or (D) of this paragraph (i) the contributions under which are held in a single trust fund or in a separate account maintained by an insurance company for a single employer and under which an amount in excess of the employer’s contribution is allocated to the purchase of securities (other than interests or participations in the trust or separate account itself) issued by the employer or any company directly or indirectly controlling, controlled by, or under common control with the employer,
(ii) which covers employees some or all of whom are employees within the meaning of section 401 (c)(1) of title 26 (other than a person participating in a church plan who is described in section 414 (e)(3)(B) of title 26), or
(iii) which is a plan funded by an annuity contract described in section 403 (b) of title 26 (other than a retirement income account described in section 403 (b)(9) of title 26, to the extent that the interest or participation in such single trust fund or collective trust fund is issued to a church, a convention or association of churches, or an organization described in section 414 (e)(3)(A) of title 26 establishing or maintaining the retirement income account or to a trust established by any such entity in connection with the retirement income account). The Commission, by rules and regulations or order, shall exempt from the provisions of section 77e of this title any interest or participation issued in connection with a stock bonus, pension, profit-sharing, or annuity plan which covers employees some or all of whom are employees within the meaning of section 401 (c)(1) of title 26, if and to the extent that the Commission determines this to be necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions of this subchapter. For purposes of this paragraph, a security issued or guaranteed by a bank shall not include any interest or participation in any collective trust fund maintained by a bank; and the term “bank” means any national bank, or banking institution organized under the laws of any State, territory, or the District of Columbia, the business of which is substantially confined to banking and is supervised by the State or territorial banking commission or similar official; except that in the case of a common trust fund or similar fund, or a collective trust fund, the term “bank” has the same meaning as in the Investment Company Act of 1940 [15 U.S.C. 80a–1 et seq.];
(3) Any note, draft, bill of exchange, or banker’s acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited;
(4) Any security issued by a person organized and operated exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes and not for pecuniary profit, and no part of the net earnings of which inures to the benefit of any person, private stockholder, or individual, or any security of a fund that is excluded from the definition of an investment company under section 3(c)(10)(B) of the Investment Company Act of 1940 [15 U.S.C. 80a–3 (c)(10)(B)];
(5) Any security issued
(A) by a savings and loan association, building and loan association, cooperative bank, homestead association, or similar institution, which is supervised and examined by State or Federal authority having supervision over any such institution; or
(B) by
(i) a farmer’s cooperative organization exempt from tax under section 521 of title 26,
(ii) a corporation described in section 501 (c)(16) of title 26 and exempt from tax under section 501 (a) of title 26, or
(iii) a corporation described in section 501 (c)(2) of title 26 which is exempt from tax under section 501 (a) of title 26 and is organized for the exclusive purpose of holding title to property, collecting income therefrom, and turning over the entire amount thereof, less expenses, to an organization or corporation described in clause (i) or (ii);
(6) Any interest in a railroad equipment trust. For purposes of this paragraph “interest in a railroad equipment trust” means any interest in an equipment trust, lease, conditional sales contract, or other similar arrangement entered into, issued, assumed, guaranteed by, or for the benefit of, a common carrier to finance the acquisition of rolling stock, including motive power;
(7) Certificates issued by a receiver or by a trustee or debtor in possession in a case under title 11, with the approval of the court;
(8) Any insurance or endowment policy or annuity contract or optional annuity contract, issued by a corporation subject to the supervision of the insurance commissioner, bank commissioner, or any agency or officer performing like functions, of any State or Territory of the United States or the District of Columbia;
(9) Except with respect to a security exchanged in a case under title 11, any security exchanged by the issuer with its existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange;
(10) Except with respect to a security exchanged in a case under title 11, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval;
(11) Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.
(12) Any equity security issued in connection with the acquisition by a holding company of a bank under section 1842 (a) of title 12 or a savings association under section 1467a (e) of title 12, if—
(A) the acquisition occurs solely as part of a reorganization in which security holders exchange their shares of a bank or savings association for shares of a newly formed holding company with no significant assets other than securities of the bank or savings association and the existing subsidiaries of the bank or savings association;
(B) the security holders receive, after that reorganization, substantially the same proportional share interests in the holding company as they held in the bank or savings association, except for nominal changes in shareholders’ interests resulting from lawful elimination of fractional interests and the exercise of dissenting shareholders’ rights under State or Federal law;
(C) the rights and interests of security holders in the holding company are substantially the same as those in the bank or savings association prior to the transaction, other than as may be required by law; and
(D) the holding company has substantially the same assets and liabilities, on a consolidated basis, as the bank or savings association had prior to the transaction.
For purposes of this paragraph, the term “savings association” means a savings association (as defined in section 1813 (b) of title 12) the deposits of which are insured by the Federal Deposit Insurance Corporation.
(13) Any security issued by or any interest or participation in any church plan, company or account that is excluded from the definition of an investment company under section 3(c)(14) of the Investment Company Act of 1940 [15 U.S.C. 80a–3 (c)(14)].
(14) Any security futures product that is—
(A) cleared by a clearing agency registered under section 78q–1 of this title or exempt from registration under subsection (b)(7) of such section 78q–1; and
(B) traded on a national securities exchange or a national securities association registered pursuant to section 78o–3 (a) of this title.

^vi I.e., they must have sufficient knowledge and experience in financial and business matters, either themselves or through an advisor that is not affiliated with the issuer, to make them capable of evaluating the merits and risks of the prospective investment.

^vii Since federal law was amended to preempt state securities laws for interstate securities offerings as they relate to registration provisions, most state securities statutes do not provide much in the way of state-only exemptions for transactions of the type that would be useful for startup companies raising capital in an initial offering. State transactional exemptions, to the extent they exist, mostly track Regulation D requirements. If the conditions of Regulation D are satisfied, why bother to establish an intrastate exemption, unless the issuer seeks to avoid federal involvement?

^viii For individuals, a non-US resident. For entities, this category includes companies formed outside the US under foreign laws (assuming they are not formed by US persons for the purpose of investing in US securities and evading the registration requirements).

^ix In 1998, the SEC issued a release entitled “Interpretation: Re: Use of Internet Web Sites To Offer Securities, Solicit Securities Transactions, or Advertise Investment Services Offshore.”