Behrens advises other entrepreneurs to consult professionals
early in the planning stage to get a good grasp of the issues from
the outset. "I spent two hours with my attorney before I even
approached an outside investor," he says. "I was better
prepared to meet with investors at that point. And when it came
down to drafting the term sheet and preparing the deal documents,
my attorney already knew the basics of the transaction."
Unwary entrepreneurs can land in hot water if they don't
fully understand the legal implications of offering an unregistered
security. Experts caution that not operating within the confines of
securities law can result in civil, administrative and even
criminal liability. Passing out a business plan, using a mass
mailing for soliciting investors and even discussing private stock
over the phone can constitute an "offering." All the more
reason to get your lawyer involved early in the process.
Even the sale of one share of private stock becomes a securities
offering "immediately," according to attorney Washburn.
"Selling one share to your next-door neighbor is a securities
offering. Period. No debate." Washburn points out, however,
that stock can be exempt from the long and expensive process of
registration with state and federal authorities. "Since the
adoption of the National Securities Market Improvement Act [in
1996], a number of useful exemptions exist for entrepreneurs
wishing to sell stock," says Washburn, "as long as the
sale of stock is structured correctly."
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Washburn explains that most private companies use an offering
known as a "private placement" to raise money. This type
of offering does not need to be registered with the Securities and
Exchange Commission or, if structured correctly, any state
securities board. Rather, it involves having a stock sale agreement
drawn up by a qualified attorney that complies with the specifics
of state and federal law.
"The overwhelming majority of entrepreneurs use the private
placement exemption known as the '4(2) exemption,' "
says Washburn. Generally, this exemption is available to companies
selling stock to individuals who have substantial financial means
and are able to evaluate the risks and merits of that investment by
looking at an investor's net worth or current gross income.
These individuals must be provided with, or otherwise have access
to, all information about the entrepreneur and full
disclosures.
Tyranny of the Minority
While the money from a stock sale comes without obligation to a
banker, entrepreneurs who sell stock to outside investors have
changed the entire dimension of their company's structure.
Though your company is still private, you now have certain
obligations to your shareholders.
Experts say that agreeing to reasonable goals and objectives at
the beginning of the relationship can save you headaches associated
with minority shareholders' rights and even lawsuits in the
future. "Be sure you have a shareholders agreement delineating
the rights between parties," advises Washburn. The agreement
should include how and when a shareholder will be paid dividends,
who controls the board of directors, and under what circumstances
shareholders must be consulted on major decisions.
Can You Relate?
Beyond the legal obligations, Behrens advises other
entrepreneurs to become investor relations experts. "You have
to be willing to invest time in building a relationship with your
investors if you want them to be an asset for your company,"
he says.
Washburn agrees. "Make sure you keep the investor as happy
as possible by providing him information about the company on a
routine basis," he advises. "Have a tour of the new
facility if one is constructed with the offering proceeds, send new
product information, maybe even call to solicit his advice from
time to time."
Most experts believe that shareholders who are more involved in
the business are much less likely to feel boxed-out and are far
less likely to be suspicious that something is being hidden from
them. Says Washburn, "Lack of information breeds disgruntled
shareholders and that, in turn, leads to lawsuits."
Sean P. Melvin is an author, attorney and assistant professor
of business at Elizabethtown College in Elizabethtown,
Pennsylvania.
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