RAISING CAPITAL THROUGH CALIFORNIA CORPORATIONS CODE SECTION 25102(N)

Q. I own a growing fast food restaurant chain with seven locations and about $5 million in annual sales. We believe that we have an opportunity to grow rapidly in our niche, but we are probably three to five years away from undertaking a public offering of our stock. We require about $1,000,000 to $3,000,000 of new expansion capital annually, depending on the number of locations that are available to us. Recently, I have heard that California has made it easier for small business owners to raise substantial financing from third party public investors without registering the securities offering with the State. This would be very appealing to us. What can you tell me about this?

A. The State of California has recently approved new Section 25102(n) of the Corporations Code which provides for a public offering of equity securities of corporations, limited liability companies or partnerships without an extensive, time consuming and expensive registration process. There are no limits on the amount of financing that can be raised using this new provision.

* “Qualified Purchasers” Required. While this sounds almost too good to be true there are certain limitations imposed by this new regulation. Perhaps the most important requirement is that the offering may only be sold to “qualified purchasers” who are generally defined as investors having a net worth of at least $250,000 (exclusive of home, home furnishings and automobiles), gross income in excess of $100,000 during the immediately preceding tax year, and a reasonable expectation of income in excess of $100,000 during the current tax year. There are additional categories of “qualified purchasers” that includes certain institutions and corporations, purchasers acquiring more than $150,000 of the issuer’s securities, high net worth individuals and various other categories.

* Comparision with Regulation D. The familiar Regulation D allows for thirty-five “unaccredited” investors and an unlimited number of “accredited” investors to participate in an offering. The issuer taking advantage of the new California provision will make a trade-off with Regulation D. The issuer will have to market his offering to a slightly higher income and net worth group, but will be able to utilize general solicitation or public offering media to accomplish this. For many issuers the ability to reach an expanded group through advertising or mass marketing techniques will be an attractive benefit that will outweigh the loss of the opportunity to market to lower income and lower net worth individuals.

* Form of General Solicitation Allowed. Advertisements in the newspaper and mass mailings (to invite people to seminars) are allowed but the information that may be provided is limited. Generally, issuers are not allowed to mail a summary of the offering, for example, but would be limited to a brief description of the offering, and a brief description of the sponsor. More detailed information may be sent out after an individual has been qualified as meeting the suitability standards. Telephone solicitations are not allowed until suitability is established. For example, a person may contact an issuer after seeing a newspaper advertisement, and once he/she has been qualified as to suitability a summary or prospectus could be sent out, and follow-up telephone communications would be permitted.

* Disclosure Document Required. One attractive feature of the new qualified purchaser regulation is that they may be made without an offering document or prospectus in some circumstances. An offering document would only be required in connection with sales to “small investors” or those investors who are qualified purchasers based on meeting the $100,000 income/$250,000 net worth test. Other than with respect to this class of potential investors Section 25102(n) does not require the provision of a detailed prospectus to offerees. Additionally, the provision of an offering document that does not comply in all respects with standard disclosure for Regulation D or public offerings will not defeat the use of this exemption. Generally, most issuers will still be advised to utilized an offering document of some kind, although the rule does not require the same extent of disclosure found in public offering documents.

* State Filing Fees and Notice Requirements. Compliance with Section 25102(n) may be achieved in two simple steps. First, a notice of the transaction is filed with the Commissioner of Corporations at the earlier of the initial offer or general announcement time, together with payment of a lump-sum fee of $600. A second notice of the transaction is required within ten days after the close of the offering, but not later than 210 days after the filing of the first notice.

* Comparable Federal Regulation 1001 Near Approval. Under prompting from the State of California the Securities and Exchange Commission has moved quickly to propose its own parallel regulation, Rule 1001 which would provide a similar exemption from registration under the federal securities laws. This rule will exempt from registration offerings of up to $5,000,000 provided that they qualify for California’s qualified purchaser exemption. Issuers using Rule 1001 will be able to utilize the same form of general solicitation or public offering media as under the state regulation. This new federal rule is expected to be approved for use in the second quarter of 1996.

* Conclusion About New Section 25102(n) and Proposed Federal Rule 1001. Taken together the new federal and state exemptions will vastly simplify the process and reduce the time and expense for small issuers to raise significant equity capital in California.

David M. Griffith is a real estate and business attorney with offices in Long Beach. He serves as legal counsel to California Centers Magazine. For more information please contact 310/983-8017.