Raising funds for your startup is never easy. Despite having interest from investors, you still need to make sure you are legally prepared to raise funds. This is part of our series of posts on how to legally raise funds in the United States.

What is a Section 4(a)(2) offering?

One common method for a startup to raise its initial funds without registration with the SEC is reliance upon Section 4(a)(2) of the Securities Act. This exemption from registration allowing a company to issue securities in a private placement is primarily used by the issuing company to receive capital contributions from its founding team. Section 4(a)(2) defines private placements as “transactions by an issuer not involving any public offering”. It is worth noting that the exemption from registration set forth under Section 4(a)(2) is relatively narrow and the SEC provides limited guidance as to what transactions fall within its scope.

When is Section 4(a)(2) available?

While an offering conducted under Section 4(a)(2) technically does not limit how much a company may raise, a set of factors, each being non-determinative, should be considered to assess the availability of the exemption. These factors include: the number of offerees and their relationship to each other and to the issuing company; the number of securities offered and the size of the offering; the manner of the offering; the expertise and experience of the offerees; the nature of the information provided to offerees; and the issuing company’s actions to prevent the resale of the securities, among other things. Based on these important factors, a few key rules to accomplish a private placement in compliance with Section 4(a)(2) are:

The offering should only be made available to a small group of offerees.
The offering should not be advertised to the public, meaning that no general solicitation or advertising should be used.
The offering should be suitable for the offerees. Section 4(a)(2) offerees should be able to “fend for themselves” and make an informed investment decision. This implies that offerees must have sufficient knowledge and experience in financial and business matters to be deemed “sophisticated investors” who are able to evaluate the risks and merits of the investment and bear the investment’s economic risk.

What information is required under Section 4(a)(2)?

Although Section 4(a)(2) does not specify what information should be shared with investors, the issuing company should provide sufficient information about itself, its business, and the securities being offered. Such information is typically presented in the form of a document called a Private Placement Memorandum, which, in a nutshell, grants the investor access to the type of information contained in an SEC registration statement for public offerings. Rule of thumb: the more information you provide, the better.

Does a Section 4(a)(2) offering require any filing with the SEC?

A compliant Section 4(a)(2) offering does not require any filing with the SEC to meet federal requirements, which makes the exemption rather attractive to founders (unlike in Regulation D offerings, no need to prepare and file a Form D with the SEC). Important: Section 4(a)(2) merely constitutes a federal exemption from registration, so relevant state blue sky laws still apply.

Should I raise under Section 4(a)(2)?

As the factors that determine the availability of Section 4(a)(2) are loosely defined, companies should retain an attorney as they explore applicable exemptions from registration to avoid being in violation of the Securities Act. Due to the uncertainties surrounding Section 4(a)(2), the SEC adopted Regulation D to offer companies a clearer roadmap to raise capital and ensure that their offer and sale of securities will be reliably exempt from SEC registration.

About the author

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Côme Laffay, Esq. is a corporate and securities attorney. He is Counsel at KBL Roche, a transatlantic full-service boutique law firm with offices in New York, Paris, and Munich. Côme's practice focuses on capital raising activities in both the private placement and the crowdfunding spaces, with the goal of supporting entrepreneurs and financial intermediaries.

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