Whenever you want to raise money from investors, there are certain bodies of federal securities laws that should always receive their due attention. These are the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940 and the Investment Company Act of 1940.  The Securities Act and the Securities Exchange Act are really the two fundamental bodies of federal law, but the other two can also make or break the possibility of an offering occurring.

The Investment Company Act is exactly what it sounds like: it contains the laws that govern investment companies at the federal level. The word investment company most likely has a broader meaning then the one you’re thinking of right now. In fact, many securities offerings fall into the definition of an investment company, but that’s a topic for another article. Here, we’re going to focus on the two main exemptions used that keep an entity from having to register as an investment company under federal law.

Exempting Out as a 3(c)(1) Fund

            If you’re raising capital from investors and you don’t want to go through with the expensive task of registering and maintaining your entity’s status as an investment company, you should look first at what’s known as the 3(c)(1) exemption. This is the easier of the two exemptions that will be discussed in this article.

The easiest requirement to comply with here is making sure your investors are accredited investors. If you’ve ever raised capital in a private securities offering, this may sound familiar. Accredited investors include: (i) an individual whose net worth, taken together with the net worth of the individual’s spouse, exceeds $1 million, (ii) an individual who had an individual income in excess of $200,000 (or joint income with their spouse in excess of $300,000) in each of the two previous years, who  reasonably expects  a  gross  income  in  excess  of $200,000 (or joint income with their spouse in excess of $300,000) in the investment year, (iii) an individual or entity which is an executive officer, director, manager, general partner or other principal of the issuer entity, (iv) an entity in which all of owners are accredited investors, (v) a trust, with total assets in excess of $5 million, which was not formed for the specific purpose of acquiring the investment, whose purchase is directed by a sophisticated person as described in the Securities Act of 1933 and (vi) certain other individuals and entities such as insurance companies, banks and investment companies.

The other requirement is not always as easy of a requirement with which to comply. In order for this exemption to be applicable, there can only be 100 investors investing in your entity. Generally, this isn’t difficult to comply with if you’re raising a smaller amount of money or at least some of your investors are investing fairly substantial sums of money; however, the greater the amount of funds you are seeking, the harder it can be to comply with this requirement. Be careful when you count investors here. While individuals and some entities are counted as one investor, others, such as entities formed for the purpose of investing in the respective investment and certain investment companies, will count as more than one investor.

Exempting Out as a 3(c)(7) Fund

If the 3(c)(1) exemption will not work for your offering, your next option is the 3(c)(7) exemption. Here, you can have more than 100 investors, but your investors must meet higher qualifications to invest.

The most important thing about the 3(c)(7) exemption is that you can no longer rely on your investors just meeting the accredited investor standard. Here, your investors will need to be qualified purchasers, a much higher standard that’s typically associated with institutional investors. A qualified purchaser includes: (i) an individual who owns at least $5 million in investments, (ii) an entity that owns at least $5 million in investments held for 2 or more individuals who are related as siblings, spouses or direct lineal descendants, (iii) a trust where the trustee is a qualified purchaser, (iv) an entity or individual which in the aggregate owns and invests at least $25 million in investments on a discretionary basis, (v) an entity in which all of the owners are qualified purchasers, (vi) certain qualified institutional buyers, as defined in the Securities Act of 1933, and (vii) an individual or entity which is an executive officer, director, manager, general partner or other principal of the issuer entity.

The second requirement is similar to the 100 investor requirement for the 3(c)(1) exemption. The 3(c)(7) exemption only applies if there are no more than 2,000 investors investing. If the investor number goes over 2,000, the entity will then be subject to registration requirements and will no longer be considered a private fund.

Skimming the Surface

Here we’re only skimming the surface. Each item mentioned here has more complexities and issues, and a securities attorney is always advised when it comes to dealing with the securities laws and investors. Other federal regulatory laws such as the Investment Advisors Act of 1940 and state blue sky laws introduce even more regulatory requirements and considerations of which any individual or entity raising capital should be aware. If you’re in need of securities counsel, please call us at 844-4DODSON for a consultation.