Selling Stock to the Public FAQs

Yes, you can; however, if you sell to certain people under certain circumstances, you must follow some rules and abide by certain federal and state laws. The rest of the questions and answers in this section will help you understand some of the fundamentals of selling part of your business to others.

A public offering is the offer to sell stock or bond securities is anyone who wants to buy them. It is an invitation to the general public to exchange money for an investment security (stock) or a debt security (bond).

They make public offerings to raise money for business purposes or to exchange ownership in a business for cash.

Businesses raise money in three ways: owner investment, borrowing from others and business profits. The owner investment can come from one person or from many. Small companies are usually owned by one or a few people. Large businesses are often owned by hundreds or thousands of individuals. When large numbers of owners are involved, they are often strangers to each other and have no connection except through their common ownership in a business. Stock certificates are evidence of business ownership and are often bought and sold on the major stock exchanges of the world.

In addition to offering to sell stock in a public offering, bonds are often used to raise money that the business pledges to repay with interest after some specified period of time. Public stock offerings carry no such promise of repayment. The buyer of public stock offerings is buying ownership and the risk and rewards that go with ownership.

The SEC stands for the U.S. Securities and Exchange Commission. It is an agency of the federal government created by the U.S. Congress to administer laws having to do with the sale of stocks and bonds to investors.

These sale of ownership interests and debt obligations can be complicated and involve giving much detailed information. The task of the SEC is to maintain an atmosphere of fair disclosure in distributing this information. It oversees rules and regulations that apply to the sale and exchange of securities so that investors can make their investment decisions with full knowledge of the risks and rewards of those decisions.

Bad experience in the 1920s in the U.S. securities markets led to the passage of two laws that now form the foundation of what the SEC does. These were the Securities Act of 1933 and the Securities Exchange Act of 1934.

The two main laws are the Securities Act of 1933 and the Securities Exchange Act of 1934.

The Securities Act of 1933, usually called the Securities Act, requires companies to give investors full disclosure of all material facts that are important in investment decisions. Companies do this by filing a registration statement with the SEC that includes detailed information important to investors.

The Securities Exchange Act of 1934, known as the Exchange Act, requires companies that have already sold securities to the public to continually provide information to its investors and the SEC about operations, financial conditions, management, profit prospects, and other matters important to investors.

Offering to sell securities to the general public, sometimes referred to as "going public," is a common choice of companies who cannot raise money by other means. Startup businesses and companies that have small capital needs usually get money from the owners and from bank loans. They can also raise money by selling securities in transactions exempt from the registration provisions of the Securities Act.

Those established businesses that decide to "go public" do so for the following reasons:

• The business has a much wider access to capital.  The public securities ownership market is a worldwide market. Exchanges, such as the New York Stock Exchange, exist in many countries for the purpose of trading publicly held stock and bond securities.
• Future financing is made easier.  When a business becomes known in the securities trading market, future sales of securities are easier and more money can often be raised than by any other means.
• The business can become better known.  Selling securities to the public involves giving information to the public and inviting investors to learn about the business. This has a number of benefits: Products and services can be sold more easily, advertising can increase in effectiveness, the hiring of employees can be helped, and obtaining bank loans can be easier.
• Company officers and directors can more easily buy and sell ownership interests.  When a company hires managers, these managers often want some ownership interest in the form of stock options. When they retire, they want to be able to sell these securities. Having a public market makes this possible.
• Business image is enhanced.  Usually a business that is traded on the stock exchanges has a better image in the investment community that one that is not. This improved image can have many benefits.

Selling securities to the public has many benefits, but it also has its obligations. The business that decides to "go public" is agreeing to take on these new obligations.

Chief among these new obligations is the agreement to provide information about the company’s operations, financial condition and management. Not only must this information be provided in connection with the initial public offering, it must also be provided periodically for as long as the public owns the securities. This is truly a long-term commitment.

The business that does not sell securities in the public market can keep much of what it does secret. The business owner who owns all of the stock does not have to tell anybody (except the IRS) about the sales and profits of the company. Details about the company’s operations and background information about its management need not be revealed. This freedom to "be private" with this information is given up when a company enters the public securities market.

Another obligation assumed by "going public" is the legal responsibility to account for mistakes in following the laws and regulations that apply to your public status. If you don't do things right, you can be sued. Investors can sue you and the SEC can sue you.

Finally, "going public" reduces the flexibility in managing your business because shareholders must be kept informed of your activities and sometimes must give advanced approval of your decisions. All of these changes that come with public offerings add to the cost of doing business. More advice from lawyers and accountants is required. Investment bankers, the people who handle public offerings, also charge fees for their services.

You should begin this process by contacting competent professional help. This is not a do-it-yourself project. A public offering is highly specialized work requiring an investment banker (not really a banker in the traditional sense), a CPA and a lawyer.

With their guidance, the first step involves drafting a registration statement. When completed, this statement will be filed with the SEC (Securities and Exchange Commission). No sale of securities can be started until the SEC reviews your registration statement and declares it "effective." This means the SEC finds that it was prepared in conformity with the rules that apply to registration statements.

This filing has two main parts: a prospectus and additional information. The prospectus describes important facts about the business operations, financial condition and management. The additional information contains data that does not have to be given to investors, but is filed with the SEC so as to be available for public reference.

The basic registration statement, called a Form S-1, generally provides narrative information on at least the following topics:

• Nature of the business
• Types of properties owned or used
• Competition
• Identity and compensation of officers and directors
• Material transactions between the business and its officers and directors
• Material transactions involving the business or its officers and directors
• Plan for distributing the securities to be sold
• Intended use of the money raised from the sale of the securities
• Financial statements audited by an independent certified public accountant

In addition to the above, the company must tell about anything else that will make the disclosure statement complete and not misleading. This includes describing any risks associated with your business. Examples of these risks include adverse economic conditions affecting your company, dependence on key personnel, lack of a business operating history, and the lack of a market for the securities being offered.

The preparation, writing and editing of this registration statement should not be taken lightly, for it is the foundation of your public offering. It is also the document that come back to haunt you if you do it poorly, including possibly providing a basis for lawsuits against you and/or your company.

Once this is done and declared "effective" by the SEC, your investment banker does most of the remaining public offering work. That firm will handle the sale of the securities, the timing with the market, the communication with potential investors, the collection of sales proceeds, and most everything else that goes on to complete the process. Your main task will be standing by with your corporate checkbook to pay for these services.

Yes. A small business has a little easier time of registering a public offering. It can choose one of two simplified small business forms, knows as Form SB-1 and Form SB-2.

SB-1 is used to raise $10 million or less and SB-2 is used to raise any amount. To qualify to use either of these simplified forms, the business must have less than $25 million in revenues in its most recent fiscal year and must have publicly-held stock worth no more than $25 million outstanding.

Like the full-fledged registration statement Form S-1, these so-called simplified forms still require a lot of information and still must be prepared with care and thoroughness. They do, however, give the small business some breaks. In the Form SB-1, for example, you can give your information in question and answer format. This is usually easier than the narrative format used in the Form S-1. Form SB-2 calls for only two years of audited financial statements (as contrasted with three in the S-1) and you may assemble your information using a set of rules (Regulation S-B) written in simple, non-legalistic terms. The words used to disclose your information can be more brief than necessary with the S-1.

The SEC approves your public offering only to the extent that it declares your registration statement "effective." This means that it has reviewed the statement for compliance with disclosure requirements in the laws and does not find it misleading, inaccurate or incomplete.

It does not pass judgment on the validity of your information, nor does it do anything that will reflect on the investment quality of the securities being offered for sale.

If you stay strictly within your state with your securities offering, you may come under Section 3(a)(11) of the Securities Act, generally referred to as the "intrastate offering exemption." This exemption exists to make it easier and less costly to finance local businesses.

To qualify for this exemption, your company must be incorporated in the state where the offering will be made, do a significant part of your business within the state, and sell securities only to residents of your state.

There is no limit on the size of the offering and you can sell to as many investors as you like, but you must know the residence of each and every purchaser. Just one out-of-state investor can ruin this exemption and put you in violation of the securities laws.

With this type of sale, seldom can the securities be traded publicly in a secondary market. Secondary markets are rarely strictly intrastate. This means that buyers of these securities have limitations on how and to whom they might resell them.

This is a sale of securities to someone you know – as contrasted with a sale to public investors you do not know. Section 4(2) of the Securities Act offers an exemption to a company wishing to sell in ways "not involving a public offering" and not using any form of public solicitation or general advertising. To qualify, the investors buying your securities must be "sophisticated investors" and be able to bear the investment’s economic risk. A "sophisticated investor" is one having enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment.

The investor must also have access to the type of information normally shown in a registration prospectus and must agree not to resell or distribute the securities to the public.

Using this exemption is a little tricky because the rules are not always clear. As the number of investors increase and the relationship between them and the company’s management becomes more remote, it becomes difficult to argue for this exemption. The law sets forth no precise limits here. If even one investor does not meet the above requirements, the entire offering may be in violation of the Securities Act.

Expert guidance by a specialized CPA or lawyer is highly recommended before using this exemption.

This is for small securities offerings. Section 3(b) of the Securities Act lets you escape registration of public offerings under 
$5 million in any 12-month period.

You still must provide some information to the SEC and to prospective investors, but it is not extensive. The SEC asks only for a "offering statement" consisting of a notification, an offering circular, and some exhibits. The offering circular is something like a prospectus, but the financial statements are simpler and do not have to be audited by an independent CPA. There are three different ways the company may pick for the offering circular, one of these ways being a simplified question-and-answer format.

Another advantage of this exemption is the absence of the usual reporting requirements of the Exchange Act. Unless the company has more than $10 million in total assets and more than 500 shareholders, no ongoing reporting requirements are necessary.

These securities may be freely sold in the secondary market after the initial sale. They are not restricted like some of the other exemptions.

There are three exemptions under this heading. They are termed "Rule 504," "Rule 505," and "Rule 506." Rule 504 gives an exemption for offers up to $1,000,000 in a 12-month period; Rule 505 covers offers up to $5 million; and Rule 506 is the so-called "safe harbor" rule for private offering exemptions.

Rule 504 (under $1,000,000 offering) does not require you to give disclosure documents to investors. You can sell your securities to an unlimited number of investors and you can use general solicitation or advertising to help you market your securities. The securities are not restricted from secondary sale.

Rule 505 (up to $5,000,000 offering) lets you sell to an unlimited number of "accredited investors" and up to 35 other persons (who do not need to meet the sophistication or wealth standards associated with other exemptions). Investors must buy for their own investment purposes only. They may not resell without a registration. General solicitation or advertising may not be used to market these securities.

An "accredited investor" is defined as any of the following:

• Bank, insurance company, registered investment company, business development company, or small business investment company;
• Employee benefit plan if a bank, insurance company, or registered investment advisor makes the investment decisions – or if the plan has total assets over $5 million;
• Charitable organization with assets exceeding $5 million;
• Director, officer or general partner of the company selling the securities;
• Any business where all equity owners are accredited investors;
• Any person with a net worth of $1 million or more;
• Any person with income of $200,000 in each of the last two years;
• Any trust with assets at least $5 million.

You may decide what information you give to accredited investors, but you must give non-accredited investors disclosure documents similar to those of a registered offering.

Financial statements need be certified by a CPA only for the most recent fiscal year.

Rule 506 is called a "safe harbor" for the private offering exemption. If you satisfy the following standards, you will fall under this exemption:

• You can raise an unlimited amount of capital;
• You cannot use general solicitation or advertising to market the securities;
• You may sell to an unlimited number of accredited investors;
• You may decide what information to give to accredited investors, but non-accredited investors must receive disclosure information like a registered offering;
• You must be available to answer questions from prospective purchasers;
• Only one year of financial statements need be certified by a CPA;
• Securities are restricted from resale.

This is the sale of $5 million or less to accredited investors. (Please review the previous question for definition of an accredited investor.) This exemption, under Section 4(6) of the Securities Act, does not permit advertising or public solicitation and there are no document delivery requirements.

Yes, if you follow Rule 701 of the Act. This exemption is available only to companies that are not subject to Exchange Act reporting requirements and is limited to offers and sales of $5 million or less. Employees receive restricted securities and may not freely offer or sell them to the public.

Yes. Each state has its own securities laws. Some track the federal laws and some do not. You must comply with both federal and state laws when you decide to use these methods of raising capital.

If your offering is to be made under Rule 504 (sale of securities up to $1,000,000) [See previous question, "What is a Regulation D exemption?"], most states allow you to use a question and answer registration form developed by the North American Securities Administrators Association (NASAA). This form is known as the Small Corporate Offering Registration (SCOR) and is recognized by most states.

A knowledgeable CPA or attorney can help you get answers to your specific questions.

The Division of Corporation Finance’s Office of Small Business [(202) 942-2950 specializes in the review of filings from small companies.

The SEC has a Special Ombudsman for Small Business (202) 942-2950 that can answer general questions.

Your local Small Business Development Center and the SBDC Research Network in New York can provide free help in understanding SEC rules and regulations.

SEC Web Site: http://www.sec.gov

SEC Telephone: (202) 942-4046

SEC forms and releases can be obtained from:

Fort Worth Regional SEC Office:
State jurisdiction: Texas, Oklahoma, Arkansas, Kansas (except for the exam program which is administered by the Denver Regional Office)

North American Securities Administrators Association:

Texas State Securities Board:

Small Business Administration: http://www.sba.gov/ADVO