SECURITIES REGULATION AND SMALL BUSINESS: RULE 504 AND THE CASE FOR AN UNCONDITIONAL EXEMPTION

Small businesses are an important part of the United States economy. In 1996, there were about 5.5 million small businesses in the United States employing between zero and five hundred workers, about 99% of all non-farm U.S. businesses. Businesses with five hundred or fewer employees employ 53% of the private non-farm work force in the United States, account for 47% of all sales, and are responsible for 51% of the private gross domestic product. During the period 1992 to 1996, small firms with fewer than five hundred employees also created virtually all of the net new jobs in the U.S. These small businesses often find it difficult to raise capital. An obvious first source of capital is the entrepreneur\u27s personal wealth, but most entrepreneurs have insufficient personal funds to finance a business. Loans are another possible source of financing, but because small startup businesses have little or no past record of performance, loans are virtually impossible to obtain. Small businesses may also have great difficulty obtaining money, particularly seed capital, from venture capital funds. Many small business owners thus turn to friends and family, and, if they provide insufficient funds, to the general public. When small businesses turn to public investors-often even when they resort only to friends and family-those small businesses, whether they realize it or not, encounter securities laws. The public sale of securities in the United States is heavily regulated. Under the Securities Act of 1933, issuers making public offerings must file a registration statement with the Securities and Exchange Commission (SEC) and comply with the Act\u27s prospectus delivery requirements and restrictions on communications. In addition, the issuer may have to undergo a similar, sometimes even more rigorous, registration process in the various states in which the offering is made. Federal and state regulation of securities offerings poses problems for small businesses. Many small business issuers and their advisers are totally unaware that they must comply with federal or state securities law. Small business issuers often sell securities without consulting an attorney. If they do consult an attorney, it is often an attorney unfamiliar with federal securities law and the many exemptions comprehensible only to the lawyer familiar with the Alice-in-Wonderland quality of securities law. Small business promoters often mistakenly believe that federal and state securities laws apply only to large corporations whose securities are listed on a national exchange. Or, they may be vaguely aware of the Securities Act exemption for transactions by an issuer not involving any public offering and think they are safe as long as they confine their offering to friends and family. But the availability of the private offering exemption turns on the investors\u27 sophistication and access to information about the business-in short, the ability of offerees to fend for themselves. The private offering exemption is not available when promoters sell to a diverse group of uninformed friends, neighbors and associates, or even to existing investors in the company. As a result, [w]ith monotonous frequency, securities lawyers are faced with small business clients who have already sold securities with no concern for the application of the Securities Act