Proposed Filing Deadlines Could Impact Fundraising in California

As a Silicon Valley business attorney, I often help small businesses and start-up companies in San Jose and Santa Clara with their financing transactions. Whether my client is a newly formed software corporation getting capitalization from its founders or an existing company trying to raise money by making a preferred stock offering, as my client’s business lawyer, I need to counsel them in their fundraising efforts to ensure that the company complies with securities laws.

However, a bill recently introduced in the California State Senate will make it harder for small businesses and start-up companies to raise money in California. The bill, SB 978, could eliminate a securities exemption commonly used in fundraising transactions and expose a company to fines, and its controlling persons to individual liability, if a certain filing is not completed in time.

A little background is helpful to understand why this bill is such a disaster. Fundraising to start or grow a company requires compliance with both state and federal securities laws. If an offering violates the securities law, anyone who purchased the securities in that offering can rescind their purchase and get their money back. The aggrieved investor can look to the company for return of funds, or can look to any of its controlling persons individually. If you are considered to be a controlling person of a company that misses a securities filing deadline for an offering, your house may be on the line.

California’s securities laws require an offering to a California resident to be “qualified” by the California Commissioner of Corporations, a somewhat time consuming and expensive process. For certain securities and securities transactions, exemptions from the qualification requirements are available. These exemptions allow a company to comply with the securities laws on an expedited and less expensive basis.

Exemptions typically outline the conditions required to use the exemption. For many exemptions, if you meet the conditions, you are good. For others, within a short period of time following the first sale in the offering, a notice has to be sent to a government agency informing the agency of the company’s reliance on the exemption. The notice is typically required so that regulatory agencies can collect information about securities offerings in their jurisdiction. The notices do not really offer any particular protection for an investor participating in the offering described in the notice.

California law contains a widely used exemption for private placements. This exemption, used for fundraising transactions ranging from the initial formation of a company to a venture financing, requires an online filing 15 days after the first sale in the offering. Currently, failure to file the form does not result in the loss of the exemption, although additional fees may be required once the company realizes it has missed the deadline.

SB 978 changes existing law by saying that if a company fails to make the filing by the 15 day deadline, then the exemption is unavailable. If a different exemption is unavailable, and the company cannot get a post sale qualification (not a particularly common practice without a rescission offer), then the offering is out of compliance. This is not pretty. If a company has just violated the securities laws, then, as mentioned above, its officers’ personal assets may be at risk. Even if none of the offending company’s current investors sues it, the company will need to disclose this problem to its future investors.

This new law does nothing to protect investors. There is simply no logical argument that filing an online form within a particular period of time protects investors in an offering. The law will, however, severely and adversely impact fundraising in California, both for California companies and California residents investing in companies in California or other states. Here’s why:

Fundraising is not a smooth process. It is not uncommon for my corporate clients to accept funds without contacting me first, or to forget to contact me once they have cashed their first fundraising check. By the time some clients get to my office, more than 15 days have gone by. Under the current state of the law, the discussion is narrowed to some theoretical risks and the need to pay additional filing fees. Under a post-SB 978 world, the discussion is more difficult because it will focus on highly expensive and potentially unsuccessful fixes and the client’s exposure to personal liability. This discussion will not stimulate fond feelings for doing business in California.

The issue is even worse for out-of-state companies. Many high tech, software and medical start-ups in Silicon Valley often seek money from California investors when fund raising. Out of state counsel and companies may not be familiar with the loss of a private placement exemption, particularly in those states where there is no need to file a form in the first place. SB 978 could impair investment opportunities for California residents, especially after a company is advised by its counsel that investment funds have to be returned because no exemption is available.

Securities laws must focus on investor protection. California’s private placement scheme has worked for years, and there is no showing that investors will be better protected by the draconian consequence of failing to timely file an online notice.

In a state with a large structural budget deficit, policy makers should be focused on encouraging increased business activity, rather than furthering the impression of California as an unfriendly business state. Please contact your state representatives to put a stop to this unwise misuse of the securities law.

Contact Anna Eshoo for the 14th Congressional District, who covers portions of San Mateo, Santa Clara and Santa Cruz Counties, including parts of Sunnyvale, Menlo Park, Mountain View, Saratoga, Cupertino and Santa Cruz. Contact Michael Honda for the 15th Congressional District, who covers much of the central, northeastern and southeastern area of Santa Clara County, including parts of Milpitas, Santa Clara, Cupertino, Los Gatos, Campbell, and Gilroy. Contact Zoe Lofgren for the 16th Congressional District, who covers portions of Santa Clara County, including parts of San Jose and Morgan Hill. For other Districts, go to: