Posted 07 Jan 2010
Founders must pay special attention when their startup issues securities–even when those securities are issued to themselves at incorporation. Whether or not founders realize it, they are issued their founders stock via an exemption from registration at both the federal and state level.
The federal exemption most likely available for founders is Section 4(2) of the Securities Act of 1933, while the state exemption is determined by the particular state’s law.
In California, founders typically use the registration exemption found in Section 25102(f) of California’s Corporations Code (see the next section for the full text). Section 25102(f) grants the issuer (the startup) an exemption from securities qualification for certain limited securities offerings.
As part of the exemption, founders in California must file a 25102(f) notice, also called a “Limited Offering Exemption Notice.”
California Corporations Code section 25102(f)
California Corporations Code section 25102(f) exempts from the provisions of section 25110:
“Any offer or sale of any security in a transaction (other than an offer or sale to a pension or profit-sharing trust of the issuer) that meets each of the following criteria:
1. Sales of the security are not made to more than 35 persons, including persons not in this state.
2. All purchasers either have a preexisting personal or business relationship with the offeror or any of its partners, officers, directors or controlling persons, or managers (as appointed or elected by the members) if the offeror is a limited liability company, or by reason of their business or financial experience or the business or financial experience of their professional advisors who are unaffiliated with and who are not compensated by the issuer or any affiliate or selling agent of the issuer, directly or indirectly, could be reasonably assumed to have the capacity to protect their own interests in connection with the transaction.
3. Each purchaser represents that the purchaser is purchasing for the purchaser’s own account (or a trust account if the purchaser is a trustee) and not with a view to or for sale in connection with any distribution of the security.
4. The offer and sale of the security is not accomplished by the publication of any advertisement. The number of purchasers referred to above is exclusive of any described in subdivision (i), any officer, director, or affiliate of the issuer, or manager (as appointed or elected by the members) if the issuer is a limited liability company, and any other purchaser who the commissioner designates by rule. For purposes of this section, a husband and wife (together with any custodian or trustee acting for the account of their minor children) are counted as one person and a partnership, corporation, or other organization that was not specifically formed for the purpose of purchasing the security offered in reliance upon this exemption, is counted as one person. The commissioner may by rule require the issuer to file a notice of transactions under this subdivision. However, the failure to file the notice or the failure to file the notice within the time specified by the rule of the commissioner shall not affect the availability of this exemption. An issuer who fails to file the notice as provided by rule of the commissioner shall, within 15 business days after demand by the commissioner, file the notice and pay to the commissioner a fee equal to the fee payable had the transaction been qualified under Section 25110.”
California set forth the requirement of the 25102(f) notice via California Code of Regulations (CCR)Section 260.102.14, since section 25102(f) only “allows” California to require the notice (see the bold language above).
When to File the 25102(f) Notice
The 25102(f) notice must be filed with, or mailed to, the Commissioner within 15 calendar days after the first sale of a security in the transaction in California. The “first sale” in California occurs when the startup has obtained a contractual commitment in California to purchase securities the startup intends to sell in connection with the transaction. No subsequent 25102(f) notices are required for sales in connection with the same transaction.
How to File the 25102(f) Notice
As of July 2005, startups must file the 25102(f) Limited Offering Exemption Notice electronically, via the California Department of Corporations website here. Startups can file the 25102(f) notice in person or by mail only if they can prove hardship. Hardship is essentially if the startup can’t use a computer without unreasonable burden or expense or you can’t provide information requested on California’s website without unreasonable burden or expense.
25102(f) Notice Filing Fees
Filing Fees are calculated based on the value of securities proposed to be sold:
$25,000 or less — $25.00
$25,001 to $100,000 — $35.00
$100,001 to $500,000 — $50.00
$500,001 to $1,000,00 — $150.00
Over $1,000,000 — $300.00
Here’s a link to a 25102(f) Notice in PDF form.