Accredited investors have access to a wider range of investment opportunities under federal securities laws. While there may be more opportunities available to accredited investors, these opportunities can also carry greater financial and legal risks. The law assumes that accredited investors have enough knowledge to protect themselves from these risks. But how does a person or company qualify as an accredited investor? In the United States, the Securities and Exchange Commission operates under the rules of Regulation D, which provides exemptions from securities registration requirements. Businesses and individuals who qualify as “accredited investors” can qualify for a registration exemption under Regulation D. There are two main tests used to prove this accreditation:

Income Test

Rule 501 of Regulation D sets forth specific income requirements for accredited investors. To qualify, an investor must earn at least $200,000 for the two years prior to the investment, with the expectation of earning the same or more income in the following year. (Couples must earn at least $300,000 annually to qualify.) An individual can not qualify by showing a single year of individual income and two years of joint income as a spouse. These qualifications can become complicated particularly when a persons marital status changes over the three-year period so it is important to consult with a securities lawyer prior to making an investment requiring accreditation.

Capitalizing any new company can be a complicated matter. If too much equity is given away, founders can lose control of their own ideas and innovations. On the other hand, if not enough capital is raised, the business could be more likely to fail due to a lack of critical resources. Consult with an experienced California startup lawyer before structuring the capitalization of any new business.

What Is Dual Class of Share Structure?

One popular method of selling equity in the early phases of a business is to create two separate classes of shares of equity. A dual-class structure gives disproportionate voting control to one class of shareholders (usually Class A shareholders). Thus, founders can retain control of their companies by selling stock to a concentrated voting block of owners whose judgment is trusted. Other shares can be sold to Class B shareholders, who still provide the capital that is critical to a companys success, but whose voting rights are limited. This allows founders to retain control over the management and overall direction of the company.

Registration of securities is a legal requirement that costs investment funds time and money. It is important to stay compliant with all applicable securities laws, so if registration is not financially or logistically feasible, be sure that you have a recognized exemption from the registration requirement. These exempt offerings are designated as “EB-5” under United States securities laws. EB-5 is also a designation used for the visa a foreign investor must obtain in order to invest in an EB-5 fund. EB-5 investments are also called private placements or unregistered offerings. Learn more about some of the common legal issues that arise with EB-5 offerings, as well as how investors and offering companies can protect themselves from financial and legal liabilities in relation to them.

Relying On Exemptions From Registration From Securities Laws

SEC Rules 504, 505, and 506 establish exemptions from the registration requirement for certain securities. These rules specify how much equity may be sold by an offering entity in a twelve-month period, how much money may be raised, and whether the investors must be accredited in order to maintain the offerings eligibility for exemption from the registration requirement. These rules also specify the manner of advertising that may be used for the offering. Each of these rules provides specific legal guidelines that must be met exactly. Failure to meet the exemption requirements can subject a business to fines, penalties, legal liability, and administrative requirements (such as limits of offering securities in the future).

An equal split of shares between founders often seems like the fairest way to split equity in a young business. While this may be the simplest option, it comes with many hidden risks that most entrepreneurs are not aware of until it is too late and the business is in serious trouble. New companies can avoid this problem by working with an experienced startup lawyer from the very start. At Structure Law Group, we help entrepreneurs build a successful business from the ground up. Whether it is making decisions on your business entity type (i.e. choice of entity), your management structure, or your equity compensation, we advise and help design a company that is best suited to your unique needs.

Why Equal Split Of Shares Is the Worst Structure

There are many reasons why an equal split of equity can be the worst structure for the founders of a new business. Often, founders have different ideas about the contributions they will be making to the business. Some envision the creation of intellectual property, while others want to manage marketing and business plans. Some want an active role in the daily management of the company, while others want to invest more passively. These issues cannot be resolved in a single meeting. Often, founders must work together for a time in order to learn each persons working style, expectations for each founders contributions, and vision for the companys future. It takes partners time to know each other in a business relationship. And just as in a romantic relationship, legal agreements cannot always prevent painful and expensive litigation when the business relationship goes sour.

A stock option pool has become an increasingly popular tool for startup companies. Entrepreneurs seeking to attract talented employees will often offer incentives that give employees motivation to make the company as profitable as possible, and equity compensation is a very popular option. There are different ways to offer these equity options to employees, and stock options pools are a popular choice. A pool allows a company to set aside a given portion of company stock to be issued to employees as stock options. While this is a convenient structure for many businesses, it is not always the best option. Learn more about the pitfalls of using a stock option pool and the other options that might be better for your business.

The Difference Between Stock Options and Restricted Stock

Both stock options and restricted stock are forms of equity compensation made to employees. There are different restrictions that come with each form of compensation, and it is important for companies to understand these effects before making the choice of how to offer equity compensation. Restricted stock creates a role more similar to a traditional stockholder, and the employee may vote and receive dividends. Employers may also reserve the right to buy back restricted stock (or at least have the right of first refusal) in order to maintain control of the company. Stock options are more limited. Employees are usually limited to the right to buy company stock at a set price in the future. This right can create a windfall if company stock exceeds the set price, but it does not give the employee voting or dividend rights. Because there are no voting rights and no set number of shares, employers generally do not retain the right to buy back stock options. Both restricted stock and stock options can be subject to vesting requirements in order to encourage long-term employment.

Delaware has long been known as a popular state for incorporation of a new business. Some entrepreneurs think this is solely because of tax benefits, but there are many legal and practical benefits to incorporating a new business in Delaware. Here are some of the most common:

Management Friendly

The Delaware General Corporation Law is considered to be friendly toward the management of corporations. There are many specific provisions that help corporations run more efficiently: for example, Delaware corporations have the option of using cumulative voting, while other states make it compulsory for corporations that are not publicly traded. The DGCL also allows for shareholder approval of mergers without separate votes in each class of outstanding stock. Special meetings can be limited to a call by the Board of Directors, which prevents the complications associated with shareholders calling special meetings. Finally, the DGCL embraces new technologies and now allows corporations to use distributed ledgers or blockchains to create and maintain the corporate records required by law. These and other provisions help corporations run more efficiently under Delaware state law.

New technologies have drastically changed the ways in which new startups raise capital. Securities laws and regulations are adapting to these changes to ensure that investors are still protected under federal securities laws when investing via new technologies. Regulation CF (aka Title III of JOBS Act) is a relatively recent rule that took effect in 2016 and recently updated in 2020. It allows new business startups to raise equity through crowdfunding, which means private from all Americans, instead of the richest 2% Americans. More importantly, crowdfunding is typically used for new companies to turn their customers into their investors, which is exciting news for startup founders. Learn more about how crowdfunding works, what its legal limitations are, and how to determine whether Regulation CF is the right tool for your new company’s capital funding, is added to every startup founder’s to-do list.

New Rules Raising Investment Limits

According to the SEC, companies currently may raise an aggregate of $5 million in a twelve-month period through crowdfunding securities. This is a significant increase from the original $1.07 million limit. The new limit greatly expands a new companys ability to raise capital through crowdfunding. These changes also work to level the inequalities faced by small companies looking for startup funding options. Traditionally, large companies have had a competitive advantage in access to startup funding, but crowdfunding has changed the dynamic considerably.

Equity compensation is an important tool employers use to attract and retain talented employees. Before you begin offering stock options, it is important to consider the amount of stock being issued to employees and how issuing it could affect the value of your business. There are many ways to structure an equity compensation package. Consult with a California startup lawyer to structure compensation packages that are best for your business, your future funding rounds, your shareholders, and your employees.

Before issuing any equity compensation, it is important to understand how this will affect the value of your business. Many businesses consider stock options as an inexpensive part of a compensation package. There is no accounting cost and no cash outlay required, so stock options might seem like an attractive option. There is even an added tax benefit: the difference between the stock price and the exercise price is a tax deduction to the business. But the National Bureau of Economic Research reports that this perception does not form an accurate picture of the actual economic cost of stock options. Understand the long-term costs of stock options and how they will affect the valuation of your business over its lifetime before making any decisions about how many employees will be awarded what amount of stock options.

The Total Percentage of Your Employee Stock Options

Venture capital is a critical source of capital for any new startup. However, venture capital does not need to come with overly draconian conditions. Venture capital may be contingent on the funders receiving Board seats, and funding is typically offered in exchange for equity. But just how much equity should venture capital investors receive? If too much is given away, founders may lose control of their own business. Founders must understand how to use equity strategically in order to get the maximum benefits.

Typical Apportionments or Dilution At Each Round Of Funding

Funding must account for the competing interest of founders, the initial seed investors, venture capital investors, and employees who receive equity compensation. This can make it difficult if not impossible to come up with a split that everyone considers to be fair. While each company has different needs, here is a common scenario at a Series A round of funding with venture capital: