INVESTED IN A PRIVATE DEAL THAT WENT SOUTH?

WHY YOU HAVE A SECURITY INTEREST AND WHY THAT MATTERS

If you have invested money into someone’s business venture, you have a security.

All investments create securities.

Back-of-the-envelop, hand-written agreement where one party puts up the money and the other party
manages the work? You have a security.

Put some money in a real estate deal with close family and friends? You have a security.

You invested in a non-profit? You have a security.

Securities include not only stocks, LLC shares, options, promissory notes, investment contracts, but all
forms of investment interest. See California Corporations Code §25019 and 15 U.S.C. §77 b (a) for
examples, and remember that these examples are illustrative not definitive.

[One of the few exceptions is when an investor is also actively involved in management (not merely is
given the right to participate in management); then the law treats him as a partner with partnership
remedies rather than securities remedies].

Entrepreneurs and start ups seeking money from individual investors violate state and Federal
securities laws as often as not.

Usually, they get away with it: Either the investors do not lose money and so do not care about their
remedies or they do lose money but are ignorant of their remedies.

California investors who have lost some or all of their money in private placements and other small
investments are often delighted to discover the remedies offered by one or more of the following:
 Sections 11, 12 and 15 of the Securities Act of 1933
 Sections 10(b), 18 and 20 of the Securities Exchange Act of 1934
 SEC Rule 10b-5
 California Corporations Code Sections 25400/25500, 25401/25501, 25402/25502 and 800
 California Business & Professions Code Sections 17200, et seq.
 California Civil Code Sections 1709 and 1710

Before you invested, do you remember seeing something along the lines of . . .

This is not an offer to sell or a solicitation of any offer to buy any securities. Offers are made only by
prospectus or other offering materials. To obtain further information, you must complete our investor
questionnaire and meet the suitability standards required by law.

You saw this language because exemptions to registration of securities require that potential investors
complete an investor questionnaire. Only if you met the suitability requirements were you to be given a
disclosure document, almost always in the form of a private placement memorandum. This document is
the equivalent of a prospectus or an offering circular for a public deal.
 Typically, the disclosure document will include a business plan and describe the company, management,
suitability requirements, risks, and legal requirements.

Only if you appeared to be qualified could offering materials may be sent to you or could a password be
given to you for access to the section of the web site with the offering materials.

It is also possible you went to an educational seminar where the company presented what it was doing
and gathered information from you, before asking you to fill out the questionnaire.

Contact Douglas Slain directly for more information at 510-450-1895.

The seminar, of course, cannot make or solicit any offer to invest. At some point -- in response to pre-
seminar inquiries about the seminar, at the seminar and/or following up after the seminar -- the company
needs to send investor questionnaires. As before, only those potential investors who reasonably appear to
be qualified can be told of the existence of the offering and be provided with offering materials. Obviously,
to show that nothing in the presentation mentioned the offer, all seminar presentations should be put in
tangible format -- whether paper (e.g., lecture notes and handouts), electronic (e.g. PowerPoint slides), or
tape (audio or visual) -- and kept permanently in a safe place.

As long as the company's web site does nothing that could be construed as an offering or a solicitation to
invest, then the site can say something like "For more information regarding our company, click here."
That link should then contain an appropriate investor questionnaire and a statement that it must be
completed and returned before more information can be provided

An attorney can review the communication and make sure it does not constitute an offer. (Merely having a
disclaimer like the one above is necessary but not sufficient.) Also, when the company does offer the
securities, it still has to comply with the requirements of the securities exemption it is using – or register
the offering.

How about the $150,000 I put into that real estate blind pool and never saw again?
A company can provide general information about what it does and its need for money or in the type of
investments it may make available without violating securities laws. This can be done on the company’s
web site, at seminars, through flyers, or similarly.

What a company cannot do is solicit offers from potential investors or mention any specifics of an offer,
such as return, percentage of ownership that will be provided per dollar amount invested, or anything
similar.

If securities are being offered to residents of one state only, then only that state’s securities laws apply if:

the entity also is formed in that state,

has its principal place of business there, and
has 80% of its assets, expenditures and sources of revenue in that state.

If securities are being offered to residents of more than one state, such as on the Internet, not only will
those states’ laws apply and Federal law applies as well.
This is because securities must be registered with a state or Federal securities agency, a costly and time-
consuming approach, or they must fit within one or more exemptions to the registration requirements.
There are both civil and criminal penalties for violating the securities laws and it is relatively
easy to violate them.

Although widely criticized for its stance, the SEC has stated that, with offerings that must comply with
federal law, if there is no pre-existing relationship between the offeror and the potential investor, the
offeror should wait 30 to 45 days after receiving the questionnaire responses before providing any
specifics about an offer.
TARGETED COMMUNICATIONS WITH SPECIFICS
In some situations it is acceptable to send specifics regarding an offering directly to individual potential
investors (by letter, email, etc.) that the offeror reasonably believes meet the investor suitability
requirements for the securities exemption that will be used. This may occur via lists of investors
previously determined by a securities broker to be accredited investors, or with certain potential investors
–- often suppliers, customers, colleagues, friends and family –- who have a substantive pre-existing
relationship with the company or one or more of its principals. The specific exemption being used
determines who may be contacted and how.
If there is any doubt, though, about whether a particular investor meets the suitability standards, the
investor-questionnaire approach must be used.
PUBLICLY ADVERTISING AN OFFERING
If public advertising is needed, the options are basically the California 25102(n) offering (which allows a
tombstone ad), a California qualification by permit (which allows full public advertising), and a Rule
504/SCOR offering, which also allows full public advertising.
A California 25102(n) offering may be used (with care) in states that have adopted the Model Accredited
Investor Act. In that case the offering must be limited to $5 million or less, the company must be a
California entity or do most of its business in California, and all the investors must be accredited.
The California qualification by permit method allows full public advertising, but the offering must be a
California intrastate offering. (All investor must be located in California, the company must be a
California entity with its principal place of business in California, and it must have and expect it will have
80% of its assets, expenditures and sources of revenue in California.)
Most states participate in regional approval for federal Rule 504/state SCOR offerings of up to $1 million.
The states are grouped in five regions and approval by the designated state gives permission to make the
offering to all participating states in the region. Full public advertising is allowed. One problem, though, is
that California does not participate in the regional-review system, so the offering has to be separately
submitted for review to the California Commissioner of Corporations.
FINDERS IN CALIFORNIA
While in theory it is possible to find licensed securities brokers to sell an offering, as a practical matter
that can be difficult. Commissions often run from 7% to 20%. In addition, licensed securities brokers are
generally reluctant to handle an offering unless the amount being raised is in excess of $5 million to $10
million and they are absolutely convinced they can sell the offering. (In addition, generally they want an
attorney other than the attorney handling the offering to issue an opinion letter stating that the offering
complies with all the securities laws.)
This raises the issue of using “finders”. Finders are people who are not licensed as securities brokers who
are paid a commission (or other performance-based compensation) for locating investors. Federal law
prohibits the use of finders. Finders may be used in California-only intrastate offerings if all the
requirements are carefully followed.
Since roughly 2000, the SEC has effectively prohibited performance-based compensation for those who
are not federally licensed securities brokers. On the federal level finders can only be paid a fee that is paid
regardless of the success of the offering - and of course offerors do not want to do that.
An intrastate offering limited to California is different because California allows finders to be paid on a
commission (or other performance-related) basis even if they don’t have a securities brokers license. The
finders cannot be officers, directors, employees or independent contractors of the offering company (and
probably cannot become so for at least six months after the offering ends). In addition, the finders may
only introduce the parties and can play no role in negotiating the terms of the investment, advising either
party, or touting the investment. This is discussed in more detail below.
Of course, to fall within the intrastate exemption, the offering company must be formed in California,
have its principal place of business in California, and have and expect to have 80% of its assets, income
and expenditures in California.
While directors and key officers (this is limited to the president, secretary and chief financial officer and
to any other officer who has been expressly given the authority) of the offeror may sell the securities, they
can only be paid their usual salary and cannot be paid any compensation based on the performance of the
offering. Other officers and employees (and very probably independent contractors of the offeror) not only
cannot sell the stock, they absolutely cannot be finders.
In terms of what a “finder” can say, basically a finder can say only that the company is seeking investors
for a particular offering and communicate the price and terms, if any, already set by the offering company.
The finder cannot even give advice to either party regarding the negotiations. Given this, the finder should
have no role in giving advice on the price or terms even before making contact with the first potential
buyer. Also, the finder cannot try to convince a potential buyer to make the investment, since this would
constitute “selling”. Finally, once the finder introduces the buyer and seller, the finder should have the
most minimal contact with the buyer that is possible until after that sale is closed (and ideally until the
entire offering is closed). It is strongly recommended that the offeror have any finders sign a finder’s
agreement stating exactly what they can and cannot do.
CONCLUSION
While many of the offering exemptions prohibit public advertising (communications giving any specifics
about an offering), between 1) general communications that invite potential investors to submit an
investor questionnaire that can be used to qualify the investor, and 2) targeted communications to those
who are reasonably believed to meet the investor suitability requirements, many companies are able to
make investment offerings without using public advertising.

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2232 Sixth Street, Berkeley, California 94710 | Telephone: (510) 649-4019
Copyright 2009 Methven & Associates
DISCLAIMER: The information presented here is general only, and should not be taken as legal advice. 
We cannot guarantee that the material

With care, general public communications about a company and its need for investment money can be
made if no specifics regarding an offering are given. Individual, non-public communications giving
specifics to potential investors believed to meet the suitability requirements for the offering are also
allowed.
In addition, a California offering in compliance with 25102(n) can use a public "tombstone" advertisement
that offers brief information on the specifics of the offering. Also, a California-only offering can use full
public advertising if it is first qualified by permit by the Commissioner of Corporations.
SOME SECURITIES LAWS BASICS