Subscription Agreements and Private Investments
In 2019, there were four million small businesses in California. But many of California’s smaller businesses are economically fragile and more likely to close during financial downturns like we’re currently experiencing. In the best of times, funding can be difficult to come by for small businesses. Your company may be too small and too new to go public, and you may not have the resources or contacts to consider venture capital funding. Luckily, there are options for startups that allow businesses to raise money by selling stocks without first registering with the U.S. Securities and Exchange Commission (SEC).
What is a Subscription Agreement?
A subscription agreement is a contract that functions in a similar way to any standard purchase agreement. It is a promise from a private company to sell shares of stock at a specified price to a private investor or subscriber. Like any stock purchase, the shares purchased make the subscriber a part-owner of the company.
A subscription agreement can also help to qualify potential investors. Under SEC regulations, only accredited businesses and individuals can purchase stock from a privately held company. If the company violates this rule, it may forfeit its private status, and regulations require that they register with the SEC. By including these requirements in a subscription agreement in conjunction with an indemnity agreement, companies can mitigate the risk of selling to an unqualified buyer under SEC rules.
Why is a Subscription Agreement Important?
For small companies that need funding, a subscription agreement is a great way to sell shares and raise capital without taking a company public or finding venture capitalists to invest. Investors will enter into a limited partnership and are only obligated to make a one-time investment. This limited partnership limits the risk for investors and often limits the say they have in the company.
Rule 506 of SEC Regulation D permits companies to raise capital if they limit how they market their securities and ensure that all buyers are accredited. The rules limit:
- How companies can solicit investors;
- The information shared with investors; and
- Who may invest.
If you’re the owner of a small business considering your options for raising capital, or if you’re an investor considering the wisdom of a subscription agreement, you should see an experienced California business attorney. An attorney can explain all of your options and help ensure that your subscription agreement complies with SEC rules and limits your liability.