CALIFORNIA SECURITIES LAW EXEMPTIONS

 

**Note: These are some of the common exemptions that are available under California state law, this is not an exhaustive list of available exemptions**

Private Loan Offerings

A business can raise money through loans without having to get a permit from the Department of Business Oversight under Section 25102(e) of the California Corporations Code, which provides:

25102. The following transactions are exempted from the provisions of Section 25110:

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(e) Any offer or sale of any evidence of indebtedness, whether secured or unsecured, and any guarantee thereof, in a transaction not involving any public offering.

But what does this mean?

Section 260.102.2 of Title 10 of the California Code of Regulations provides that for purposes of subdivision (e):

. . . an offer or sale, does not involve any public offering if offers are not made to more than 25 persons and sales are not consummated to more than 10 of such persons, and if all of the offerees either have a preexisting personal or business relationship with the offeror or its partners, officers, directors or controlling persons or by reason of their business or financial experience could be reasonably assumed to have the capacity to protect their own interests in connection with the transaction. The number of offerees and purchasers referred to above is exclusive of any described in subdivision (i) of Section 25102 of the Code and a husband and wife (together with any custodian or trustee acting for the account of their minor children) are counted as one person. This section does not create any presumption that a public offering is involved in offers not conforming to this section, and the determination of whether or not a transaction not covered by this section involves a public offering shall be made without reference to this section.” (emphasis added)

So, if an entrepreneur solicits loans from no more than 25 people who are among the entrepreneur’s close family, friends, or business colleagues, and no more than 10 of those solicited actually make a loan to the enterprise, this is clearly in compliance with the exemption stated in California Corporations Code Section 25102(e).

Additionally, if an entrepreneur solicits loans from no more than 25 people who can reasonably be assumed to have, based on their business and financial experience, the ability to protect their own interests in connection to the transaction, and no more than 10 of those solicited actually make a loan to the enterprise, this would also be in compliance with the exemption stated in California Corporations Code Section 25102(e).

A practical note: The exemption available under California Corporations Code Section 25102(f) is a broader exemption than what is available under Section 25102(e). However, unlike Section 25102(f), the exemption under 25102(e) does have a notice requirement.

Are there situations where an offering can exceed the 25 and 10 person limitations in Section 260.102.2?

The last sentence of Section 260.102.2 indicates that there may be situations where one could exceed those limits and still be within the spirit of the exemption in Section 25102(e). Unfortunately, it is not clear what an offering like that would like, so we take a look at California case law for some guidance on determining whether an offering is private or public.

In one California case, People v. Humphreys,[1] the court adopted the following six main factors to use in determining whether an offering is public or private:

(1) The number of offerees.

(2) The relationship of the offerees to each other.

(3) The relationship between the issuer and the offerees.

(4) The size of the offering.

(5) The manner of the offering.

(6) The character of the security offered.

The court also took into consideration whether the particular persons affected were in need of the protection of the registration and how easily the security could be transferred from the original to the subsequent purchasers.[2]

One case where this analysis was used to determine whether an offeror of securities complied with California Corporations Code Section 25102(e) is In re Christian Life Center.[3] In that case, the church, Christian Life Center, solicited loans from people who regularly attended meetings and the Reverend encouraged people to ask their friends and family to invest. No media announcements were made about the loan opportunity. The court found that the offering had not conformed to the limits of a private offering for several reasons, including that the number of people solicited was too high (thousands of people), that many offerees did not have a close relationship with the Reverend, that not all people solicited were part of a close community, that the Church raised a large amount of money from a large amount of people ($7.2 million from 1100 depositors). The court also noted in its analysis that “the solicitations made by Reverend Argue were not aimed solely at sophisticated lenders.”

This case, however, provides an example that far exceeded the parameters provided by Section 260.120.2 of the California Code of Regulations, and there is a lack of additional case law specific to California Corporations Code Section 25102(e). It might be risky, therefore, to make loan offerings that exceed the limits provided in Section 260.120.2 of Title 10 of the California Code of Regulations without clearer examples of offerings that lawfully exceed those limits.

A note of caution: California Corporations Code Section 25102(e) is an exemption from the permitting requirements, and not an exemption from the definition of a security or the sale of a security. So offerings under Section 25102(e) can be integrated with other securities offerings.

Private Offerings

Under Section 25102(f) of California’s Corporations Code, your offering is exempt if sales are made to no more than 35 persons and all purchasers have a preexisting relationship or business relationship with your business, or by reason of their business or financial experience (or the business or financial experience of their advisors) can be reasonably assumed to have the ability to protect their own interests in connection with the transaction.

 

Exemption for Qualified Purchasers

Similar to the exemption under Rule 506 above, there is an exemption under Section 25102(n) of California’s Corporations Code that allows for the offer and sale of securities to “qualified purchasers” through a public announcement that must comply with specific requirements. There are, however, no limits on the number of investors or on the amount of money that can be raised.

Who is a Qualified Purchaser?

California law defines a qualified investor in several ways, including:

  • An accredited investor under federal law
  • A business with assets in excess of $5 million according to its most recent audited financials
  • Natural persons, if certain conditions are met, including all of the following:
    • The person either individually or combined with a spouse has a minimum net worth of over $250,000, and gross income over $100,000 in the previous taxable year, as well as a reasonable expectation of gross income for the current year of the same amount; or a minimum net worth of $500,000 exclusive of home, home furnishings, and automobiles;
    • Each person’s investment shall not exceed 10 percent of their net worth;
    • Each person by reason of his or her business or financial experience, or that of his or her uncompensated professional advisor, can be reasonably assumed to have the capacity to protect her interests in connection with the transaction.

Shares or Memberships of Certain Cooperatives

Under Section 25100(r) of California’s Corporation Code, shares or memberships issued by cooperatives organized and operated under California’s Cooperative Corporation Law that do not exceed $1000 are exempt.

This exemption can also be used specifically by worker cooperatives to raise community-based investments from “community investors.” Community investors are not worker-members, but rather persons who invest in the worker cooperative with an expectation of a limited return and limited voting rights. Click here for more information on how worker cooperatives can use this exemption.

 

Agricultural Cooperatives

Agricultural cooperatives organized and operating under the Nonprofit Cooperative Associations provisions of the California Food and Agriculture Code (Sec. 54001 et seq., Food & Ag. Code) are expressly exempt from the California Corporate Securities Law,[4] and can therefore issue memberships, stock, or other securities without obtaining qualification.

Securities issued by a nonprofit cooperative association are also expressly exempt under Section 25100(m) of the California Corporations Code, which provides:

25100. The following securities are exempted from Sections 25110, 25120, and 25130:

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(m) Any security issued by any corporation organized and existing under the provisions of Chapter 1 (commencing with Section 54001) of Division 20 of the Food and Agricultural Code.

 


 

[1] People v. Humphreys, (1970) 4 Cal. App. 3d 693, 697 (4th Dist.). These factors originally appeared in the article “Guidelines for Determining when Securities are Being `Offered to the Public.'” in Bulletin No. 67-5, issued by Robert H. Volk, Commissioner of Corporations, May 25, 1967.

[2] Humphreys, 4 Cal. App. 3d at 698.

[3] In re Christian Life Center, (1984) 45 BR 905 (Bankr. Appellate Panel, 9th Circuit).

[4]  Sec. 54201, Cal. Food & Ag. Code; Sec. 25000 et seq., Cal. Corp. Code.