The use of social media for business, networking and personal purposes is increasing exponentially. Savvy entrepreneurs and businesses are using social media to market their products to a wider audience, drive traffic to their websites and increase sales. It’s hardly surprising that many of those same individuals and companies are turning to social media to fulfill their funding needs. However, in doing so, they may be inadvertently violating federal and state securities laws and putting themselves in a difficult situation.

You may have seen posts on LinkedIn, Facebook, or other social media websites requesting funding or suggesting a great investment opportunity. You might even have thought it would be a great way to raise money for your own business. What you are probably not aware of is that the primary method of raising money is by selling your company’s securities, which is a highly regulated practice. Federal securities laws generally prohibit any person from selling securities unless a registration statement covering the securities has been declared effective by the SEC or an exemption from the registration requirement is available. As you might imagine, registering securities in a public offering can be prohibitively expensive. Consequently, the only option most private companies have to raise money relies on certain limited exemptions from registration referred to as “private placements”.

Private placements are exactly that – private. A company seeking to raise money through a private placement may not offer or sell its securities by any form of “general solicitation” or “general advertising” and, in some cases, may only sell the securities to a limited number of eligible investors. Due to the restricted nature of these offerings they are not considered “public offerings” and, therefore, are not subject to the registration requirements.

What does this mean to the young company looking to raise money? It means what may seem like a harmless online post may in fact be deemed a “public” communication prohibited by federal and state securities laws. Although the law has not kept pace with social media, and there is no clear rule on what constitutes “general solicitation” or “general advertising”, securities laws generally prohibit communications regarding a stock offering published in any newspaper, magazine or similar media. Consequently, a widely disseminated online post that your company needs money is likely a prohibited communication.

What about posts in group forums on LinkedIn or to “friends” on Facebook you may ask? That is not quite as clear. A company may prove a stock offering was not based on general solicitation or advertising if the company or its principals had a pre-existing substantive relationship with the prospective investors. It may be possible for such a relationship to develop online. However, companies should be wary of making such an assumption. The SEC has stated that such a relationship is one that existed before the offering was contemplated and that enables the company to be aware of the financial circumstances or sophistication of the potential investors. While parties may develop such a relationship in an online setting, it is unlikely that merely joining a group on LinkedIn or adding a new “friend” on Facebook would, by itself, be sufficient for a company to understand all of the group’s members’ or friends’ respective financial circumstances or sophistication. The relationship must be substantive enough to ensure a reasonable belief can be formed that the potential investor meets the requirements to invest.

That are the consequences of these violations? First, the private placement exemption may no longer be available, resulting in the delay or even termination of your effort to raise capital. Second, the investors could have the right to rescind the offering, essentially giving them the right to demand the return of their investment at any time if they are not pleased with the company’s performance. Finally, the SEC could impose civil, and possibly criminal, enforcement actions against the company and its principals. Given these potential ramifications, it is in each company’s best interest to carefully consider what it, and its employees and agents, are posting online.


For the owners of most private companies, selling is a new and daunting process. Capitalizing on the value of the business in such a situation can be difficult for the unprepared. If you are considering selling your business, careful planning early in the process can help you ensure the process runs smoothly and ends with the best results.

1.   Know Your Goals

Before taking any steps, you should first have a clear understanding of why you are selling. A sophisticated buyer will question why they should buy your business if you no longer want to own it. It is important to be prepared to answer this question both for the buyer and for yourself. If your goal is to retire, you should have a firm understanding of how much money you will need to receive for your business to maintain the lifestyle you want during retirement. A qualified financial planner can assist you in making that determination. If your goal is not to retire, you should carefully consider how selling the business will affect you. Most buyers will require you to sign a non-competition agreement, prohibiting you from competing with the business for several years after the sale. If you cannot retire on the sale proceeds, can you afford to be out of work in the industry for several years? If not, you may need to negotiate an exit that provides for your continued involvement in the business after the sale or reconsider whether a sale to a third party is the proper exit for you. Other options include an installment sale to a key employee or succession planning to a family member.

2.   Understand your company’s value.

A realistic expectation of your company’s value is needed to make these tough decisions. While business owners typically have a general idea of their company’s worth, they may not have a firm grasp of its actual current market value. Obtaining a valuation from a professional source can provide you with a realistic expectation for your exit and help you negotiate proper value for your business based upon defensible information.

3.   Put your house in order.

Before proceeding to market, make sure your business is ready to go under a microscope. Potential buyers will typically conduct in-depth due diligence on your business before acquiring it. If their review uncovers any potential risks, they could be scared off or reduce the purchase price. By carefully reviewing your business in advance, you can identify potential weaknesses, eliminate red flags, alleviate a buyer’s potential concerns and maintain your bargaining position. Make sure your corporate records and financial statements are accurate and up-to-date, important arrangements are properly documented, your key employees are retained, lawsuits have been settled and there are no skeletons likely to pop out of your company’s closet.

4. Keep it quiet.

News of a potential sale may cause suppliers, customers or employees to look for opportunities elsewhere due to the company’s uncertain future, which can decrease the company’s value. It is important to maintain confidentiality by restricting disclosure of the proposed sale to those individuals needed for the sales process and requiring nondisclosure agreements when prudent.

5.   Stay focused on your business.

Selling your business can be a full-time job. Don’t forget that potential buyers will be scrutinizing the profitability of your business. If revenues falter or other concerns arise because you have not concentrated sufficiently on your business, buyers may seek to reduce your purchase price or back out of the deal entirely.

6. Learn and manage the process

Commencing the sales process, identifying the right buyer, negotiating the terms of the sale and closing the transaction can take longer than expected. Depending on the risk adversity of the buyer, due diligence alone may take 30 to 60 days, or in some cases longer. Understanding the sales process will allow you to be prepared, plan accordingly and start the process at the right time to maximize the marketability of your business. You should also identify upcoming issues, such the expiration of critical licenses, leases or other agreements, and be ready to deal with them. Don’t let surprises derail your transaction.

7.   Get the right help

Most business owners have little, if any, experience selling a business and find themselves negotiating with experienced buyers. Engaging professional advisors that are experienced in mergers and acquisitions early in this process will level the playing field, help maximize the value you receive for your business and ensure you are protected in the process. The sale of your business is not the time to hire a family friend or relative that is not an experienced mergers and acquisitions professional. The right professionals will guide you through the entire sales process and help you avoid common mistakes and pitfalls that can be difficult and expensive to fix in order to get your deal back on track.
It is never too early to begin this process. By taking the steps to evaluate your options, understand your company’s value, put your business in order and obtain professional assistance, you are strategically planning for the successful exit you want.

Jason Femrite’s practice focuses on the representation of both private and publicly held companies, funds and investment firms in a wide range of transactions from structure and formation to capitalization and finance, and sale and acquisition. Mr. Femrite’s emphasis is in the areas of mergers and acquisitions, private equity, corporate and venture finance, securities and general corporate matters. His experience in these areas includes the representation of both buyers and sellers in mergers, management buyouts, stock and assets sales and private placements. He also has significant experience in the areas of corporate governance and securities compliance for both public and private clients. He represents clients involved in many industries, including biotechnology, cleantech, action sports, financial institutions, automotive and manufacturing. Reach him at 858.720.6334 or
January 2011
Copyright @2012 Procopio, Cory, Hargreaves & Savitch LLP


Raising investment  capital  for  a  busi‐ ness  isn’t  easy  in  this  climate  and  most  entrepreneurs  are  willing  to  take any help they can get. Few entre‐ preneurs have sufficient personal con‐ tacts  to  fund  an  offering  and  when  they  are  not  an  attractive  candidate  for  the  venture  capital  market,  they  enlist  the  services  of  well‐connected  individuals  who  make  introductions  and open up  their contact lists. These  individuals who act as intermediaries  in  the  capital  raising  process  are  called “finders.”  The problem is these “finders” may be  acting as unregistered broker‐dealers.  The Securities and Exchange Commis‐ sion  (SEC),  the  Financial  Industry  Regulatory Authority (FINRA), as well  as  state  regulatory  agencies  highly  regulate  the  activities  of  broker‐ dealers.  In  the  past,  private  place‐ ments  involving  unregistered  finders  ran  little  risk  to  the  finder  or  the  is‐ suer.  The  SEC  rarely  investigated  or  pursued  finder  arrangements,  and  sought  enforcement  only  when  the  unlicensed match‐making occurred in  connection  with  much  more  signifi‐ cant wrongdoing.    This  has  changed.  Over  the  past  18  months,  the SEC has actively pursued  investigation and enforcement actions  for violation of the broker‐dealer laws  as  they relate  to unregistered  finders.   In  addition,  in  this  current  economic  climate  where  investors  in  private  placements  have  seen  their  invest‐ ments  sour,  or  at  best  their  path  to  liquidity  shut  down,  investors  are  bringing  private  actions  against  issu‐ ers to rescind their investments.   California  Corporations  Code Section  25501.5  gives  investors  the  right  to  rescind a  transaction when an unreg‐ istered  broker‐dealer  procures  their  investment.  If  the  investor  no  longer  holds the securities, he or she may sue  for damages. Pursuant to its authority  under an amendment  to Code of Civil  Procedure Section  1029.8,  the  court  may  award  attorney’s  fees,  costs  and  treble damages up to $10,000.  As a  result  of  the civil and  regulatory  exposure,  companies  seeking  to  at‐ tract  private  capital  have  wisely  re‐ considered  their  use  of  finders.  If  not  doing away with  finder arrangements  entirely,  they  have  tailored  their  ar‐ rangements to ensure  their  finders  fit  within  a  very  narrowly‐tailored  ex‐ emption from registration.   The “Finder’s Exemption” From Broker­Dealer Registration Section  15  of  the Securities  Exchange  Act  of  1934,  as  amended,  defines  a  “broker” as any person engaged in the  business  of  effecting  transactions  in  securities.  Section  15(c)(6)  makes  it  unlawful  for  a  person  not  registered  as a broker‐dealer to effect any trans‐ action  in  securities.  California’s  “blue  sky” securities laws essentially restate  the  federal  law.  Corporations  Code  Section 25004 defines a broker‐dealer  as any person engaged in the business  of  effecting  transactions  in  securities  in  California.  Under  Section  25210,  any  person  acting  as  a  broker‐dealer  must  be  licensed  by  the  Department  of  Corporations  unless  they  are  oth‐ erwise exempt.   Finders  argue  they  are  not  “effecting  transactions” in  securities, and  there‐ fore  are  not  acting  as  broker‐dealers,  when  they  facilitate  investments.  Finders  and  issuers  have  historically  relied  on  a  1991  SEC  no‐action letter  (Paul Anka, July 24, 1991)  to  support  this  position.    In  the  Anka  no‐action  letter,  the  SEC  blessed  a  “finder’s  ex‐ emption”  for  persons  that  merely  open  up  their  contact  lists  or  make  introductions  to  potential  investors.  The  SEC  found  it  important  that  the  finder  merely  furnished  his  contact  list of accredited investors and did not  negotiate or offer advice in the financ‐ ing. Although  the SEC looked askance  at  the  compensation  arrangement  where  the  finder was  paid  a  percent‐ age of the money he raised, it noted he  had  not  previously  arranged  invest‐ ments and agreed he would not do so  in the future.   JUNE 2009 JOHN P. CLEARY John P. Cleary is a nominee for the North County Bar Association’s 2010 Writer’s Award for the following article which appeared in the November 2009 edition of North County Lawyer Magazine. Copyright @2009 Procopio, Cory, Hargreaves & Savitch LLP.  All rights reserved. │ 2 California  case  law  and  interpretive  guidance  from  the  Commissioner  of  Corporations also address the issue of  finders.  In  each  instance,  the  finder’s  exemption  has  been  narrowly  con‐ strued  to exclude most capital raising  efforts by unregistered finders.    Based  on  available  authority,  several  issues  must be  examined before  en‐ gaging a  finder. Each issue is relevant  to whether a finder will be deemed an  unregistered  broker‐dealer  for  pur‐ poses  of  regulatory  action  or  liability  under Section  25501.5.  The  determi‐ nation is not a balancing  test of  these  factors.  Rather,  violation  of  one  of  these  factors  will  render  the  finder  arrangement illegal.   1. Is the Finder Providing Services Other Than Simple Introductions? Black’s  Law  Dictionary,  Sixth  Edition,  defines  a  finder  as  “an  intermediary  who  contracts  to  find,  introduce  and  bring  together  parties  to  a  business  opportunity, leaving ultimate negotia‐ tions  and  consummation  of  business  transactions  to  the principals.” A per‐ son  loses  his  or  her  finder  status  by  taking any role, however minor, in the  ultimate  sale  of  the  securities.  The  finder’s  involvement  must  start  and  stop with making introductions.   Issuers  must  ensure  the  finder  is  not  involved in presentations to investors,  negotiation  of  transactions,  structur‐ ing  of  deal  terms  and  similar  activi‐ ties. Other activities that will render a  finder non‐exempt include:   • providing advice or recommenda‐ tions  about  the  merits  of  a  par‐ ticular transaction.   • providing  assistance  to  investors  in  completing  the  purchase  agreement,  subscription  agree‐ ment or other documentation.   • providing  financing  to  any inves‐ tor for purchase of the securities.   • providing assistance to the issuer  in  drafting  or  distributing  any  material  including  financial  data  or sales materials.   • introducing  the  issuer  to  com‐ mercial  banks,  lawyers  or  other  professionals  to  facilitate  the  fi‐ nancing.   • handling  the  funds  or  securities  involved in the transaction.   The  more  information  and  assistance  the  finder  gives  to  investors  or  the  issuer,  the  less  likely  he  or  she  will  maintain exempt  status. Even arrang‐ ing  meetings  between  the  issuer  and  prospective  investor  will  jeopardize  the exemption. Both issuers and  find‐ ers  are  well‐advised  to  ensure  the  scope  of  engagement  is  clearly  and  conspicuously  committed  to  writing  and followed in practice.  2. Does the Finder Regularly Engage in the Business of Facilitating Investments? As  the  SEC  first  made  clear  in  the   Anka no‐action letter, the regularity of  a  finder’s activity is crucial  to  the de‐ termination of whether he is acting as  a  broker‐dealer. Nothing is more  cer‐ tain  to  blow  the  finder’s  exemption  than engaging a person who regularly  acts as a finder.  Individuals who profess to be “profes‐ sional  finders”  may  be  successful  in  raising  money,  but  they  will  put  that  money  at  risk  and  expose  the  com‐ pany  to  the  potential  of  regulatory  action, fines, penalties, litigation and a  myriad  of  other  consequences.  If  an  issuer  is  looking  for  a  proven  finder,  the  only  safe action  is  to  employ  a  registered broker‐dealer or placement  agent.   3. Is the Finder’s Compensation Dependent on Success in Raising Capital?   It is  a  common misperception  among  entrepreneurs  and  finders  that  the  payment  of  a  fee  in  cash  or  equity  is  acceptable if  the  finder merely makes  introductions.    This  is  wrong.    It  is  a  myth  perpetuated  by  entrepreneurs  and finders who have not been caught.  It  is  verboten  to  pay  a  finder  a  fee  based  on  the  amount  of  capital  he  or  she is  responsible  for  bringing  to  the  company.  SEC  no‐action  letters  post‐ Anka  and  recent  guidance  from  the  SEC could not be clearer that success‐ based  compensation  is  the  primary  characteristic  of  broker‐dealer  activ‐ ity. Whenever  the  finder will be com‐ pensated  based  on  success  in  raising  capital,  he  or  she  has  the  “salesman’s  stake”  characteristic  of  a  broker.    In  the  SEC’s  view,  it  is  this  “salesman’s  stake”  that creates  the risk of unscru‐ pulous  activity  and  the  need  for  the  regulation  and  oversight  that  broker‐ dealer registration provides.  I have heard countless proposals from  entrepreneurs  and  consultants  seek‐ ing  to  avoid  the  success‐based  com‐ pensation  prohibition.  The  most  common  would  involve  hiring  the  finder  as  a  “consultant”  and  paying  him  a  “consulting  fee”  for  unspecific  business  purposes,  payable  if  and  when  the company achieves a certain  funding threshold.  No matter how the  arrangement is structured, if the fee is  tied  to  the  finder’s  activity  in  raising  investment  capital,  and  he  would  not  have  received  the  fee  absent  his  suc‐ cess in doing so, then it is not permis‐ sible.   The safest course is to pay the finder a  fixed  fee regardless of the outcome of  his  or  her  efforts  (for  example,  the  finder receives a $10,000 fee for mak‐ ing  the  introduction  regardless  of  whether  the  investor  purchases  shares).  This  of  course  requires  the  assumption of some risk on the part of  the  entrepreneur  in  the  event  the  in‐ troduction  does  not  lead  to  an  in‐ vestment.  If  practicality  requires  a  success‐based  compensation  ar‐ rangement,  the  only  solution  is  to  have  the  finder  affiliate  with  a  regis‐ tered  broker‐dealer,  essentially  be‐ coming  a  “back  office”  entity.  For  smaller transactions, this is not a real‐ istic  solution  because  the  finder  would  have  to  pass  the  relevant  li‐ censing  exams,  find  a  firm  willing  to  undertake supervisory duties over his  activities and he certainly would have  to  share a  portion  of  the  fee with  the  supervising firm.  The Consequences of Using an Un­ Copyright @2009 Procopio, Cory, Hargreaves & Savitch LLP.  All rights reserved. │ 3 registered Finder Using  an  unregistered  finder  to  help  fund  a  deal  poses  significant  risks  to  both  parties involved.  The issuer will  face regulatory action by  the SEC and  state authorities, and may face private  actions by investors for damages or to  rescind  their  investments.  Using  an  unregistered finder will call into ques‐ tion  reliance  on  the Regulation D pri‐ vate  placement  exemption  and  be‐ cause  Section  25501.5  allows  inves‐ tors  to  rescind  investments  procured  through  the  use  of  unregistered  find‐ ers, the  funds  raised  will  be  at  risk  during  the  statute  of  limitations  pe‐ riod.    The  contingency  created  through  the  rescission  right  also  causes  accounting  troubles.  Finally,  if  the  investors  demand  a  legal  opinion  to close the transaction, the issuer will  also  have  a  hard  time  convincing  counsel to issue one.   Using an unregistered  finder will also  jeopardize future efforts to raise capi‐ tal. A common sanction sought by the  SEC  against  issuers  utilizing  unregis‐ tered finders is to bar the issuer from  conducting  Regulation  D  offerings  in  the  future. This, of course, could have  a  lethal  effect  on  a  start‐up  company  dependent on private capital.  In addi‐ tion,  some  regulators  have  at  least  informally  advised  issuers  that  the  use of non‐exempt finders will render  the company liable as aiders and abet‐ tors of securities law violations under  Section  20(e)  of  the  Securities  Ex‐ change  Act  of  1934.  For  emerging  growth companies planning to tap the  public  markets  in  the  future,  these  issues  will  at  best  be  spoilers  during  the  road  show  presentations  to  large  banks.   The  consequences  to  the  finder  also  are  severe. If  a  finder’s  activities  do  not  fall  within  the  exemption  from  registration,  his  or  her  agreement  with  the  issuer  will  be  wholly  unen‐ forceable  in  court.  As  a  result,  the  finder has no way to enforce payment  by  the  issuing  company  and  may  not  be  compensated  for  his  or  her  ser‐ vices.  In addition, non‐exempt  finders  are  susceptible  to  civil  and  criminal  penalties under both federal and state  law.