Florida Law
Florida Securities & Venture Finance Law
Securities & Venture Finance Law
A brand new business that survives more than a few years is bucking the odds. The vast majority of new businesses do not reach their first anniversary and only a handful reach their fifth. Lenders are keenly aware of these statistics, and thus they view funding startup businesses as highly risky. Conventional banks generally are wary of lending money to new businesses and usually require a large capital investment by the prospective business owner as well as a personal guarantee from him or her to repay the loan if the business cannot. In practice, therefore, securing money for a new venture largely depends on what owners can raise on their own. The following is a discussion of some options for those looking to finance new ventures.
Securities
An option for business owners in need of capital but unable or unwilling to go into debt is to sell equity stakes in the business. Securities such as stocks and bonds are different from other commodities because they have no value by themselves. Rather, they are evidence of a debt owed to their holder. They are written secured promises to pay back money or other payment. All offerings of securities can be placed into one of two categories, depending on the regulations that govern them. Securities that are exempt from the registration requirements of the Securities Act of 1933 are called private placements, while all other sales of securities are called public placements. Although the majority of business issue securities are exempt from registration requirements, it can be very difficult to discern whether a specific business is exempt.
Stocks and Bonds
There are two different types of securities: stocks and bonds.
Bonds are documents that signify a debt owed. Selling a bond is
like a loan agreement in which the bond holder is promised the
return of the original sum loaned out plus interest over time.
Generally, a bond is secured with collateral, which ensures that
the debt will be satisfied even in the case of default by the
party that issued the bond.
Stocks signify an equity or ownership interest in a company. The
unit of ownership is the share, and the holder of one or more
shares in a company has some say in how the company is run, how
profits are spent, and how the company's assets should be divided
upon dissolution of the company. Some companies distribute profits
to shareholders by paying dividends. Other corporations reinvest
the profits within the business, thereby theoretically increasing
the value of the stock.
Securities Markets
The vehicles through which sales and purchases of securities are
conducted are called securities markets. These markets do not
necessarily have a physical location; sometimes they are just
informal networks through which buyers and sellers of securities
make transactions. The largest securities market–in terms of the
value traded–is the bond market. The bond market is the means
through which the United States government, state and local governments,
and corporations borrow money from the public. Because bonds generally
are less attractive to individual buyers and are more likely to
be purchased by professional investors, bond markets are less
widely regulated than are markets for common stock.
There are two kinds of markets for stocks–over-the-counter markets
and exchange markets. An over-the-counter market is the less rigid
of the two. This type of market exists via a network of transactions,
with no permanent physical location. Instead, the market uses
telephone and computer connections. This kind of market allows
a wider variety of firms to participate in the trading of securities.
Exchange markets differ from over-the-counter markets in several
important ways. Exchange markets operate in a facility in which
actual transactions occur between parties on a trading floor.
The New York Stock Exchange is the largest such exchange. Exchange
markets differ further from over-the-counter markets in that they
operate under stricter guidelines that govern who may and may
not trade on the exchange. The distinction between over-the-counter
and exchange markets is blurring because of new technologies that
call into question the need for "floor" trading.
A securities firm makes its money in several different ways. In
an exchange transaction, the firm charges a commission on the
purchase or sale of the stock. In the case of over-the-counter
stock, a firm is hired to create a market for a certain stock.
In this case, the firm will sell the stock to customers at a price
higher than the sale price to other brokers. The firm makes its
profit from the difference between its cost for the stock and
the price of stock as offered to the public.
Private Placements
Private placements or private offerings are sales of securities
that are not subject to requirements for registration under the
Securities Act of 1933. As these exemptions are fairly complex,
and the punishment for breaking securities regulations are severe,
legal advice from an expert in the field of securities regulation
is highly recommended for business people with an interest in
private placements.
Initial Public Offerings
A business "goes public" when it solicits or concludes a sale of securities from a group of public investors. Although there are exemptions available under both federal and state laws, public offerings generally must comply with registration requirements set forth by the federal Securities and Exchange Commission (SEC) and state authorities. An initial public offering, often referred to as an IPO, is the first such public sale by an organization.
Regulation
Largely because of the nature of securities–they do not have a
value in and of themselves and therefore can be created and sold
in unlimited amounts–there has developed a fairly sophisticated
network of laws governing their use and sale. Securities law is
governed by both state and federal laws, but all these laws have
four main purposes:
• To ensure that investors have an accurate idea of what (and
how much) they are getting when they purchase securities
• To ensure disclosure of information concerning corporations
or other entities that are trading in securities
• To prevent fraud, insider trading, abuse of non-public information,
or other price manipulation
• To govern those who buy and sell securities on the secondary
market to investors
Securities regulations can be extremely technical. A business
seeking to issue securities to finance its business should consult
an expert. If the business is not exempt from registration, meeting
the registration requirements can be quite expensive. On the other
hand, public placements offer distinct advantages over private
placements. Though complicated, securities regulations protect
the investor or buyer of the securities. For this reason, sales
of securities in violation of state and federal rules are subject
to strict civil and criminal penalties, even if the violations
are inadvertent or the result of ignorance.
Federal Laws
There are a number of federal laws upon which much of the regulation
of the sale of securities is based. The Securities Act of 1933
deals with the initial public offering of securities. The aim
of this legislation is to prohibit fraud or deception in the sale
of the securities by providing for full disclosure of facts concerning
the securities for sale and the business and finances of the issuer.
The Securities Exchange Act of 1934 regulates trading in the secondary
market. Like the earlier Securities Act of 1933, it requires disclosure
of information about the offering. This Act established the Securities
and Exchange Commission, the principal regulatory body policing
securities markets. It also instituted several other restrictions
on publicly held corporations, such as a restriction on the amount
of credit that can be extended for the purchase of securities.
The Act further requires brokers, dealers, and businesses that
deal in securities to register with the SEC. It was amended in
1975 to give the government even broader powers over securities
exchange and the structure of the market system.
The Trust Indenture Act of 1939 regulates public issues of large
securities. The Investment Company Act of 1940 regulates publicly
owned businesses that deal primarily in the buying and selling
of securities. The Investors Advisers Act of 1940 sets down rules
for the registration and regulation of investment advisors, similar
to those used in the Securities Exchange Act of 1934. The Securities
Investor Protection Act of 1970 established the Securities Investor
Protection Corporation, which has the authority to oversee the
liquidation of securities firms and to pay off debts owed to their
customers.
Florida Laws
In addition to federal securities laws, there are state securities
laws, generally referred to as "blue sky laws." Like federal laws,
blue sky laws provide for registration of brokers and dealers,
require information to be made available about securities open
for trading, and also mandate penalties for fraudulent or deceptive
practices.
The Florida securities laws are administered by the Florida Department
of Banking and Finance. Violation of state securities laws can
result in cease and desist orders, administrative and civil fines,
and, if the violation involves in excess of $50,000 from five
or more individuals, criminal felony penalties.
Registration of Securities
Sale of securities, unless exempt, is unlawful unless the securities
are properly registered. The Florida Department of Banking and
Finance oversees the registration process. Registration may be
denied or revoked if the terms of the offer or sale are not "fair,
just or equitable." Registration typically requires filing a written
application detailing information regarding the issuer of the
securities and any other amendments or applications requested
by the Department. Often, the Department requires that the issuer
provide supplemental statements, exhibits, and documents within
30 days of the effective registration. In Florida, except for
issuer dealers and primary governmental securities dealers, issuers
also are required to register with the federal SEC.
Issuers of securities always must provide prospective investors
with a copy of the current prospectus prior to consummating a
sale of securities. The prospectus must detail the business dealings
and identify whether the issuers do business with anyone in Cuba
or the Cuban government. Certain ventures in gas, oil, petroleum,
or mineral titles or leases will not be allowed. All real estate
securities registrations must have specific provisions in the
declaration of trust and have an offering price not to exceed
the established market price.
Filing Fees
The State of Florida requires a nonrefundable registration fee
of $1,000 per application. Investment companies are charged a
filing fee of $1,000. National Association of Securities Dealers
broker-dealers must file licensing applications with the Department
of Securities and Investor Protection and pay related annual assessment
fees.
Exemptions
Exemptions from many securities rules are available under both
federal and state laws. The burden of proving an exemption is
on the person raising it as a defense. If a security is exempt,
it need not comply with the registration requirements. Religious
organizations may not directly or indirectly offer or sell securities
except by an offering circular containing full and fair disclosure
of financial and other specific information.
A limited offering (issuance of securities within a 12-month period)
is exempt if made to no more than 35 purchasers. Offers or sales
of registered securities appearing in any list of securities dealt
on any registered stock exchange are exempt.
Debt Financing
Selling securities is difficult and highly regulated. The cost
of complying with these regulations, as well as the difficulty
in convincing buyers that a business is a good investment, makes
offering securities impractical for many startup companies. Another
way of selling ownership in a company–by admitting partners into
the deal for a cost (called a limited liability company)–is an
option, but a business owner must be willing to forgo some of
the profits and must convince prospective members they will make
money. Further limiting the appeal of memberships in limited liability
companies is the fact that they are not freely transferable to
third parties. Thus, it is a somewhat easier task to raise money
through debt financing from a bank, credit corporation, or local
or state loan program. There are various ways a business can go
about finding venture capital from public and private sources.
Anyone trying to use a lender to raise money for a new business
will need to give a prospective lender detailed information about
the form the new company will take. At a minimum, a prospective
business owner will have to provide information about his or her
current financial situation, including all business and personal
assets and debts. Also, an applicant must be prepared to provide
information about how the money requested will be spent and a
full description of the intent of the business, along with information
about the experience and management capabilities of the owner
and those expected to be employed in top positions. A lender also
will want to know how much money the owner plans to invest in
the business and any projections of how much the business is expected
to earn in its first year.
Retail and service-oriented businesses often have more difficulty
obtaining financing because the funding for these types of businesses
is used for expenses such as inventory, fixtures, and working
capital–collateral that usually does not meet a lender's criteria
for resale recovery. Often, these endeavors are financed primarily,
if not fully, through equity. With that background in mind, following
are various types of debt financing options that are available.
Conventional Bank Loans
Bank loans are a common way of financing new ventures. The most
advantageous to young businesses, but toughest to obtain, are
unsecured loans. These are usually available only for short-term
loans to borrowers with strong balance sheets, ample cash flow,
and a low debt-to-equity ratio. Unsecured loans usually are made
for less than one year, and the interest rate is based on the
size of the loan, the financial health of the borrower, and the
type of industry or business in which the borrower engages. Easier
to obtain are a variety of secured loans, which can be structured
in a variety of ways and which can give the lender a security
interest in accounts receivable, inventory, or raw materials.
It is almost impossible to finance a business with 100 percent
debt. Cautious bankers–and bankers are a cautious bunch–typically
require that at least half of the startup costs be covered by
the owner, and nearly any source of financing will require at
least a 20 percent equity stake by the owner.
As noted above, financiers are more willing to provide funding
for projects in which there is collateral that can be easily sold
if necessary to recoup their investment. Thus, manufacturing and
industrial operations historically are easier ventures to finance
than retail and service businesses.
A bank is a corporation that earns money by maintaining savings
and checking accounts, issuing loans and credit, and dealing in
negotiable securities for governments and corporations. Banks
invest the money entrusted to them by their customers. The investments
that banks are allowed to make are regulated, and banks are defined
by the limitations put upon them. The types of banks (in order
from least to most regulated) are commercial banks, savings banks,
and savings and loans.
Commercial banks are the most common and least regulated type
of bank. These banks must have more deposits on hand than other
types of banks in order to handle the daily transactions of the
bank and prevent a money shortage (and the panic that can result).
These types of banks are often publicly held corporations.
Savings banks, a rarer form of bank, are limited-service banks
that were originally formed to encourage people to save their
money. To this end, savings banks traditionally offered as their
major service "time" savings accounts that prevented withdrawal
of deposited money until a set period of time had elapsed. In
modern times, the services of this type of bank have expanded
somewhat. A businessperson looking for a lender should note that
a savings bank sometimes offers higher interest rates on accounts
than a commercial bank. This is because a savings bank does not
have to keep as high a portion of its deposits in reserve as commercial
banks. Savings banks are usually owned in the form of a partnership
of depositors who receive dividends in the form of interest on
their accounts.
The third type of bank is a savings and loan association. Despite
news of scandals and problems in recent years, savings and loan
banks traditionally have been highly regulated, conservative organizations
whose primary purpose–other than encouraging savings–is to provide
loans for homes and businesses. Other information about banks
can be found in the Banking & Financial Institutions Law Chapter.
Asset-Based Lenders
Asset-based lenders use assets as collateral to lend money to businesses that would not ordinarily qualify for bank loans. Businesses that are growing fast but have not established a credit history with a bank might find these lenders helpful. Generally, businesses that seek asset-based loans are high risks, so asset-based lenders charge a premium for their service. Some asset-based lenders will use a business' receivables and inventory as collateral. Others may prefer to use real estate or equipment as collateral.
Commercial Finance Companies
Commercial finance companies specialize in financing high-risk applicants unable to obtain conventional bank financing. Their interest rates tend to be substantially higher than those offered by conventional banks because of the increased risks. Because commercial finance companies have more experience evaluating the liquidation value of failed businesses, they often are more willing to finance riskier applicants.
Venture Capital Companies
Venture capital companies specialize in lending to start-up companies
or established companies expanding into new risky markets. They
provide capital to businesses that might not be eligible for straight
bank loans but have high potential in their market. These companies
assess the viability of an emerging business and fund it by taking
a stake in the company. They may prefer to acquire stock in the
company as a way to finance the loan and insist on playing a substantial
role in managing the company. Thus, the success of the venture
capital firm depends on the success of the business. Many investors
demand a say in management decisions in exchange for their investment
capital–a demand that is an anathema to some entrepreneurs.
Only about one out of every ten investments reaps profits for
venture capital companies, so they are choosy about where they
place their money. Many firms specialize in certain areas in which
they have expertise. Before approaching a venture capitalist,
a business owner should prepare a solid business plan that takes
into account marketing plans, cash flow, and research needs.
Public Financing
There are many government programs charged with helping businesses
succeed. One of the ways the government encourages new businesses
is by making loans easier to obtain. The United States Small Business
Administration (SBA) helps qualified small businesses get loans
by offering lending banks guarantees on the loans. The SBA will
guarantee 85 to 90 percent of a loan depending on the size of
the loan (the maximum is $750,000). It is difficult to receive
the SBA's help, however, without sizable investment capital from
investors.
In addition to the SBA, there are a number of other government
programs–at the local, state, and federal levels–designed to help
specific kinds of businesses. For example, some programs are designed
to assist minority-owned businesses.
Franchises
Strictly speaking, franchising is not a type of new venture financing,
but it can be a way for an existing business to expand rapidly
and move into new markets for a reasonable cost. A franchise is
a right given to a private person or corporation to market a given
product within a certain area. When a business with a trademark
sells the right to use that trademark to a distributor of products
or services, the business distributor may be a franchise. Usually
the business selling the franchise also provides market assistance
to the buyer.
Franchises are governed by both state and federal law. It is extremely
important to know these laws before starting a business that may
franchise or if considering becoming a franchisee for another
business. The laws are drafted using broad language and some people
find themselves in violation of the laws, even though they are
not engaged in activities they consider to be franchising.
The Federal Trade Commission (FTC) enforces laws and rules regulating
franchises. These rules do not require a business to register
with or seek the approval of the FTC before offering or selling
a franchise; they only apply to franchises that are "in or affecting
interstate commerce." Although there are differences between state
and federal franchise laws, it is most important to remember that
the name of a company is not important as long as the relationship
meets the definition of a franchise. This means that if a business
is entering into a limited partnership, it may also be entering
into a franchise agreement. The FTC rules define a franchise as
a "continuing commercial relationship" between two or more parties.
This continuing relationship is further defined as one in which
supplies for reorder are made available to the purchaser after
the first required inventory is purchased.
There are three basic types of "continuing commercial relationships"
covered by the rules:
• Package franchises, or "business format" franchises, which
are defined as prepackaged business programs developed and identified
by the franchisor. McDonald's is an example of this type of franchise.
• Product franchises, in which the franchisor sells goods that
bear his or her trade name to a franchisee, who in turn sells
them to the public under the same name. The dealer company maintains
some degree of control over the selling of the goods by the franchisee
in this arrangement.
• Business opportunity ventures, in which the franchisor retains
more control than in either of the previous arrangements. In this
type of franchising agreement, the franchisee is required to buy
and sell the goods or services of the franchisor or another business.
The franchisor also arranges the location of the business, seeks
out business for the junior partner, and even provides employees.
An example of this type of arrangement is a vending machine route.
The franchisor company finds a place to put the machines and sells
the candy to the franchisee, but the franchisee collects the money
and restocks the machines.
Franchises also are discussed in the Small & Closely Held Business Law and Franchise & Dealership Law Chapters.
Resources
Federal Trade Commission, Sixth and Pennsylvania, Washington,
D.C. 20560, (202) 326-2000.
United States Security and Exchange Commission, 450 Fifth Street
NW, Suite 31024, Washington, D.C. 20549, (202) 942-8088.
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United States Small Business Administration, Region IV: 1720 Peachtree
Street NW, Suite 496, South Atlanta, GA 30309, (404) 347-4999;
Coral Gables District Office: 1320 South Dixie Highway, Coral
Gables, FL 33146, (305) 536-5521; Jacksonville District Office:
7825 Bay Meadows Way, Suite 100-B, Jacksonville, FL 32256-7504,
(904) 443-1900.
The Florida Department of Banking and Finance is the enforcement
body for violations of Florida's securities laws and oversees
securities registration. Contact the Department at The Capitol,
PL-9, Tallahassee, FL 32399-0350, (904) 488-0370.