Foundations of New Venture Finance 287sold to even one out-of-state person, the exemption may be lost. Without the exemp-
tion, the company might be in violation of the Securities Act registration requirements.
If, within a short period of time after the company’s offering is complete (the usual test
is nine months), a purchaser resells any of the securities to a person residing outside the
state, the entire transaction—including the original sale—might violate the Securities
Act. Since secondary markets for these securities rarely develop, companies often sell
securities in these offerings at a discount.^35
These regulations refer to accredited investors, a very specific legal term.^36
Generally, accredited investors are investment companies, wealthy individuals, and the
officers of the issuer of the securities. The language of the regulation indicates the
importance of having experienced legal counsel guide the process of issuing and selling
private security offerings. More detail can be found at http://www.sec.gov/info/small-
bus/qasbsec.htm.
In addition, all the exemptions listed are subject to integration principles. This
means that the securities must conform to a single plan of financing, be used for the
same general corporate purpose, be paid for with the same consideration, and be the
same class of securities. They should also be offered or sold at or about the same time.
Under Rule 147 or regulation D, any offering made six months prior or six months after
will be integrated into the exempt offering. Violation of any of these principles violates
the regulation, and the entire offering is considered nonexempt and in violation of the
securities laws.
Last, in addition to compliance with all laws requiring securities registration, entre-
preneurs must provide potential investors with full and complete disclosure about the
security, the use of funds, and any other consideration affecting the decision to invest.
Both federal and state laws prohibit making any untrue statement of a material fact or
omitting any material fact. A “material fact” is one that a reasonable investor would con-
sider significant in making an investment decision.
An investor who can show that the issuer misstated or omitted a material fact in con-
nection with the sale of securities is entitled to recover the amount paid either from the
firm or from the individual directors and officers of the venture. Liability may also be
imposed on the entrepreneur as the “controlling person” of the actual issuer. Legal
actions on such matters must begin within one year of the discovery of the misstatement
and no later than three years after the sale of the security.
Cases such as these are complex and expensive. The court has the benefit of hindsight,
which can lead to second-guessing the original issuer. The outcomes frequently depend
on who can prove what a “fact” was at the time of the issue. A carefully prepared offer-
ing document can be invaluable in legal proceedings.^37
U.S. Bankruptcy Laws
A discussion of the risky nature of entrepreneurial activity must confront the ultimate
negative consequences of risky behavior—bankruptcy. Bankruptcy is an option for deal-
ing with financial troubles, primarily an impossible debt burden. The declaration of
bankruptcy by a firm is an attempt to wipe the slate clean, equitably pay off creditors,
and start again. Because of the potential rejuvenating effect of bankruptcy and the for-