Blue Sky Exemptions in California – When is a Sale Not a Sale?

Nothing is more exciting than closing on a tech start-up’s target Series A preferred stock fundraise, and conversely nothing can be more of a drag than having to work your way through ancillary agreements and filings to close on the round. I feel like I’m sitting by the victrola in a creeker rocker sometimes when I tell people how much it is a relief that the North American Securities Administrators Association (NASAA) consolidated the states’ Form D notice requirements—“YOU DON’T KNOW HOW GOOD YOU HAVE IT!!” Having to go state-by-state to figure out what their notice requirements were after submitting a Form D relying upon Rule 506(b) was the ultimate buzzkill. “What do you mean preemption isn’t 100% preemptive??”

That said, a 506(b) offering is not for everyone. In some cases, a company may prefer to generally rely upon the private offering exemption Section 4(a)(2) of the Securities Act of 1933 (of which Rule 506(b) of Regulation D is a safe harbor). If that is the choice, Section 4(a)(2) is not preemptive of state Blue Sky laws, so the company must still go through the exercise of Blue Sky compliance with each state in which the securities are offered.

Here in the Silicon Valley, new investments occur daily, such that Blue Sky compliance occurs daily. Probably the most common statute that early-stage California-based companies rely upon is under California Corporations Code Section 25102(f), which provides the state’s limited offering exemption notice. I don’t want to spell this exemption out in too much detail, but suffice it to say that if there is a small number (35 or less) of sophisticated investors capable of enduring the risk of investment in private companies, the 25102(f) exemption is usually the go-to.

Do not, however, be fooled by the California Code of Regulations Title 10 Section 260.102.14(b), which declares “No notice is require if none of the securities offered are purchased in this state.”

“Hooray!” you might say, “we only sold to a handful of investors we met at Crab Island in Destin, Florida!” Unfortunately, the fact that no purchasers live here is quite different from the proposition that no purchase occurred here. You have to dig a little deeper and read California Corporations Code Section 25008 to figure out what the State means by “purchased.”

As per Section 25008(b) “[a]n offer to sell or to buy is made in this state when the offer… originates from this state…” and “[a]n offer to buy or to sell is accepted in this state when acceptance is communicated to the offeror in this state…”

Therefore, in the context of a purchase and sale transaction, where one party must make an offer and the other party must accept the offer, Section 25008(b) establishes that, if the offer originates from California (regardless of where it is going), and the acceptance is communicated back to California (regardless of where it came from), there is a purchase, even if none of the purchasers set foot in the State.

So, if you read the CCR 260.102.14(b) language and clocked out simply because your investors live in other states, consider clocking back in, as there may still be work ahead.