Rule 147 – Intrastate Offerings and SEC Exemptions

What Is Rule 147?

SEC Rule 147 allows small local companies to raise intrastate funds without having to register with the Securities & Exchange Commission. Rule 147 can be used by a company to raise funds within its own state of operations.  Further, they can do this without actually registering with the Securities and Exchange Commission (SEC). This ruling is also known as the “safe harbor” rule.  It usually only applies to small companies that want to raise money locally without incurring the expensive fees associated with registering with the SEC.

The Intrastate Exemption is applicable to both public and private corporations based in the United States. If the conditions of the exemption are satisfied, both SEC reporting and non-reporting issuers may rely on the Intrastate Exemption. The intrastate offering exemption does not impose any restrictions on the size or number of investors. However, each offeree and purchaser’s residency should be determined by the issuer. The exemption may be withdrawn if any of the securities are offered or sold to even one out-of-state individual. Without the exemption, the issuer may be in violation of state and federal securities laws.

In summary, the issuer (company) must be incorporated in the state where the offering is made.  At least 80% of the issuer’s revenues must come from business within that state.  A least 80% of the issuer’s assets must be located in that state.  And, at least 80% of the offering proceeds must be used in that state.

 Rule 147 Vs. Securities Act Section 3(a)11 

Rule 147 relates to the intrastate offering exemption under Section 3(a)11 of the Securities Act of 1933. As a result, the regulation is sometimes referred to as the intrastate offers and sales rule.  This clause allows issuers with localized operations to offer securities as part of a local financing strategy. To qualify for exemption under Section 3(a)11, the firm must demonstrate the following:

• Residency – The issuer is a resident of the state in which the offering occurs and, if the company is a corporation, it is in that state.
• Commerce – The issuer does a substantial amount of its business in that state.
• Proceeds – The proceeds of the offering will be used within that state.
• Purchasers – All the offerees and purchasers of the securities are residents of that state.  Further, the securities offered to end up resting in the hands of persons residing in that state.
• Qualification – The entire issue of the securities falls under section 3(a)(11).

Why Rule 147 Matters

The rule was enacted in 1974 with the intention of providing more confidence to firms.  The rule provides a consistent set of criteria under which the SEC would consider the issue of securities to be exempt under Section 3(a)11. However, the SEC highlighted at the time that its rule was not exclusive.  Failure to comply with the regulation would not result in a presumption against a claim for exemption under Section 3(a)11. The SEC construed Rule 147 to mean that the criteria of Section 3(a)11 have been satisfied if:

• State of incorporation – The company is incorporated in the state in which it is offering the securities.
• Majority of business operations conducted there – The company carries out a significant portion of its business in that state.  The majority is defined as at least 80% of its operations.
• Purchasers must also reside in the same state – The company must only sell the securities to individuals residing in the state of incorporation.

Rule 147 – Recent Changes

The SEC revised Rule 147 in 2016 to update it and provide an intrastate offering exception known as Rule 147A. The modified regulation enables securities offerings to be made accessible to out-of-state residents.  Also, exemptions apply to issuers of securities incorporated outside of the state. The new guidelines, in particular, enable corporations to promote or issue securities online.  For example, via crowdfunding. Or, through other channels where they may be accessible to out-of-state investors.  Also, to loosen the prior requirement that enterprises be specifically incorporated in that state.

Adjustments to the regulation resulted in changes to the requirements. To be eligible under Rule 147 and Rule 147A, the company’s officers, partners, or managers must substantially command, control, and coordinate the company’s in-state operations. The firm’s sales of securities must be confined to in-state residents or those whom the company reasonably thinks are in-state residents. In addition, the corporation must satisfy at least one of the following “doing business” requirements:

• Revenues – The company derives at least 80% of its consolidated gross revenues from the operation of a business or of real property located in-state, or from the rendering of services in-state.
• Assets – The company had at least 80% of its consolidated assets located in-state.
• Proceeds – The company intends to use at least 80% of the net proceeds from the offering towards the operation of a business or of real property in-state, the purchase of real property located in-state, or the rendering of services in-state.
• Employees – A majority of the company’s employees are based in-state

 How do amended Rule 147 and Rule 147A differ?

Amended Rule 147 and new Rule 147A are almost identical, except that Rule 147A:

• Offers – There is no restriction on offers to out-of-state residents.  This permits issuers to use the internet or other technologies to offer the securities;
• Place of incorporation – Allows issuers to be incorporated or organized outside of the state in which the intrastate offering is conducted.  However, they must maintain their principal place of business in the state.
• Not a Safe Harbor – It is not a safe harbor under Section 3(a)(11) and thus is not subject to its statutory limitations.

Rule 147 & Integration of Other Offerings

Issuers making simultaneous or successive offers should take care to avoid integrating the numerous offerings. If two or more products are considered a single offering, they are integrated. Under these conditions, all of the criteria for the exemption rely upon each of the offers must be met. As a result, a single investment from outside the issuer’s home state might result in the loss of the Rule 147 Intrastate Exemption.

Resale of Securities Purchased in Intrastate Offerings

Unless they are registered with the SEC, securities acquired in intrastate offerings are restricted securities. As such, an investor in an Intrastate Offering can’t resell any of the securities purchased to someone residing outside the state.  At least, within a short period of time after the issuer’s offering is completed.  The usual test is nine months.  If a resale occurs before nine months elapse, the entire transaction may violate the Securities Act. This includes the original sales made within the required state.

Up Next: What Are Drag-Along Rights?

Drag-along rights let majority shareholders drag minority shareholders into the sale of a company if minority holders are given the same price, terms, and conditions.

Share offerings, mergers, acquisitions, and takeovers can all be complicated transactions. The more parties involved, the more complicated and difficult a change of ownership can be.  In view of this, certain rights may be included upfront as part of the terms of a share class offering or a merger or acquisition agreement. A drag-along rights clause is significant in the sale of many businesses.  This is because many new owners or purchasers often want the entire control of a firm. Drag-along rights aid in compelling the minority shareholders to bow to the will of the majority.  As a result, the sale of 100 percent of a company’s stocks can be made available to a prospective acquirer if required.