Restricted Securities . . .
refer to shares of company stock that have not been
registered in a public offering and consequently cannot be resold or
transferred until certain events occur that exempt the resale from
registration or fulfill the registration requirements. Usually, the
certificates for restricted securities bear legends identifying the
limitations on their transferability. When issuing restricted
securities, prudent management requires its investors to represent in
writing that they are purchasing the shares for investment purposes
only and do not intend to resell them.
The shares of stock a venture capitalist buys from a
company are usually restricted securities. The reason for this is that
most companies rely upon exemptions from the 33 Act registration
requirements when selling their shares and thus do not register them.
As a result, the venture investor cannot resell them without first
causing the company to either register the shares with the Securities
and Exchange Commission (SEC) and state securities commissions or
complying with an exemption to those registration requirements. It is
for this reason that venture investors look to other devices, or
exits, to enable them to liquidate, or cash out.
The shares held by management and other company
shareholders are usually restricted too. Unless these shareholders
negotiate rights to participate with the companyís venture investor
in some of its exits, they must register their shares or rely upon an
exemption from registration before they can sell them. Without
registering their shares, this usually means selling their
unregistered shares under the provisions of SECís Rule 144. This
rule identifies circumstances under which restricted securities may be
sold by affiliates. In general, it allows affiliated holders of
restricted securities who have held their securities for 12 months
after they have paid for them to sell in any three-month period a
number of their shares no greater than the larger of
1 percent of the total number of shares of their
class of stock then outstanding or, if the security is listed on a
national exchange or quoted on the National Association of
Securities Dealers Automated Quotations (NASDAQ), the average weekly
trading volume of their class of stock.
To qualify as a Rule 144 sale, there must be adequate
public information available about the company at the time of the sale
and the sale must be handled by a broker.
After three years, most resale restrictions lapse for
persons who are not significant shareholders or members of company
management. State securities laws and other rules relating to insider
trading and certain SEC reporting requirements must be complied with
before any restricted security is sold. Because of the complexity of
these laws, any holder of restricted securities should consult an
attorney before transferring ownership of his stock. See:
IPOs (Initial Public
Stock, Liquidity Agreements,