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 company’s 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 SEC’s 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: Exits, Going Public, Investment Reps, IPOs (Initial Public Offerings), Legend Stock, Liquidity Agreements, Private Placements, Reg D, Registration Rights.