A few observations:

1. Under federal and state securities laws, an issuance of stock can lawfully be done only if the issuance meets SEC registration requirements or if it is exempt from registration.

2. Registration is an elaborate and expensive process and is basically what companies do when they go public (it has many other variations as well).

3. Therefore, startups can realistically issue their stock only if any given offering is "exempt" from securities law registration requirements.

4. SEC registration requirements arise from the Securities Act of 1933.

5. The 1933 Act contains a statutory exemption under Section 4(2) for private placements.

6. Whether something is a private placement or a public offering is a factual question turning on such factors as the size of the offering, the number of purchasers, the use of advertising to induce investors to invest, the sophistication of the investors, etc. This is basically a highly murky area and it is therefore normally somewhat treacherous to structure an offering purely under Section 4(2).

7. Why treacherous? Because if you think your startup is doing an exempt private placement and investors can demonstrate that it was not truly exempt, then it is an illegal offering and investors can rescind and get their money back from the issuer and from its officers and directors. Thus, that great success you thought you had when you raised that $5 million can become a personal judgment against you as a founder who sat on the company's board when the offering was made.

8. In addition to federal law, all U.S. states impose their own forms of securities regulation. Therefore, in issuing stock to investors, a startup must make sure that all shares sold are exempt under both federal and state securities laws. In practice, this means that you need to fit the offering within an applicable exemption for each state in which one of your investors resides. Since state laws of this type are referred to as "blue sky" laws, this is known as blue sky compliance.

8. Regulation D, adopted in 1982, brought tremendous benefits to startups by taking the murky standards of Section 4(2) and blue sky compliance and simplifying them greatly. It did so by setting forth specific criteria that, if met, would ensure the startup that its offering was exempt. No more murkiness. That is why the relevant categories are known as "safe harbors." Regulation D also preempted significant aspects of state regulation, meaning that, if its standards were complied with, the issuer would not need to worry about states trying to impose special regulatory burdens in excess of whatever was required by Regulation D itself.

9. The "accredited investor" concept is an integral part of Regulation D and it lies at the core of its simplification of the offering process. In essence, if an issuer deals only with accredited investors, the process of keeping the offering exempt is highly certain and very easy.

10. In practice, this has meant that, if a startup sells stock to investors, the "securities law compliance" aspects are easy to meet and become pretty much a checklist item that is done by junior attorneys or even by paralegals working under an attorney at very little cost.

11. While the "accredited investor" concept thus worked to bring great rationality to this process, Regulation D itself does not preclude issuing stock to some non-accredited investors even under its own rules and, moreover, Regulation D did not and does not supersede the prior regime under Section 4(2), meaning that any startup can issue stock to any person (accredited or not) in any "private placement." Thus, startups can and do issue stock all the time to persons who are not "accredited investors." This can be done in many cases without problem, including to friends and family investors. The problem is that it is riskier to do, leaving the issuer and its officers and directors at greater potential legal risk whenever they issue stock to non-accredited persons.

12. The Dodd bill would sharply reduce the pool of persons who would qualify as accredited investors and would also require issuers in more situations to meet special regulatory burdens imposed by various states in which their investors reside. Since there have been no big problems in this area, I believe this is a step backward in the world of startup funding, and it will hurt startups in their funding efforts. With the Dodd changes in place, the pool of investors from which to draw will shrink and the process of complying with securities laws will likely go up significantly for many offerings for which formerly accredited investors will need to be treated as non-accredited.