Before we even discuss investors and investment transactions, we first need to talk about what a company should be cautious about when approaching investors and what obligations it has under securities laws during fundraising.
This is quite a broad question, but at its core, the company is obligated not to offer securities to the public without a prospectus (except in a few specific exceptions).
Public Offering – What is it and Who is the Public?
The offering and sale of securities to the public is an action regulated under the Securities Law, which states that an offering is "an action intended to induce the public to purchase securities" and that "no person shall make a sale to the public except pursuant to a prospectus whose publication has been authorized by the Authority."
The term "public" is not explicitly defined in the Securities Law, but from the exceptions that allow an offering, we learn that offering securities of the company to 35 people in Israel within a 12-month period without a prospectus does not constitute a public offering—that is, it is permitted to offer securities to up to 35 people in Israel within 12 months without a prospectus. This count does not include the company's directors, existing shareholders, or company employees. Qualified investors are also excluded from this count (more on qualified investors later), which is a very important element in capital raising—this is an official exemption under the law.
In Israel, an unofficial exemption is often applied when it comes to startups, as these tend to raise funds from many investors even when they are private companies (sometimes going through multiple funding rounds). On the face of it, startups offer securities to far more than 35 people in Israel per year who are not exempt under one of the exceptions mentioned above. In other words, there is a technical violation of the Securities Law, but this is not enforced in practice. This provision is essentially intended for large companies to prevent them from offering securities to the public without a prospectus.
In summary, the public is defined as 35 or more people in Israel to whom securities of the company have been offered within a one-year period, excluding qualified investors, company directors, existing shareholders, and company employees.
What is a Prospectus?
A prospectus is essentially a book of several hundred pages that serves as a "ticket" to the capital market. The process of preparing a prospectus is very lengthy (usually several months). The key parties involved in drafting it are the company's lawyers and accountants, company management (CEO, CFO, etc.), and the board of directors. Once drafting is complete and approved within the company, it is submitted for approval by the Securities Authority and the stock exchange.
A prospectus serves two main functions: it is a means of addressing the "public" and providing "proper disclosure" regarding the securities and the company offering them. The prospectus details what type of securities are being offered and includes extensive information about the company so that investors can make informed decisions—this includes details about the market in which the company operates, its advantages, its disadvantages, company management, major competitors, and more.
Misleading statements or omissions of material information in a prospectus constitute a criminal offense.
Qualified Investors
As noted, in order to offer securities and raise funds from the public, and to protect the public, strict regulatory requirements must be met, including preparing a prospectus and operating under the oversight of the Securities Authority and the stock exchange (or raising relatively small amounts through offer coordinators, i.e., crowdfunding platforms).
However, this can be avoided by raising capital primarily from qualified investors, along with a limited number of non-qualified investors (as mentioned above, in Israel, the threshold currently stands at 35 people per year, unless the crowdfunding route is taken).
Qualified investors are defined in the Securities Law's annex as investors recognized by the law as having significant financial means, including high-net-worth individuals, venture capital funds, institutional investors, and others. These entities are exempt from the public offering rules because they have the experience and resources to conduct due diligence on the company or engage experts to properly evaluate it on their behalf.
