A group of three friends, Eric, Dave, and Bob, have an idea to start a new wine bar, “KurniWines, Co.,” located in a small but wealthy town in Ohio. Their goal is to stock the bar with many types of rare and expensive wines from around the world and allow regular customers to maintain “wine lockers” containing their favorite vintage. The wine bar will also offer a “wine acquisition service” for a monthly fee in which a sommelier (wine specialist) from the wine bar will attend wine auctions around the world on behalf of the customers to acquire their favorite vintage.

In addition to the cost of the build-out of the bar, the friends also anticipate needing approximately $5,000,000 to obtain a sufficient stock of rare wine to open the bar. They plan on purchasing the wine from auctions in New York, Paris, and Hong Kong.

Rather than using their own money, or obtaining a bank loan, the friends decide to raise the capital by getting some of the wealthy people they know to invest in the business. However, it is very important to the friends that they are able to maintain control of the business and that they represent the majority of stockholders with voting power. Therefore, they decide to file paperwork to form a corporation where they retain all the common stock which has voting rights, and they issue a second class of stock (preferred stock) to raise capital which does not have voting rights but which has the privilege of being paid out first in the event that the company fails financially.

In the process of preparing the paperwork, Eric researches the blue sky laws of Ohio (the state in which they have formed their corporation) and sees the following statutory language:

Ҥ 1707.03 Exempt Transactions: The sale of any equity security is exempt from registration with the State of Ohio if all the following conditions are satisfied:

1. The sale is by the issuer of the security.
2. The total number of purchasers in this state of all securities issued or sold during the period of one year does not exceed 10.
3. No advertisement is used in connection with the sale.”

DISCUSSION QUESTIONS:

Answer each of the following questions in 3–5 sentences:

1. Why should the sale of a security to investors fall under a higher level of scrutiny than dividing up the common stock among the three friends/co-owners?

2. What is the benefit of blue sky laws? Does this benefit counteract the additional burdens placed on securities issuers?