Business Transactions

Additional Exemption Available to Federal Securities Registration for Selling Equity in Your Company

When you sell equity in your company, you must either (i) register with the Securities and Exchange Commission (“SEC”) and with each state in which investors reside, or (ii) qualify for an exemption to registration.

 

Regulation D Offering Exemptions to Securities Registration

One of the available federal exemptions is Regulation D to the Securities Act of 1933. Regulation D provides three “safe harbors” that give companies some assurance that their capital-seeking activities are in compliance with federal securities laws. Those other Regulation D exemptions include exemptions under Rule 504, Rule 505, and Rule 506 (now Rule 506(b)). I discussed the Rule 504, Rule 505, and Rule 506(b) exemptions in a previous blog posting, “Finding an Exemption to Federal Securities Registration for the Sale of Equity in Your Company”.

 

New Regulation D, Rule 506(c)

As of September 23, 2013, Regulation D, Rule 506(c) offerings became permissible. This new category of offering exemption differs from traditional 506 offerings in a few ways:

Advertising Allowed. Companies offering securities under the Regulation D, Rule 506(c) exemption may use general solicitation and advertising in connection with selling equity in the company.

Accredited Investors Only. The issuing company may sell securities only to accredited investors. There are requirements to verify the accredited investor status of investors.

Bad Boy Provisions Apply. The company cannot rely on a 506 exemption if the company, its officers, directors, 20% or more shareholders have been involved in any acts on the statutory “bad acts” list. Those bad acts include securities-related or fraudulent acts resulting in criminal convictions or administrative/regulatory discipline. As of September 23, 2013, the “bad boy” provision applies to both Rule 506(b) and Rule 506(c) offerings.

 

Some Points to Remember

Regulation D, Rule 506(c) is an additional available exemption. All the Regulation D exemptions that existed prior to September 23, 2013 are still available and work in the same manner.

Relying on Rule 506(c) requires a Form D filing just as all the other Regulation D offerings do. As of the 506(c) launch date, the Form D remains the same except for two additions to accommodate the new 506(c) exemption:

• There is a checkbox which the company selling equity must check if it is relying on the Rule 506(c) exemption.
  
  
• The issuing company must state that it is not disqualified from relying on Rule 506 due to any “bad actor” factors.

Seller Financing for Company Purchases

If you’re a prospective buyer who is short on cash or a seller who wants to sell his company quickly, you might consider seller financing.

With seller financing, the seller defers a portion of the purchase price. The buyer pays a portion of the purchase price at closing and pay the remainder over a period of years at a market interest rate. Structures for seller financing are as varied as structures for residential mortgages. The seller typically wants payment completed within one to five years and a security interest in the assets of the company. The seller’s willingness to be flexible in financing terms is directly proportional to the seller’s eagerness to sell the company.

From the buyer’s perspective, the seller financing arrangement should be independent from other aspects of the deal. For example, sellers often hang around as consultants to the company. Sometimes, those arrangements do not work out. If the consulting arrangement with the seller goes sour, there should be no ripple effect that negatively impacts the financing deal between the seller and buyer.

How the SEC’s Electronic Filing System Might Trick Start-Ups Into Violating Securities Laws

In 2009, the SEC began requiring that the Form D notice filings used for Regulation D offerings be filed electronically. The SEC’s motivation for the mandatory electronic filing included a desire to make information included on Form D filings more easily available to and searchable by the public.

A By-Product of Form D Electronic Filing

Well, it worked – as I’ve learned. Within days of filing Form D in connection with clients’ private placement offerings, announcements of the clients’ Form D notices and the information therein begins appearing on websites and blogs. There’s one little hiccup with that situation.

Many Securities Registration Exemptions Used by Start-ups Prohibit Advertising

Regulation D is a common exemption to securities registration used by companies seeking financing. In order to qualify for one of the Regulation D exemptions, the company cannot use advertising to find investors. (There is an exception to the no- advertising rule for certain Rule 504 offerings.)

Posting information online or using any type of viral email marketing to find capital would likely be considered advertising and could make the company ineligible for the more streamlined securities law compliance procedures offered by Regulation D.

What Companies Should Not Do with Those Postings about Their Form D Filings

That means you should not re-distribute links to websites that mention your Form D notice filing and private offering. For example, DON’T mention those third-party announcements on the company’s Twitter account, blog or other social media. Re-distribution by the company might be viewed as solicitation and general advertising.

June 9 Webinar for Start-Up Companies Seeking Seed Financing

In its third year of operation, the LaunchBox Digital Accelerator program includes seed funding and a twelve-week business building program in Durham, NC where start-up companies refine their ideas with the help of mentors and advisors. The program culminates with demo days, where each new business presents to angel investors, venture capital firms, strategic partners, bloggers and media.

On Wednesday, June 9 at 7 p.m. LaunchBox is offering a webinar featuring a panel discussion among start-up entrepreneurs who have previously participated in the program.

Visit the Launch Box Digital website at www.launchboxdigital.com/ for more information and to register.

What the Financial Reform Bill Might Mean for Small Companies Seeking Accredited Investors

Whether your investors are accredited is important if you plan to rely on Regulation D as your exemption to federal securities registration for your private placement offering. Pending financial reform legislation may decrease the number of potential investors who qualify as accredited.

Currently, an individual qualifies as an accredited investor if the individual earns over $200K annually ($300K with spouse) OR has a net worth of $1M. The Financial Reform Bill proposes modifications to narrow the accredited investor exemption. For example, an amendment added to the Senate version of the bill narrowed the definition for accredited investor by excluding the investor’s primary residence from the $1M net worth calculation.

The House and Senate versions must be reconciled before a final law is passed so it’s unknown what the final impact on the accredited investor definition will be. The full name of the Financial Reform Bill is Wall Street Reform and Consumer Protection Act of 2009 . H.R. 4173. You can find additional information (including the full text) about it by searching by the name at thomas.loc.gov

What Is a Private Placement Offering?

When you sell securities in your company, you make the sale as either a private placement offering or as a public offering. Being classified as private rather than public means your offering has an easier time complying with applicable federal and state securities laws.

The IPOs (i.e., initial public offerings) you read about in the newspapers are public offerings. However, your sale of securities need not be as large as one of the IPO’s discussed in the Wall Street Journal to qualify as a public offering. Most venture capital financings qualify as private offerings. A private offering might also be one in which a start-up entrepreneur obtains financings through friends, families, and angel investors.

Categorizing an offering as private versus public is often a subjective determination dependent on the number and type of investors, the amount of the money being raised, and other factors. To reduce the uncertainty of knowing whether your offering qualifies as a private offering, the SEC offers the safe harbor of Regulation D which defines three categories of offerings that qualify as private.

Securing Upfront Money

If you plan to finance your company by offering equity to private investors, you cannot use any investor funds until your offering closes. Until closing any money provided by investors should be held in an escrow account or in a bank account that is separate from your company operating account.

For example, if you have told investors that you will not close the offering until you have raised a minimum of $1,000,000 and to date you have raised only $500,000, you can’t touch the $500,000. The exception is if one of your early investors agrees to provide “upfront money”. By upfront money, I mean money that an investor has given permission to use prior to the full capitalization of the company.

The upfront money arrangement can be structured in a variety of ways including as an early subscription to the offering in which the investor waives the right of refund if the offering fails to close. If you use that mechanism, the investor waiving refund must acknowledge the possibility of losing all or part of her investment if insufficient funds are raised to complete the offering.

Another method of structuring an upfront money arrangement is as a loan which can later be converted to equity as part of the offering. Of course, remember that if the offering does not go forward, the loan is ostensibly repayable.

How Your Business Plan Differs From Your Private Placement Memorandum

A business plan is your blueprint for building your business venture.  It explains the operational and marketing strategy for your business and lays out financial projections.  In addition to being your road map, the business plan hopefully motivates potential investors and lenders to finance you.

 

While the business plan is a planning and marketing document, a private placement memorandum (“PPM”) is a legal document used in a private placement offering.  The PPM’s primary legal purpose is ensuring compliance with federal and state securities disclosure and anti-fraud laws.  Compliance with those laws requires providing investors with accurate and complete information about the company.  The PPM is sometimes referred to as an offering memorandum or simply a disclosure statement.  A prospectus is the disclosure statement used in a public offering. 

 

 

Changes in Regulation D and Form D

Changes are ahead for Regulation D and Form D. Regulation D to the Securities Act of 1933 provides three “safe harbors” that give companies some assurance that their capital-seeking activities are in compliance with federal securities laws. Form D is the notice filing a company must file with the Securities and Exchange Commission (SEC) when it relies on one of the Regulation D safe harbors.

The SEC describes the revisions as simplifying Form D and updating some of the information required by Form D. For example, while a company issuing securities will still need to identify its executive officers, directors, and promoters on Form D, it will no longer have to identify those who own ten percent or more of the company’s stock.

The big change for Form D is “how” it is to be filed. Starting on September 15, 2008, companies may file Form D electronically with the SEC. Electronic filing becomes mandatory on March 16, 2009. As a result, the SEC will be able to make information included on Form D filings more easily available to, interactive, and searchable by the public. Eventually, the SEC hopes to enable companies to file Form D with the SEC and with any applicable states via one electronic transaction. Forty-eight states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands accept filings on Form D.

Finding an Exemption to State Securities Registration for the Sale of Equity in Your Company

In my last postings, I discussed compliance with federal securities laws and finding an exemption to registration with the Securities and Exchange Commission when you want to raise money by selling equity in your company.

In this posting, I'll discuss compliance with state securities laws.