When a company sells shares of its stock (or limited liability company membership interests or partnership interests) to third party investors, an offer and sale of securities has occurred. The general rule both under US federal law and state securities laws is that all securities must be registered unless the offer and sale qualifies for an exemption from the US federal and state securities laws registration requirements. Registration is a costly process that requires extensive interaction with the SEC and generally is a task undertaken by companies with larger capitalizations. Legal fees alone can range into the hundreds of thousands of dollars. An example of such a company would be any company whose securities are freely tradable on a public stock exchange, such as NASDAQ or NYSE.

A securities offering exempt from registration with the SEC is sometimes referred to as a private placement or an unregistered offering. Generally speaking, private placements are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings. Private and public companies engage in private placements to raise funds from investors. Hedge funds and other private investment funds also engage in private placements. The transaction costs (i.e., legal fees) for a private placement almost always will be substantially lower than with a publicly registered offering.

As an individual investor, you may be offered an opportunity to invest in an unregistered offering. You may be told that you are being given an exclusive opportunity. The opportunity may come from a broker, acquaintance, friend or relative. You may have seen an advertisement regarding the opportunity. Keep in mind that private placements can be very risky and any investment may be difficult, if not virtually impossible to sell. On the buy side, while you are buying a bona fide interest in the company, you may not know all of the implications associated with the investment, and that is why it is so crucial to engage an attorney to represent your interests.

If you are a company that is interested in selling its securities to raise capital, it is very important to understand what your specific obligations are to your investors so that you can avoid the risk of liability for securities fraud. Selling securities in a private placement can be a great tool to raise capital for your company, but it is a substantial undertaking and should not be attempted without the advice of an experienced securities attorney.

Written by:  Roland Wiederaenders

FoundersFirm.com

If you ever raised money for your business through the sale of securities, you probably are at least somewhat familiar with United States federal and state laws governing the sale of private securities.  Specifically, these laws provide for exemptions from the general rule that all securities must be registered (i.e., publicly-traded) before they are sold to investors.

Historically, Rule 506 under Regulation D (of the United States federal Securities Act of 1933, as amended) has been the most commonly used exemption from the U.S. federal securities registration requirements.  Nearly all states have an exemption that corresponds to this federal-level exemption.

Recent changes to Rule 506 have added a new exemption, Rule 506(c), that is very similar to the old exemption with a key distinction: an offering of securities under Rule 506(c) may employ advertising and general solicitation.

Previously, no advertising or general solicitation was allowed in connection with sales of private securities.  Consequently, it was not permissible to buy advertising space in a newspaper or magazine to notify the world that you were attempting to raise money through the sale of interests in your business.  Importantly, this prohibition against print advertisement meant that companies also were not allowed to use the internet and their websites to sell their private securities.

While Rule 506(c) allows for general solicitation and advertising, it imposes an additional requirement from the old Rule 506 exemption that ALL investors participating in the offering must be “accredited investors”.  Whether an investor is accredited differs for individual investors and investors that are business entities.  Individual investors may qualify as accredited investors either by having a net worth of at least $1 million (excluding the value of their principal residence) or an annual income of at least $200,000 (or $300,000 together with their spouse) and a reasonable expectation of earning at least those amounts in subsequent years.  Business entities generally qualify by satisfying a $5 million minimum net worth requirement.

Under the old Rule 506 exemption (and continued under the Rule 506(b) exemption in effect now), an issuer may rely on self-certification that an investor was accredited.  This typically was obtained by asking the investor to complete and sign a questionnaire. The SEC specifies now that under Rule 506(c), the reasonable steps the issuer must take to verify that its investors are accredited include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, and credit reports.  For individual investors, tax returns, pay stubs and W-2s readily document that the investor satisfies the accredited investor minimum income requirement.  If an investor is not willing to provide this type of information (and many are understandably reluctant to, particularly because self-certification has been the standard for so long), the issuer should rely on self-certification and not use advertising or general solicitation in connection with the offering.

Advertising and general solicitation can be powerful tools for your fundraising efforts.  Please let us know if you are considering using advertising in connection with your securities offering.

Written by: Roland Wiederaenders

FoundersFirm.com