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