I was asked this question today:
“If I filed a Form D late a couple of years ago, and the proposed rules go into effect as written, they provide a 5 year look back. Does that mean I will suffer a 1 year disqualification on using Rule 506 immediately upon the effectiveness of the proposed rules?”
The proposed rules provide as follows:
(b)(1) No exemption under § 230.506 shall be available for an issuer if such issuer, or any of its predecessors or affiliates, has, within the five preceding years, failed to comply with the requirements of § 230.503 in connection with an offering conducted in reliance on § 230.506, except that such exemption shall be available for offers and sales in connection with offerings that commenced before the failure to comply occurred. In determining compliance with § 230.503 for purposes of this paragraph (b)(1), a notice on Form D (§ 239.500) or amendment thereto will be deemed timely if it is filed not later than 30 calendar days after the date specified for such filing in § 230.503, unless the issuer previously failed to comply with such a filing deadline in connection with the same offering.
But the proposed rules go on to say:
(3) For purposes of paragraph (b)(1) of this section, failures to comply with § 230.503 that occurred before [effective date of final rule] shall be disregarded.
This means that if you have missed a Form D deadline in the last 5 years, you won’t automatically be disqualified from using Rule 506 on your next financing when the rules become effective, if they become effective in their current form.
Can you generally advertise your private company securities offering now?
Yes! This became possible on September 23, 2013.
But here are some notes of caution. Some suggestions. Some things I’d recommend you do before you generally solicit, if you decide to generally solicit at all. (Keep in mind, many, many companies will choose not to generally solicit because of the potential complications.)
The overarching suggestion here: If you choose to generally solicit, don’t do anything until you have made sure that you are completely ready and are able to generally solicit in compliance with the rules.
Another example: Can the shareholders take action by less-than-unanimous written consent without a shareholder meeting? If not, this should be fixed as well; otherwise, you may have to hold actual shareholder meetings to approve matters that could otherwise be approved in a less cumbersome way, by less-than-unanimous written consent.
- Make sure your company is legally set up to accept investments and make sure you can generally solicit
Many companies will have organizational documents that are missing key provisions or that handle fundamental governance points in the wrong way. For example, some companies will inadvertently set themselves up so that all shareholders are entitled to statutory preemptive rights. Meaning, the company can’t raise any money from anyone without first giving all existing shareholders notice and an opportunity to participate. Statutory preemptive rights can be cumbersome and they are generally not recommended for angel or venture-backed companies. Be aware that if you sold shares in the last 6 months to non-accredited investors, or if you have non-accredited investors holding convertible notes that will convert on your generally solicited offering, you may NOT be able to generally solicit your offering. The problem? Generally solicited offerings cannot include any non-accredited investors, and if you sold shares in the last six months to non-accredited investors your generally solicited offering may be “integrated” with your prior offering, causing the whole offering to fail to have an exemption. This is another reason it is critical for you to have competent securities counsel on your team.
- Are your accounting systems and processes ready?
Do you have a good accounting system and good accounting practices in place? How soon after the end of each month, quarter and year end can you close your books? Is your accounting team ready to respond to investor requests for financial statements? Under state corporate laws, shareholders are entitled to certain financial information. You will have to be ready to respond to requests for information promptly and efficiently.
- What does your board look like?
Do you have a board of directors that includes at least two independent directors who are neither employees, members of the executive management team, or related to any of them? If not, once you have outside investors how are you going to approve related party transactions? This old standard business advice resounds: Surround yourself with top notch business advisors.
- Consider the risks
- Know your Blue Sky securities law or work with a lawyer who does
Some states may require additional filings before general solicitation (e.g., New York). “Blue Sky” refers to state securities laws.
- Beware that the SEC may change the rules on you midstream
Proposed rules have been issued. No one knows what final form they might take or when they may become final.
- Know your investors
Due diligence is a two way process. It is really important that you don’t accept as an investor in your company someone who doesn’t understand the risks or whose expectations are not consistent with yours. This can literally kill your company. It is easier to get divorced than to get someone off your cap table. Don’t accept just anyone simply because they can provide all the information to show that they qualify to make an investment as an accredited investor.
- Construct a general solicitation plan
General solicitation can include simply putting something on your company’s web site. It can also include running ads on TV. What kind of general solicitation will you conduct? What will you say about your company in your generally solicited statements? You are going to want to be careful here. Any statements made here in the nature of promises about future performance that turn out to be untrue will subject you to potential personal liability.
- Has your board approved the plan?
It should do so. And you will want it to do so.
- Slow down
If you hurry through this process, you may make a mistake that will be costly financially and in numerous other ways.
A lot of folks are confused about the SEC’s repeal of the ban on general solicitation and how it relates to crowdfunding. Is general solicitation crowdfunding?
The SEC’s repeal of the ban on general solicitation relates to accredited investor-only offerings under Rule 506(c) of Regulation D. Accredited investors are generally individuals with a greater than $1M net worth. This is excluding their primary residence, taking into account debt on that residence in excess of its Fair Market Value (FMV). This includes individuals with incomes in excess of $200,000 in the last two years, with the expectation of the same in the current year, or $300,000 with spouse.
Rule 506(c) allows issuers to raise an unlimited amount of money from accredited investors (subject to the other conditions of the rule). Under SEC new rules, companies can generally solicit their offerings under Rule 506(c) (subject to conditions and requirements).
Rule 506(c) offerings are not crowdfunding offerings under the JOBS Act. Crowdfunding is embodied in Title III of the JOBS Act. The repeal of the ban on general solicitation in all accredited investor Rule 506 offerings appears in Title II of the JOBS Act. So, the SEC’s repeal of the ban on general solicitation is not what is referred to as crowdfunding under the JOBS Act.
Crowdfunding under Title III of the JOBS Act will allow sales of securities to both accredited and non-accredited investors, in small amounts (there are individual investor caps), with an aggregate total fund raise capped at $1M during any 12 month period.
Crowdfunding is not yet legal.
The JOBS Act provides that it will not be legal until the SEC issues regulations allowing it. We don’t know when this will happen. Ironically, once crowdfunding becomes legal, companies crowdfunding won’t be able to generally solicit their offerings. Instead, under the JOBS Act, they will not be able to “advertise the terms of the offering, except for notices which direct investors to the funding portal or broker.” See the Full Text of the JOBS Act.
The key differences between Rule 506(c) offerings and crowdfunding offerings are:
- Rule 506(c) offerings are legal now; an unlimited fund raise is possible, but only from accredited investors. There is no cap on the amount an individual investor can invest or the total all investors may invest collectively. General solicitation is allowed. Other conditions apply. (For example, there is an obligation to take reasonable steps to verify the accredited investor status of the investors, and to keep records; such as reviewing Forms W-2, etc.) Companies engaged in Rule 506 offerings are not required to use an intermediary, like a registered broker‑dealer.
- Crowdfunding under Title III of the JOBS Act is not legal yet; it won’t be legal until the SEC issues regulations and it’s unclear when that will happen. When it does become legal, companies will be able to raise money from both accredited and non-accredited investors, but there will be limits on the amount each investor can invest, and a cap on the overall amount all investors can invest during any 12 month period. No advertising will be allowed. Companies that crowdfund will have to use a registered broker or registered funding portal.
|Individual Investor Limits?||No||Yes|
|Aggregate Fund Raise Cap?||No||Yes|
|Advertising Allowed?||Yes. Companies can use any type of media they like.||No, once legal, issuers will not be able to “advertise the terms of the offering, except for notices which direct investors to the funding portal or broker.”|
|Investors Eligible?||Accredited Investors Only||Both accredited and nonaccredited investors can participate.|
|Broker or Intermediary Required?||No||Yes|