More Questions About Generally Solicited Offerings

GENERALLY SOLICITED OFFERINGS(2)If You Generally Solicit, Can You Go Back?

Come September 23, 2013, companies are going to be able to generally solicit and generally advertise their private company securities offerings under Rule 506(c) of Regulation D.

This is a big deal. 80 years of prohibition, over.

This must be too good to be true, right? What are the gotchas?

Well, in general, there are three:

(1) If you generally solicit, you will have to take reasonable steps to verify the accredited investor status of your investors, and keep records that you did so. This means, reviewing Forms W-2, etc. In a generally solicited offering, you cannot rely on a simple check-the-box certification from an investor. Investors may not like this. They may refuse to give a startup their personal financial information.

(2) In a generally solicited offering, you can only take money from accredited investors. “Accredited investor” means someone with income of at least $200,000 a year for the last two years, with the expectation of the same in the year of investment, or $300,000 with spouse; or $1 million net worth excluding the investor’s primary residence.

(3) If you generally solicit your offering, you have to check the box on your Form D that you generally solicited.

What could go wrong?

One additional thing to think about before you generally solicit on September 23rd. If you generally solicit, you can’t go back. You can’t revert your offering to a non-generally solicited offering to avoid the three drawbacks listed above.

The SEC made this clear in its final rules, when it said the following:

“We remind issuers that once a general solicitation has been made to the purchasers in the offering, an issuer is precluded from making a claim of reliance on Rule 506(b), which remains subject to the prohibition against general solicitation, for that same offering.”

Something to think about before you generally solicit.

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Proposed Rules Just That, Proposed

SEC proposalA fundamental question that has been lingering for some time was answered recently by the Chair of the SEC, Mary Jo White. The question was, can a company start generally soliciting on September 23, 2013, and only comply with the final rules that go effective on that day, or do companies that generally solicit also have to comply with the proposed rules that were introduced on the same day?

If you are not aware, the final rules contain three requirements if you generally solicit:

  1. That you only take money from accredited investors. An “accredited investor” is generally an investor that either (i) made more than $200,000 a year for the last two years, with the expectation of the same in the current year, or $300,000 with spouse; or (ii) has a net worth in excess of $1,000,000 excluding primary residence (but taking into account debt on the residence to the extent that it exceeds the FMV of the residence).
  2. That you take reasonable steps to verify the accredited investor status of your investors and keep records you did so. This means reviewing Forms W-2 and financial statements, etc.
  3. That you check a box on your Form D that you generally solicited.

The proposed rules require much, much more.

  1. That you file an Advance Form D 15 days before generally soliciting;
  2. That you submit your written offerings materials to the SEC;
  3. That you include legends on all of your written general solicitation materials;
  4. That you file a closing amendment to your Form D after the termination of your offering; and
  5. That your Form D include a lot more information.

In addition, it is the proposed rules that contain the onerous 1 year penalty box provision if you miss a Form D filing deadline.

In her letter to Congressman McHenry, Chair White confirmed that issuers will not have to comply with the proposed rules on September 23, 2013.

“Issuers are not required to comply with any aspect of the Commissioner’s July 10th rule proposal until such time as the Commissioner may approve a final rule and such rule becomes effective.”

This is obviously good news.

You can find a link to the letter here: http://www.scribd.com/doc/160734110/2013-08-08-Letter-From-SEC-Chair-to-McHenry

 

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Can I Generally Solicit Now?

Question and answerQ: Can I generally solicit or generally advertise my offering before September 23, 2013?

A: No. You can’t generally solicit or generally advertise your offering until September 23, 2013. Until September 23, 2013, general solicitation or general advertising of securities offerings is still illegal.

So please don’t do it. It is not worth it.

If you want to have a sense of how much trouble you can get into, you can review this SEC action:

SEC Press Release

See also: NY Times Article

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Do I have to make a Section 83(b) election?

Q&AQ:   I just exercised a vested stock option.  Do I now have to make a Section 83(b) election?

A:   No, unless your company’s stock option plan documents contain unusual or atypical provisions.  Typically you do not have to make a Section 83(b) election on shares you acquire upon the exercise of a vested stock option.  (The same is not true for the exercise of an immediately exercisable stock option, which allows an optionee to exercise an option and acquire unvested shares.)

The reason you don’t have to make an 83(b) election on the exercise of a vested stock option is because the shares acquired, being vested, are not subject to a substantial risk of forfeiture under Section 83 of the Internal Revenue Code.

Section 83(a) says the following:

“Substantial risk of forfeiture” – The rights of a person in property are subject to a substantial risk of forfeiture if such person’s rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual.

    If, in the connection with the performance of services, property is transferred to any person other than for whom such services are performed, the excess of –
  1. the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of a person having the beneficial interest in such property are transferrable or are not subject to a substantial risk of forfeiture, whichever occurs earlier over the amount (if any) paid for such property,
  2. shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or not subject to a substantial risk of forfeiture, whichever is applicable.

The regulations add a little detail to this. For example, the regulations provide that “[p]roperty is not transferred subject to a substantial risk of forfeiture to the extent that the employer is required to pay the fair market value of a portion of such property to the employee upon the return of such property.”

In general, the answer to this question is found in the statute itself, in the provisions quoted above.

Conclusion

If you are exercising a vested option, consult with your tax advisors to confirm, but a Section 83(b) election should not be required.

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The World Changes on September 23rd

The World Changes for Startups on September 23rd from Joe Wallin
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