Published in the New Hampshire Business Review
By: Julie Richardson Morse
Issuing securities in private placements allows companies to avoid the significant time and expense of the federal registration process and often avoid state registration and qualification requirements.
The most commonly used federal exemptions for private placements are Section 4(a)(2) of the Securities Act, which provides a statutory exemption for “transactions by an issuer not involving any public offering,” and Regulation D, which describes some “safe harbors” for companies engaged in unregistered offerings.
But a newly enacted rule known as Regulation A+ also provides an interesting option for growing companies that require significant capital.
While the term “public offering” has never been formally defined, several factors have emerged from case law and SEC guidance on how to avoid involving a public offering:
- Investors must be limited to those sophisticated enough not to need the information required in registered offerings to make an informed investment decision.
- The number of offerees and purchasers must be limited to decrease the risk that an offer or sale is made to an unsuitable investor.
- General solicitation or advertising of the offering is prohibited.
- The issuer must provide offerees and purchasers with information about the issuer and the securities being offered.
- Investors are required to buy the securities for their own account, without a view to immediately resell or distribute to others.
- The offering, when viewed together with the issuer’s other similar offerings made closely in time, cannot be part of the same financing plan.
But these factors do not provide definitive guidance on how to conduct private placements that qualify for the Section 4(a)(2) exemption.
To provide greater certainty, the SEC adopted Regulation D, Rule 506. Rule 506(b) allows the issuer to offer securities for sale to an unlimited number of “accredited investors” – i.e., potential investors who meet specific net worth or income criteria – but to only 35 potential investors who do not meet those criteria.
Any non-accredited investors must possess sufficient knowledge and experience that they can evaluate the risks and merits of the offered investment, and the issuer must provide them with significant, specified disclosures about the company and the offering. Rule 506(b) prohibits general solicitation and advertising.
Newly enacted Rule 506(c) allows the issuer to offer securities for sale to an unlimited number of accredited investors, and permits the use of general solicitation, as long as the issuer takes reasonable steps to verify that each purchaser is an accredited investor. No non-accredited investors can invest in a Rule 506(c) offering.
Securities offered under Rule 506 qualify as “covered securities” under the Securities Act and therefore enjoy a blanket exemption from the registration requirements of state securities laws. However, state regulators are permitted to require issuers to make notice filings and to pay filing fees with respect to covered securities.
The SEC has authority to exempt transactions from registration if it finds that enforcement is not necessary to protect the public interest because of the limited size or character of the offering. Using this authority, the SEC enacted Regulation A, which allows issuers to raise up to $5 million in a private placement.
In an effort to make capital more accessible to small businesses, the SEC recently implemented Regulation A+, which took effect on June 19.
It permits issuers to publicly advertise their offerings and, with certain restrictions, to “test the waters” by advertising and gauging investor interest ahead of the preparation of formal offering documents. Additionally, Tier 2 offerings (up to $50 million in a 12-month period) are exempt from state registration and qualification requirements and, subject to certain limitations, permit issuers to raise capital from non-accredited investors.
Reg A+ requires preparation of a formal offering circular containing specified disclosures about the company and the offering similar to a registration statement filed by a public company. Companies conducting Tier 2 offerings also are required to prepare audited financial statements and to file annual, semiannual and current event reports with the SEC.
Despite its intentions, it is unlikely that Reg A+ will be the best option for most early-stage companies seeking to raise capital in New Hampshire. It will likely be most useful to larger, later-stage companies or early-stage companies that have attracted significant financial backing and can shoulder its onerous requirements.
For most, if not all, early-stage companies in New Hampshire, Rule 506 of Regulation D is going to continue to provide the most efficient, cost-effective and workable path to raising capital through a private placement.
Julie Morse is an attorney in the Corporate Department of McLane Law Firm. She can be reached at (603) 628-1441 or at [email protected]. McLane is the largest law firm in New Hampshire with offices in Manchester, Concord, and Portsmouth as well as Woburn, Massachusetts.