Yesterday, the SEC took a big step in finally making the JOBS Act (or at least a portion of it) a reality for businesses trying to raise capital. One of the biggest problems with the private offerings has been the difficulty in finding investors. General solicitation / advertising has always been a no-no unless there was a public, registered offering. With the introduction of new Rule 506(c), that all changes (albeit with some important caveats).
Prior to New Rule 506(c) - No General Soliciation / Advertising
Prior to the approval of 506(c), most exempt private offerings required that businesses raising capital have a "pre-existing substantive relationship" with anyone that invests in that business's private offering. That means no advertising, no website investor solicitation, no flyers, no social media....you get the point. It made it difficult and time consuming to find potential investors by severely limiting the pool of potential investors to which a business had access.
Rule 506(c) - Lifting the Ban on General Solicitation/ Advertising
With the SEC's approval of the final rule on July 10, 2013, certain types of private offerings will be permitted to employ general solicitation and advertising to offer securities and solicit potential investors - no more requirement to have a "pre-existing substantive relationship" with investors. It is important to note that, although yes the regulation has been approved - it is not effective until 60 days after publication in the Federal Register.
There are, of course, caveats and conditions.
There are, of course, a few hoops businesses will need to jump through in order to employ general solicitation and advertising without going awry of federal securities rules and regulations. Of course, you should consult with an attorney to help craft a private offering structure and documents that comply with the new regulations. That being said, in a nutshell, in order to employ general solicitation / advertising in a private offering:
- An issuer must take reasonable steps to verify that the investors are accredited investors.
- All purchasers of securities must fall within one of the categories of persons who are accredited investors under an existing rule (Rule 501 of Regulation D) or the issuer reasonably believes that the investors fall within one of the categories at the time of the sale of the securities.
The determination of the reasonableness of the steps taken to verify an accredited investor is an objective assessment by an issuer. An issuer is required to consider the facts and circumstances of each purchaser and the transaction. What this likely means is that a widely posted social media solicitation would likely require a higher degree of assessment than a post to pre-screened network of accredited investors.
Taking reasonable steps to ensure investors are accredited.
An individual investor (the requirement for entities is different) is considered accredited if:
- Individual net worth or joint net worth with a spouse exceeds $1 million at the time of the purchase, excluding the net value of a primary residence, OR
- Individual annual income exceeded $200,000 in each of the two most recent years or a joint annual income with a spouse exceeding $300,000 for those years, and a reasonable expectation of the same income level in the current year.
In the past, it was enough to have a reasonable belief that either of these conditions were true - and to simply get a signed representation from the investor. Now "reasonable steps" are required. Luckily, the SEC provided a "non-exclusive" list of methods that issuers may use to satisfy the verification requirement for individual investors, which include:
- Reviewing copies of any IRS form that reports the income of the purchaser and obtaining a written representation that the purchaser will likely continue to earn the necessary income in the current year.
- Reviewing copies of recent documents that verify assets and income.
- Receiving a written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that such entity or person has taken reasonable steps to verify the purchaser's accredited status.
A New Box to Check on Form D.
The new rule also amends Form D, which is the notice that issuers must file with the SEC when they sell securities under Regulation D. The revised Form D adds a new check box that indicates if an issuer is claiming the new Rule 506 exemption that would permit general solicitation or general advertising.
A Few Other Important Things to Note.
The SEC also approved a rule disqualifiing felon and other "bad actors" from Rule 506 offerings. This blog post won't get into that, but take a look, and be sure to discuss with your attorney.
The SEC is also proposing some significant changes to Form D for private offerings that choose to employ general solicitation and advertising. Any changes there will take awhile as right now it is just a proposed rule, but certainly something to keep an eye on.
As always, you should consult an attorney with experience in these matters.