The Securities and Exchange Commission has made some changes to the rules governing private offerings of securities. These are some of the biggest changes we’ve seen in a while and many of them will make fundraising much easier! The new rules are expected to go into effect by February 2021. Note that none of these rules pre-empt state law, so it is always necessary to determine whether applicable state laws may limit the usefulness of these new rules.
The integration doctrine seeks to prevent an issuer from improperly avoiding registration by artificially dividing a single offering into multiple offerings, such that Securities Act exemptions would apply to the multiple offerings that would not be available for the combined offering. In practice, the integration doctrine often results in us telling our clients that they must have a six-month quiet period between two types of offerings. The SEC has done away with all of the old integration rules and created a new rule that will make things a bit easier for anyone doing a series of offerings under different rules. The new rule creates some “safe harbors,” which, if you comply with any of them, you don’t have to worry about your offerings being integrated. Below are two of the more important safe harbors:
- If two offerings are separated by 30 days they won’t be integrated, provided that for an exempt offering for which general solicitation is not permitted, the safe harbor would require either: (i) that the purchasers were not solicited through the use of general solicitation, or (ii) that the issuer established a substantive relationship with the purchasers prior to the commencement of the offering. Where an issuer conducts more than one offering under Rule 506(b), the number of non-accredited investors purchasing in all such offerings within 90 calendar days of each other would be limited to 35.
- An offering made in reliance on an exemption for which general solicitation is permitted will not be integrated with a previous terminated or completed offering.
If none of the safe harbors apply to your situation, there is a general principle that you may be able to use. The general principle under the new rule is that offers and sales will not be integrated if, based on the particular facts and circumstances, the issuer can establish that each offering complies with an exemption from registration. However, there is a caveat related to whether one of the offerings involves public solicitation. For example, let’s say you start with a Rule 506(c) offering (which permits public solicitation) and then you stop that offering and switch to an offering under Rule 504 (which does not permit public solicitation). In that case, you can only avoid integration of the two offerings if you have a reasonable belief, based on the facts and circumstances, that none of the purchasers in the Rule 504 offering were solicited through public solicitation or that you have a substantive relationship with each purchaser that was established before you started the Rule 504 offering.
Exemption from General Solicitation for “Demo Days” and Similar Events The new rules provide that certain “demo day” communications will not be deemed general solicitation. This means that if you are conducting an offering under Rule 506(b) (which prohibits general solicitation) for example, you can go to a demo day that meets the requirements of the new rule and tell the people in attendance that you are raising money without worrying about whether you are violating the rules against general solicitation. The event sponsor must be a college, university, or other institution of higher education; state or local government; a nonprofit organization; or an angel investor group, incubator, or accelerator. The event sponsor is not permitted to:
- Make investment recommendations or provide investment advice to attendees of the event
- Engage in any investment negotiations between the issuer and investors attending the event
- Charge attendees of the event any fees, other than reasonable administrative fees
- Receive any compensation for making introductions between event attendees and issuers, or for investment negotiations between the parties
- Receive any compensation with respect to the event that would require it to register as a broker or dealer under the Exchange Act, or as an investment adviser under the Advisers Act
Advertising for the event may not reference any specific offering of securities by the issuer, and the information conveyed at the event regarding the offering of securities by or on behalf of the issuer is limited to:
- Notification that the issuer is in the process of offering or planning to offer securities
- The type and amount of securities being offered
- The intended use of the proceeds of the offering
- The unsubscribed amount in an offering
Online participation in the event is limited to: (a) individuals who are members of, or otherwise associated with the sponsor organization (for example, members of an angel investor group or students, faculty, or alumni of a college or university); (b) individuals that the sponsor reasonably believes are accredited investors; or (c) individuals who have been invited to the event by the sponsor based on industry or investment-related experience reasonably selected by the sponsor in good faith and disclosed in the public communications about the event.
Testing the Waters: The new rules create some ways that a business can “test the waters” with potential investors before doing any legal filings. This means that you can talk to potential investors about your offering and gauge interest and solicit feedback before doing the legal work required to formally launch your offering. There are two new rules for testing the waters—one applies to the situation where you still don’t know what exemption you plan to use for your offering, and the other one applies when you plan to use Regulation Crowdfunding.
Generic Testing the Waters Exemption—before you know what exemption you want to use
This new rule allows you to tell potential investors that you plan to raise money and ask for their feedback. You must provide the following disclosures to anyone you talk to: (1) You are considering an offering of securities exempt from registration under the Act, but have not determined a specific exemption from registration you intend to rely on for the subsequent offer and sale of the securities. (2) No money or other consideration is being solicited, and if sent in response, will not be accepted. (3) No offer to buy the securities can be accepted and no part of the purchase price can be received until it is determined which exemption will be used and, where applicable, the filing, disclosure, or qualification requirements of such exemption are met. (4) A person’s indication of interest involves no obligation or commitment of any kind. Under the new integration rules, you will not be able to follow a generic solicitation of interest that constituted a general solicitation with an offering pursuant to an exemption that does not permit general solicitation, unless you have a reasonable belief that the purchasers were not solicited via general solicitation or you have established a substantive relationship with them.
Regulation Crowdfunding Testing the Waters Exemption
Under the current rules, you are not allowed to tell anyone that you are raising money under Regulation Crowdfunding until you have filed your Form C. Under this new rule, you can talk to potential investors to gauge their interest as soon as you decide that you want to do a Regulation Crowdfunding campaign. You need to provide everyone you talk to with the following disclosures:
- No money or other consideration is being solicited, and if sent, will not be accepted.
- No sales will be made or commitments to purchase accepted until the Form C offering statement is filed with the Commission and only through an intermediary’s platform.
- Prospective purchaser’s indications of interest are non-binding.
Regulation Crowdfunding Offering Communications
The new rules slightly expand what you are allowed to say during your Regulation Crowdfunding campaign. The rules now explicitly permit oral communications with potential investors and expand the information you can provide outside of the platform to include:
- A brief description of the planned use of proceeds of the offering
- Information on the issuer’s progress toward meeting its funding goals
Rule 506(c) Verification Requirements
This is a very minor change that is helpful for anyone who does more than one offering under Rule 506(c) which requires you to take reasonable steps to verify that all of your investors are accredited. If you do more than one 506(c) offering in a 5-year period and someone from the first offering wants to invest in the second offering, you don’t have to re-verify their status as accredited as long as they provide a written representation that they continue to qualify as an accredited investor and you are not aware of information to the contrary.
Harmonization of Disclosure Requirements
Participation of Unaccredited Investors in a 506(b) Offering: Under the current rules, you are allowed to have up to 35 unaccredited investors in a Rule 506(b) offering. In practice, very few businesses allowed any unaccredited investors in these offerings because the disclosure requirements are increased if you make the offering to even a single unaccredited investor and the disclosure requirements include an audited balance sheet which most businesses don’t have. Under the new rules, if you are raising up to $30 million under Rule 506(b), you will no longer need to provide an audited balance sheet, although the disclosure requirements are still relatively extensive.
Proposed Amendments to Simplify Compliance with Regulation A: These are a handful of technical rule changes to make Reg A filings easier. They address things like whether you are allowed to redact sensitive information from contracts included in Reg A filings and simplification of other filing requirements.
Offering and Investment Limits
Reg A: The maximum offering amount under Tier 2 of Reg A is being increased to $75 mill. The maximum offering amount for secondary sales under Tier 2 of Regulation A is being increased from $15 million to $22.5 million.
Rule 504: The offering limit is being increased from $5 million to $10 million.
Reg CF: The offering limit is being increased from $1.07 million to $5 million. Investment limits no longer apply to accredited investors—in other words there is no cap on how much an accredited investor can invest in a Regulation Crowdfunding offering. Unaccredited investors may rely on the greater of their income or net worth in calculating their investment limit (under the current rule they had to rely on the lower number).
The new rules authorize a new type of entity called a “crowdfunding vehicle.” This is a special type of entity that can be used when a company conducting a raise under Regulation Crowdfunding wants to avoid having all of its crowdfunding investors having a direct investment in the issuer. The issuer can form a crowdfunding vehicle and the investors invest in the vehicle rather than the issuer. The vehicle then becomes the owner of the securities in the issuer.