Can I Talk about My Raise? Communicating with Investors about a Securities Offering
A private placement of securities is one of the most popular ways for a start-up to raise capital. This post discusses the regulatory framework for discussions with investors about private placements. Please note that this post does not substitute for legal advice that addresses the facts and circumstances of a specific placement.
Without embarking on a full securities registration, how can you inform investors that your company is raising capital? The answer is “carefully.” Limiting communications with the public and finding investors through existing relationships has long been the essence of keeping the “private” in ‘’private placement.”
In a traditional private placement, if you want to include non-accredited investors – up to 35 “sophisticated” investors – in the offering, you must avoid any kind of general solicitation of investors under SEC Rule 506(b). If instead participation will strictly be limited to “accredited investors,” as defined by Rule 501, then may advertise broadly under the newer Rule 506(c).
The U.S. Securities Act of 1933 prohibits the offer and sale of unregistered securities to the public. But the law does permit certain exempt transactions in unregistered securities as long as they do not involve a public offering. The SEC therefore allows private placements and takes care that such transactions do not involve members of the public by limiting how investors are solicited.
In its Rule 502(c), the SEC provides some guidance on what it considers to be general solicitation. Articles, advertisements, and notices, whether print or broadcast, constitute general solicitation. Informational seminars that are widely advertised are also general solicitation. Additionally, the SEC has indicated that it views unrestricted Internet equivalents such as websites, general emailing, and social media as general solicitation. General solicitation is out-of-bounds for traditional private placements.
There are a few exceptions to the narrow definition of general solicitation. For example, when raising capital from non-U.S. investors, foreign-targeted notices and company statements to foreign press made outside the U.S. in accordance with SEC Rule 135c are not considered general solicitation. But be aware that there may be local securities rules that still limit communications. Filing information with the SEC that will become public – for example, a Form D – and thus may alert the public to an offering, is acceptable, as are “tombstone” notices of closed offerings published in newspapers, provided the notices are not intended to drum up investor interest in a subsequent offering.
Relationships with investors in traditional private placements
The provisions of Rule 506(b), which permit the inclusion of up to 35 non-accredited investors in the offering, forbid general solicitations of investors. How canAnother way that an issuer can know that they are avoiding general solicitation in a traditional private placement is by pursuing investors only through private relationships. But how can an investor know whether those relationships are private enough?
For one, the SEC has indicated that communications with investors should be conducted within the context of substantive pre-existing relationships with the issuer or someone – like a broker – acting on the issuer’s behalf. The nature of the relationship should be one that would allow an assessment whether the investors are sophisticated and have the appropriate financial situation to make such an investment. Broker questionnaires are a common way to obtain the necessary information.
The pre-existence of the relationship can be demonstrated by observing a period of time between establishing the relationship and presenting the investment opportunity.
The risk of violating the rule on substantive pre-existing relationships with investors increases with the number of investors who are solicited since it becomes harder to assure that there were appropriate pre-existing relationships in place before solicitations were made. But it is not impossible include a greater number of investors in a private placement, especially if broker access and angel investor groups are leveraged. If the company is offering securities under Rule 506(b) to a very few non-accredited persons – even just one, it must avoid broad solicitation of any number of persons because of the non-accredited investor.
The SEC has provided additional guidance on what it considers to be general solicitation over the years, mostly by issuing no-action letters. One series of letters addressed online matching services that list issuers looking for investors but which do not publicize any one issuer. The SEC has also provided no-action relief to a broker-dealer affiliate that provided a password protected website for accredited investors who could review offerings online. Pitch contests and demo days which include discussions of financing might not be considered general solicitation if there was no prior advertising of the pitches, and if other conditions are met. Since guidance is provided by the SEC in very facts-and-circumstances intensive conditions, issuers should get specific legal advice before relying on no-action letters.
Offerings with advertising
SEC Rule 506(c), in contrast, lets the issuer of unregistered securities solicit accredited investors generally for an unregistered securities offering. The solicitations must focus exclusively on accredited investors. The rule also requires vigilance in verifying investor qualifications well beyond simple check-the-box self-identification. Issuers or their agents should be prepared to ask investors to demonstrate that they meet either the asset or income tests for accredited investor status and are sophisticated enough with financial matters to assess the issuer’s current offering as an appropriate investment. As of late 2013, 506(c) private placements can legally be advertised in print and other media, including websites and social media so long as the details disclosed to unaccredited investors are sufficiently limited and do not disclose the details of the raise.
The SEC has also permitted issuers of unregistered securities to advertise and publicize their products and services as long as the advertisement is not meant to promote the company as a good investment opportunity.
When the SEC updated its rules to facilitate capital formation – particularly for start-ups – the SEC left its old regulatory framework for private placements intact. Either set of rules will work for your company as long as you stay within the restrictions, whether those are restrictions on who may invest, how the sale can be advertised, or other requirements.