November 15, 2013

Presentations in the Era of General Solicitation

In September 2013, the long anticipated final rules issued by the Securities and Exchange Commission (SEC) eliminating the prohibition against general solicitation and advertising went into effect (as covered in this previous legal update). While this creates new financing opportunities for start-ups and emerging companies, potential issuers need to understand the rules governing this option, evaluate the pros and cons of general solicitation, and avoid general solicitation if an issuer decides to proceed under the traditional private placement rules.  

While these new rules may be immediately helpful to certain corners of the market, such as those raising investment funds, investors and companies raising capital in the traditional startup sphere are expressing significant concern that the new rules are overly cumbersome and invasive.  As such, many companies raising capital, or thinking about raising capital, are taking efforts to avoid a general solicitation at demo days or business competitions.

Additional Rule 506 Proposed Amendments

To review, general solicitation is regulated by Rule 506 of Regulation D of the Securities Act of 1933. As a result of the SEC's final rules, Rule 506 now includes a new subsection (c) allowing issuers to use general solicitation, including Internet, print and television advertising, to offer and sell securities.

In connection with lifting the ban on general solicitation, the SEC proposed certain amendments to Regulation D that would require:

  • The filing of a Form D in the new Rule 506(c) offerings before companies engage in general solicitation
  • The filing of a closing amendment to Form D after the termination of any Rule 506 offering
  • Written general solicitation materials used in new Rule 506(c) offerings to include certain legends and other disclosures
  • The submission, on a temporary basis, of written general solicitation materials used in Rule 506(c) offerings to the SEC

The amendments would also disqualify an issuer from relying on Rule 506 for one year for future offerings, if the issuer, or any predecessor or affiliate of the issuer, did not comply with the Form D filing requirement in a Rule 506 offering within the past five years.

Current Status of Proposed Amendments to Rule 506

On September 27, 2013, the SEC re-opened the comment period on these proposed amendments; this extended comment period ended on November 4, 2013. Even though the SEC confirmed that issuers could rely on Rule 506(c) effective September 23, 2013 (so long as they comply with the conditions of that exemption), it is unknown what these requirements will look like until the SEC adopts these amendments as final rules.

Is General Solicitation Right for My Company?

Given this recent activity, many companies presenting at demo day events, pitch day events or business plan competitions this fall are asking how their presentations should change. The answer depends on these key questions:

1. Does general solicitation make sense for my company in light of our corporate finance objectives?

While general solicitation may have the potential to expose issuers to many new potential investors, companies have been able to raise funds privately under existing Rule 506 for quite some time without general solicitation, and can opt to continue to do so. Below are a few reasons you might decide not to be a pioneer under the new Rule 506(c):

  • To continue selling to non-accredited investors: Emerging companies and start-ups may want to preserve their ability to sell securities to a small number of non-accredited investors, such as friends and family. This option is governed by Rule 506(b), which allows an issuer to offer and sell securities to up to 35 purchasers that are not accredited investors, but prohibits general solicitation. By contrast, Rule 506(c) offerings allow general solicitation, but only in offerings sold solely to accredited investors.
  • If final Regulation D amendments are overly burdensome: Depending on what happens with respect to the proposed amendments to Regulation D described above, issuers might want to avoid the proposed additional conditions on Rule 506(c) offerings. In addition, it may be impossible in practice for issuers to comply with the additional conditions. Among other things, these conditions include a requirement to file a Form D at least 15 days in advance of general solicitation, which your company may not have done. The SEC has suggested that transitional relief will be provided for Rule 506(c) offerings that commenced before the effective date of any final rules, but whether that's the case remains to be seen.
  • To avoid verifying accredited investors: Rule 506(c) requires that the issuer take reasonable steps to verify that all purchasers in the offering are accredited investors. Your company may want to avoid having to undertake the reasonable verification steps required of Rule 506(c).
  • To avoid extension of anti-fraud liability: Anti-fraud provisions of the federal securities laws, including Rule 10b-5, apply to all Rule 506 transactions, including those covered under 506(c). Offering participants might choose to refrain from general solicitation due to concerns about related anti-fraud liability and how far such liability might extend.

2. If general solicitation doesn't make sense for my company, what should we do to make sure that our presentations don't involve general solicitation?

Even though the rules of Section 506 remain unchanged in this respect, below are a few reminders for companies that do not plan on using general solicitation:

  • Do not mention anything about your fundraising plans, financials or financial projections, and do not discuss the terms of any offering.
  • Avoid questions touching on fundraising issues.
  • Do not send email blasts about your offering.
  • Do not post anything about your offering online (or in other media), or permit others to do so on your company's behalf.
  • Do not allow the press or bloggers to speak about your offering (but it is okay for them to talk about your company in general).

If you want to adhere to existing 506(b) rules, avoid any activity that could be viewed as general solicitation that might result in your company having to comply with Rule 506(c).

3. If my company does plan on engaging in general solicitation, what comes next in terms of how we must conduct any Rule 506(c) offering?

Unfortunately, this is a hard question to answer. In the August 8, 2013, letter from SEC Chairman Mary Jo White confirming that issuers can rely on the Rule 506(c) exemption effective as of September 23, 2013 (as long as they comply with the conditions of that exemption), she noted that final rules will likely consider the need for transitional guidance for ongoing offerings that commenced before the effective date of any final rules. At this point, however, it is unclear what this transitional guidance will look like. One thing that is certain is that all purchasers of securities in a Rule 506(c) offering must be accredited investors and you will have to take reasonable steps to verify that this is the case.

While additional SEC guidance is expected now that the comment period has ended, the above considerations are a critical first step in determining  whether to pioneer the brave new world of general solicitation. In any event, carefully consider whether you plan to engage in general solicitation before saying anything in a presentation that might later foreclose the possibility of a traditional private placement.

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