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Raising Capital: Navigating SEC Regulations of Private Placements
By Anand A. Acharya on November 1, 2019

Capital raising is the sine qua non of small and medium-sized enterprises (SMEs). Few SMEs, however, have the inclination to register the sale of their securities with the Securities and Exchange Commission given the high costs and extensive regulatory requirements. Private placements, which are the offer and sale of securities by the issuer itself, often prove effective in allowing business entities to raise capital without having to meet the burdens of public offerings. Navigating the process of initial issuance of unregistered securities, nevertheless, requires a tactful approach. This article seeks to provide the reader a general roadmap of the steps necessary of an issuer.

The Securities Act of 1933 requires that all companies seeking to offer their securities for sale must register with the Securities and Exchange Commission or demonstrate the offering falls within the stipulated exemptions therein. The preliminary step, therefore, is to consider which exemption under the Securities Act is available to the issuer. The most commonly used exemptions are the Section 4(a)(2) exemption and the safe harbors under Regulation D.

4(a)(2) is designed for transactions that do not involve a public offering or distribution. To determine if an offering is a public offering, as used therein, several factors must be analyzed including the sophistication of investors, the limited solicitation of the offering, thoroughness of the information supplied to potential investors, proper notation of the restricted nature of the securities and their prohibition against being resold.

Regulation D contains three separate safe harbor rules: Rule 504, Rule 506(b) and Rule 506(c). First, Rule 504 allows an exemption for securities offered with an aggregate price of up to $5MM during a 12-month period. 506(b) and 506(c), on the other hand, allow an issuer to raise an unlimited amount through the offerings. However, 506(b) and 506(c) place limitations on the sophistication of the investor whereas 504 does not. In particular, under both 506(b) and 506(c), the issuer must have a reasonable belief that the investor is accredited and, under 506(c), must also take reasonable steps to verify such accreditation. An “accredited investor,” as used in Regulation D, are investors that fall under one of several stipulated categories including institutional investors, business development companies, small business investment companies, private business development companies, and entities with over $5MM in assets.

After confirming the exemption to be used, a disclosure of the facts are an integral part of the offering. Issuers are bound by federal securities laws that require thorough disclosure of all material facts of the issuer and their business operations. This is statutorily required when securities are being offered to non-accredited investors. A private placement memorandum (“PPM”) is designed to satisfy this requirement. A PPM is usually drafted in conjunction with the issuer, the issuer’s accountants, and the issuer’s counsel and serves to, along with the necessary subscription documents, disclose all pertinent facts, create a liability shield for the issuer, and govern all solicitation materials of the offering. Offers for the sale of the securities should be made through a finely-tuned PPM to ensure all representations are accurate and in line with verified information.

Lastly, Rules 504 and 506 necessitate the filing of Form D with the SEC, which must be filed no later than 15 days after the first sale of the securities takes place. The date of first sale is the date on which the first investor is irrevocably contractually committed to purchase the securities. This filing notifies the SEC of an exempt offering of securities so as not to contravene the Securities Act. Notably, a failure to file Form D is not a condition to the availability of the exemptions previously mentioned.

Parker McCay’s Corporate Department can provide essential guidance during the capital raising process. Please contact us to discuss how to we can help you navigate these regulations.

The content of this post is for informational purposes only and should not be construed as legal advice or legal opinion. You should consult a lawyer concerning your specific situation and any specific legal question you may have.

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