Private Placement

A securities offering exempt from registration with the U.S. Securities and Exchange Commission (“SEC”) is sometimes referred to as a private placement or an unregistered offering.  Under the federal securities laws in dealing with private placement, a company may not offer or sell securities unless the offering has been registered with the SEC or an exemption from registration is available.  Private placement is the most commonly recognized transaction exemption from Section 5 of the Securities Act of 1933, which requires companies to file a registration statement with the SEC prior to offering to sell any security in interstate commerce.  Private placement egistration under Section 5 is an expensive and time-consuming process, and a network of underwriters and brokers/dealers must be assembled to make a market for the security, and HLS can assist with private placement in this regard. An issuer registering under Section 5 is also subject to strict periodic reporting requirements, and the penalties for failing to register, or for disclosing inaccurate or misleading information, are quite stringent.

To qualify for a private placement, a company must structure the transaction within the various categories of exemptions available, such as Section 4(2), considered the broad “private offering” exemption; Section 4(a)(5), considered the accredited investor exemption; intrastate offering exemption – Section 3(a)(11), the intrastate exemption; Regulation A; or Regulation D, which specifies three distinct exemptions from the registration provisions.

Private Placement Law – Section 4(a)(2) Highlights

Section 4(a)(2) of the Securities Act exempts from registration “transactions by an issuer not involving any public offering.” To qualify for this exemption, which is sometimes referred to as the “private placement” exemption, the purchasers of the securities must: (i) either have enough knowledge and experience in finance and business matters to be “sophisticated investors” (able to evaluate the risks and merits of the investment), or be able to bear the investment’s economic risk; (ii) have access to the type of information normally provided in a prospectus for a registered securities offering; and (iii) agree not to resell or distribute the securities to the public.

In general, public advertising of the offering, and general solicitation of investors, is incompatible with the non-public offering exemption.

The precise limits of the non-public offering exemption are not defined by rule. As the number of purchasers increase and their relationship to the company and its management becomes more remote, it is more difficult to show that the offering qualifies for this exemption. If your company offers securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Securities Act.

Rule 506(b) of Regulation D provides objective standards that your company can rely on to meet the requirements of the Section 4(a)(2) non-public offering exemption.

Private Placement Law – Section 4(a)(5) Highlights

Section 4(a)(5) of the Securities Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million.

The definition of accredited investor is the same as that used in Regulation D referenced below. Like the exemptions in Rule 505 and 506, this exemption does not permit any form of general solicitation or advertising. There are no document delivery requirements, but all transactions are subject to the anti-fraud provisions of the securities laws.

Private Placement Law – Intrastate Offering Exemption – Section 3(a)(11) Highlights

Section 3(a)(11) of the Securities Act is generally known as the “intrastate offering exemption.”  This exemption facilitates the financing of local business operations. To qualify for the intrastate offering exemption, your company must: (i) be organized in the state where it is offering the securities; (ii) carry out a significant amount of its business in that state; and (iii) make offers and sales only to residents of that state.  The intrastate offering exemption does not limit the size of the offering or the number of purchasers. Your company must determine the residence of each offeree and purchaser.  If any of the securities are offered or sold to even one out-of-state person, the exemption may be lost.

Private Placement Law – Regulation A Highlights

Regulation A is an exemption from registration for public offerings, although offerings made pursuant to this exemption share many characteristics with registered offerings. In March 2015, pursuant to the Jumpstart Our Business Startups (JOBS) Act, the SEC amended Regulation A by creating two offering tiers: Tier 1, for offerings of up to $20 million in a 12-month period; and Tier 2, for offerings of up to $50 million in a 12-month period.  For offerings of up to $20 million, companies can elect to proceed under the requirements for either Tier 1 or Tier 2.  The amendments became effective on June 19, 2015.

There are certain basic requirements applicable to both Tier 1 and Tier 2 offerings, including company eligibility requirements, bad actor disqualification provisions, disclosure, and other matters.  Additional requirements apply to Tier 2 offerings, including limitations on the amount of money a non-accredited investor may invest in a Tier 2 offering, requirements for audited financial statements and the filing of ongoing reports.

Other specific requirements that need to be met prior to this exemption being available include: (i) SEC reporting companies (public companies) are not eligible to use Regulation A.  Other types of ineligible companies are development stage companies without a specific business plan or purpose (i.e., “blank check companies”) and investment companies registered or required to be registered under the Investment Company Act of 1940. The rules specify additional types of companies that are ineligible to rely on Regulation A; (ii) the types of securities eligible to be offered and sold pursuant to Regulation A are equity securities (including warrants), debt securities and debt securities convertible or exchangeable into equity interests, as well as guarantees of any such securities.  Asset-backed securities, and fractional or undivided interests in oil, gas or other mineral rights, are excluded from the list of eligible securities; and (iii) an issuer seeking qualification under Regulation A pursuant to Tier 2 is required to limit the amount of securities that an investor who is not an accredited investor (term defined below) under Regulation D can purchase to no more than: (a) 10% of the greater of annual income or net worth (for natural persons); or (b) 10% of the greater of annual revenue, or net assets at fiscal year-end (for non-natural persons).

Securities in a Regulation A offering can be offered publicly, using general solicitation and advertising, and sold to purchasers irrespective of their status as accredited investors.  Securities sold in a Regulation A offering are not considered “restricted securities” for purposes of aftermarket resales.  “Restricted securities” are securities issued in private offerings that must be held by purchasers for a certain period of time before they may be resold though.

To sell securities pursuant to Regulation A, the SEC must first issue a “notice of qualification,” after their personnel review prospective issuer’s offering materials filed in accordance with the requirements of  Form 1-A.

Private Placement Law – Regulation D (“Reg. D”) Rules 504, 505 and 506 Highlights

For purposes of Reg. D and the various rules contained therein, it is important to understand the term, “accredited investor”.  This term is defined below.

An “accredited investor” is:

(i) a bank, insurance company, registered investment company, business development company, or small business investment company;

(ii) an employee benefit plan (within the meaning of the Employee Retirement Income Security Act) if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;

(iii) a tax exempt charitable organization, corporation or partnership with assets in excess of $5 million;

(iv) a director, executive officer, or general partner of the company selling the securities;

(v) an enterprise in which all the equity owners are accredited investors;

(vi) an individual with a net worth of at least $1 million, not including the value of his or her primary residence;

(vii) an individual with income exceeding $200,000 in each of the two most recent calendar years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or

(viii) a trust with assets of at least $5 million, not formed only to acquire the securities offered, and whose purchases are directed by a person who meets the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment.

Private Placement Law – Rule 504

Regulation D contains Rules 504, 505 and 506, which establish exemptions from Securities Act registration. The only filing requirement under each of these exemptions is the requirement to file a notice on Form D with the SEC. The notice must be filed within 15 days after the first sale of securities in the offering. Many states also require the filing of a Form D notice in a Regulation D offering. The main purpose of the Form D filing is to notify federal (and state) authorities of the amount and nature of the offering being undertaken in reliance upon Regulation D.

Rule 504, sometimes referred to as the “seed capital” exemption, provides an exemption for the offer and sale of up to U.S. $1 million of securities in a 12-month period.  There are pending SEC regulations to increase the offering amount up to U.S. $5 million but are not effective as of the writing of this publication.

In general, an issuer may not use general solicitation or advertising to market the securities, and purchasers generally receive “restricted securities.” Purchasers of restricted securities may not sell them without SEC registration or using another exemption.  Investors should be informed that they may not be able to sell securities of a non-reporting (non-public) company for at least a year without the issuer registering the transaction with the SEC.

Private Placement Law – Rule 505

Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, the issuing company may sell to an unlimited number of “accredited investors” and up to 35 persons that are not accredited investors. Purchasers must buy for investment purposes only, and not for the purpose of reselling the securities. The issued securities are “restricted securities,” meaning purchasers may not resell them without registration or an applicable exemption.  If the issuing company is not an SEC reporting or public company, investors should be informed that they may not be able to sell securities for at least a year without the company registering the transaction with the SEC. Your company may not use general solicitation or advertising to sell the securities.

In a Rule 505 offering, if the offering involves any non accredited purchasers or non accredited investors, you must give these purchasers disclosure documents that generally contain the same information as those included in a registration statement for a registered offering.  There are also financial statement requirements that apply to Rule 505 offerings involving purchasers that are not accredited investors.

Private Placement Law – Rule 506

Rule 506 provides two different ways of conducting a securities offering that is exempt from registration: (i) Rule 506(b); and (ii) Rule 506(c).  Rule 506(b) is an exemption rule that was in place prior to the JOBS Act. Rule 506(c) was added in 2013 to implement a statutory mandate under the JOBS Act.  Purchasers receive “restricted securities” in a Rule 506 offering.

Private Placement Law – Rule 506(b)

Rule 506(b) is a “safe harbor” for the non-public offering exemption in Section 4(a)(2) of the Securities Act, which means it provides specific requirements that, if followed, establish that your transaction falls within the Section 4(a)(2) exemption. Rule 506 does not limit the amount of money your company can raise or the number of accredited investors it can sell securities to, but to qualify for the safe harbor, your company must: (i)
not use general solicitation or advertising to market the securities; (ii) not sell securities to more than 35 non-accredited investors (unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must meet the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment); (ii) give non-accredited investors specified disclosure documents that generally contain the same information as provided in registered offerings (the company is not required to provide specified disclosure documents to accredited investors, but, if it does provide information to accredited investors, it must also make this information available to the non-accredited investors as well); (iii) be available to answer questions from prospective purchasers who are non-accredited investors; and (iv) provide the same financial statement information as required under Rule 505.

Private Placement Law – Rule 506(c)

To implement Section 201(a) of the JOBS Act, the SEC promulgated Rule 506(c) to eliminate the prohibition on using general solicitation under Rule 506 where all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers are accredited investors.

Under Rule 506(c), issuers may offer securities through means of general solicitation, provided that: (i) all purchasers in the offering are accredited investors, (ii) the issuer takes reasonable steps to verify their accredited investor status, and (iii) certain other conditions in Regulation D are satisfied.

Private Placement – U.S. State Securities Laws

Full compliance with the federal securities laws is only one level of regulation that must be taken into account. You must also consider the expense and requirements on the state level. Regulation D was designed to provide a foundation for uniformity between federal and state securities laws. This objective has been met in some states but still has a long way to go on a national level. Whether or not the offering is exempt under federal laws, registration may still be required in the states where the securities are to be sold, under applicable “Blue Sky” laws.  These state laws regulate the sale of securities, intended to protect the public from fraud, at the state level (e.g., Texas, New York, California).

Every state in the nation has some type of statute governing securities transactions and securities dealers. There are a wide variety of levels of review among the states, ranging from very tough “merit” reviews (designed to ensure that all offerings of securities are fair and equitable) to very lenient “notice only” filings (designed primarily to promote full disclosure). The securities laws of each state where an offer or sale will be made should be checked very carefully prior to drafting and distribution of the private placement offering documents.  For example, an issuing company seeking to raise capital under Rule 504 should examine applicable state laws very carefully because although many states have adopted overall securities laws similar to Regulation D, many of these laws do not include a similar exemption.  As a result, a formal memorandum may need to be prepared.

Private Placement

If you would like to have further discussions on what private placement exemptions to utilize when raising equity and/or debt financing, then please do not hesitate to reach out to Hollister Legal Services, PLLC via Contact page. Or just call us now: 512-761-2782.


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