The SEC Analyzes Rule 506 l Going Public Attorneys
In its recently proposed Regulation Crowdfunding (“Reg CF”), the Securities and Exchange Commission (“SEC”) produced some interesting statistics on the types of unregistered offerings that have been popular with smaller issuers and private companies over the past few years. Since the crowdfunding proposals won’t become effective until later this year, private and public companies interested in conducting offerings in the next few months should consider the impact of recent rules. Companies should follow the guidance of an experienced going public attorney prior to undertaking an offering..
Many startups begin by raising capital from family and friends. Funds may be raised through donations, loans, or the sale of stock. Unfortunately, family and friends are rarely able to contribute large amounts, and the startup will soon be forced to look elsewhere for money.
Traditionally, business owners have looked to banks for personal and commercial loans, business credit cards and lines of credit, but since the economic crisis of 2008, bank lending to startups has fallen sharply.
In 2012, fewer than one third of small businesses reported a business bank loan. While large business loans have been on the rise since 2010, small business loans continue to decline in 2013. The Small Business Association seems a logical place to turn, but currently it administers less than two percent of all small business loans.
Young companies may hope to attract venture capitalists or angel investors, but in most cases those hopes are unrealistic.
In the end, startups usually choose to launch offerings making use of exemptions from registration under the federal securities laws. That means that they are not required to register the offering with the SEC, or to become SEC registrants, though SEC registrants not trading on national exchanges may make use of them.
Two obvious possibilities are Regulation D and Regulation A. They are available to all OTC issuers.
The SEC points out that Regulation A is “not widely used,” in part because issuers must file an offering document with the SEC that may be reviewed by staff who will request amendments, and because it provides no safe harbor from state securities regulations, which means that issuers may be required to register in every state in which they intend to offer and sell their securities. (A new coordinated review program proposed by the North American Securities Administrators Association should make the latter easier in the near future.)
Given the SEC’s recognition that Regulation A offerings are unpopular, it is somewhat surprising that the Commission has designed requirements for issuers using Regulation CF that closely resemble those for Regulation A.
Regulation D is by far the preferred choice for companies seeking to sell equity in unregistered offerings. There are three types of offerings, each with its own restrictions and requirements.
Rule 504 permits the issuer to raise no more than $1 million within a 12 month period. A Form D must be filed with the SEC not later than 15 days after the first sale. The stock sold will be restricted. Compliance with state blue sky laws is required.
Rule 505 permits the issuer to raise up to $5 million within a 12 month period. Participants may be any number of accredited investors and 35 non-accredited investors.
Rule 506(b) allows the issuer to raise an unlimited amount of money from an unlimited number of accredited investors and up to 35 non-accredited investors. Filing a Form D is encouraged, but not required. Securities sold are exempt from state blue sky laws as “covered securities.”
Rule 506(c) is recently mandated by the JOBS Act. The benefits and requirements are the same as for Rule 506(b), with three differences: general solicitation and advertisement are allowed, only accredited investors may participate, and the filing of a Form D is mandatory.
The SEC noted that although Rule 504 is designed for companies seeking capital of raise less than $1 million, those companies rarely use it, preferring instead to use Rule 506. Rule 506 is more than ten times more popular than all exemptions from registration, as a table furnished by the SEC clearly illustrates.
What all this tells us is that at some point nearly all small companies and private companies in going public transactions will make use of Regulation D, and will probably choose a Rule 506 offering. Given that between 2009 and 2012 only 16 companies chose to venture a Regulation A offering, it may be wondered how many will be interested in Regulation Crowdfunding, which, as designed by the SEC, will be very similar to Reg A.
Issuers interested in raising money for their small business should carefully consider the options available to them. It is important to remember that not all offerings are successful, so costs should be taken into account as well as the conditions of the offering. A qualified securities and/or going public attorney can advise on the advantages and disadvantages of all types of exempt offerings.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
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Brenda Hamilton, Securities Attorney
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