What is an Exempt Direct Public Offering? Rule 506(c) Offering Attorneys

Direct Public Offering Lawyers - Going Public

The Direct Public Offering plays an important role in the going public process. Direct Public Offerings provide flexible options for issuers and allow the issuer to structure its going public transactions a variety of ways. Rules adopted pursuant to the JOBS Act, make an exempt Direct Public Offering an appealing and uncomplicated method of raising capital.One of the most important aspects of the going public process involves deciding the terms of the offering that will be presented to investors.  The terms of a company’s direct public offering could have future impacts on its business.  Investors want to know they will have an exit strategy in the future. This exit strategy can be accomplished a number of ways. 

What is a Direct Public Offering?

Direct Public Offerings are not complicated. They are simply securities offerings sold by a company without an underwriter.  Direct Public Offerings allow companies to structure their offerings a variety of ways. Direct Public Offerings can include equity, debt, revenue share or royalty payments, memberships, and other securities.  Offerings with common shares can pay dividends, offer different classes of shares, limit voting or be structured a number of ways.  Debt offerings can be convertible or secured by the company’s assets, revenues or other criteria.  Direct Public Offering structures are endless.

Choosing The Best Exemption From Registration
An exempt Direct Public Offering can involve a private placement under Rules 506 or 504 of Regulation D.  The most commonly used Direct Public Offering exemption is Rule 506.

Rule 506 (b) of Regulation D

Section 4(a)(2) of the Securities Act exempts from registration “transactions by an issuer not involving any public offering.”  Rule 506(b) is a rule under Regulation D that provides conditions that an issuer may rely on to meet the requirements of the Section 4(a)(2) exemption.  One of these conditions is that an issuer must not use general solicitation to market the securities.

“General solicitation” includes advertisements published in newspapers and magazines, public websites, communications over television and radio, and seminars where attendees have been invited by general solicitation or general advertising.  In addition, the use of an unrestricted, and therefore publicly available, website constitutes general solicitation.  The solicitation must be an “offer” of securities, but solicitations that condition the market for an offering of securities may be considered to be offers.

Rule 506 (c) of Regulation D

Section 201(a) of the JOBS Act requires the SEC 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.

To implement Section 201(a), the SEC adopted paragraph (c) of Rule 506.  Under Rule 506(c), issuers can offer securities through means of general solicitation, provided that:

  • all purchasers in the offering are accredited investors,
  • the issuer takes reasonable steps to verify their accredited investor status, and
  • certain other conditions in Regulation D are satisfied.

An “accredited investor” includes a natural person who:

  • earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or
  • has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

The JOBS Act requires that issuers wishing to engage in general solicitation take “reasonable steps” to verify the accredited investor status of purchasers.  Rule 506(c) sets forth a principles-based method of verification which requires an objective determination by the issuer (or those acting on its behalf) as to whether the steps taken are “reasonable” in the context of the particular facts and circumstances of each purchaser and transaction.  Among the factors that an issuer should consider under this principles-based method are:

  • the nature of the purchaser and the type of accredited investor that the purchaser claims to be;
  • the amount and type of information that the issuer has about the purchaser; and
  • the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

Rule 506(c) includes a non-exclusive list of verification methods that issuers may use, but are not required to use, when seeking greater certainty that they satisfy the verification requirement with respect to natural person purchasers.  This non-exclusive list of verification methods consists of:

  • verification based on income, by reviewing copies of any Internal Revenue Service form that reports income, such as Form W-2, Form 1099, Schedule K-1 of Form 1065, and a filed Form 1040;
  • verification on net worth, by reviewing specific types of documentation dated within the prior three months, such as bank statements, brokerage statements, certificates of deposit, tax assessments and a credit report from at least one of the nationwide consumer reporting agencies, and obtaining a written representation from the investor; and
  • a written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant stating that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the last three months and has determined that such purchaser is an accredited investor.

Compliance Strategy

Federal and state laws apply to Direct Public Offerings. Generally, unless an offering is registered with the SEC it must be exempt from registration.

Companies should be prepared to file a notice filing for their exempt Direct Public Offering offering in every state where they want to accept investors.  Most state securities regulators require a filing fee for Rule 506 offerings, which can range from $100 to $3,000.

If a company conducts its private placement in reliance upon Regulation D Rule 506, state laws are pre-empted and states can only require issuers to pay a filing fee and make a notice filing.  Rule 506 allows issuers to raise an unlimited amount of capital but specific disclosures and other limitations are applicable in some circumstances.

The Private Placement Memorandum

The Private Placement Memorandum is a document that describes your business and the offering. It should disclose everything a reasonable investor would want to know before deciding whether to purchase the securities being offered.

Marketing the Offering

Issuers seeking to use the Rule 506 (c) exemption should start planning their marketing strategy for the offering including establishing their marketing budget.  Issuers should determine who will be its target investors and what media will be used to advertise the offering.   Companies can market the offering using press releases, websites, email solicitations, social media, public events and phone calls.  All marketing materials, like the Private Placement Memorandum, are subject to the anti-fraud provisions of the federal and state securities laws.

Issuers should exercise care when structuring their Direct Public Offering.  New rules ease the offering process and impose manageable requirements for general solicitation and advertising.  While the rules are manageable, non-compliance with Rule 506(c) could cause the issuer to lose its exemption from registration.   As such, issuers should consult with an experienced securities attorney to assist them with structuring and conducting their offering.

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 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.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855