Businesses looking for investors just got some good news from the Securities and Exchange Commission. On July 10, 2013, the SEC eliminated its ban on "general solicitation" of investors under Rule 506 of Regulation D. Mandated by last year's JOBS Act, these amendments will permit businesses raising capital through so-called "private" offerings to advertise and otherwise publicly seek potential investors. New Rule 506(c) should unshackle issuers in their quest for funding and increase their success.
A bit of background: U.S. securities laws generally require that an issuer register an offering of securities with the SEC, absent an exemption from registration. For businesses, the most widely used exemption is that for "transactions by an issuer not involving any public offering." This private offering exemption was codified as a safe harbor in Rule 506 of Regulation D. Generally, under Rule 506, an issuer can raise an unlimited amount of capital from an unlimited number of "accredited investors" and up to thirty-five non-accredited investors who meet "sophistication" requirements. A central tenet of the private offering exemption is that securities must be offered and sold privately rather than publicly: no securities can be sold by general solicitation or general advertising.
As a result of the ban on general solicitation, issuers making private offerings have had to exercise caution in their sales efforts. They could not advertise on their websites or in newspapers or industry journals. Mentioning the offering in public speaking engagements was off limits. They were prohibited from soliciting potential investors they did not know. What issuers generally could do was approach persons with whom they had a preexisting business relationship. (In practice, some "relationships" developed in mere minutes, as aggressive issuers pushed the envelope of the law.) The prohibition on general solicitation could make raising private capital a daunting task, particularly for entrepreneurs seeking angel funding. As a result, the prohibition has likely contributed to market inefficiency, making it more difficult for issuers and potential investors to find each other.
Under the SEC's new Rule 506(c), an issuer is now free to engage in general solicitation and advertising. Conditions include compliance with other current Rule 506 requirements, as well as two new ones: (i) the issuer must take reasonable steps to verify that all purchasers in the offering are accredited investors; and (ii) all purchasers must actually be accredited investors or the issuer must reasonably believe that they are accredited investors. "Accredited investors" include individuals who meet certain net worth or net income thresholds, as well as trusts, corporations and other entities that meet certain asset levels.
It will be important for issuers to take reasonable steps to verify the accredited status of investors. The SEC has stated that reasonableness will be objectively determined based on the particular facts and circumstances of each purchaser and the transaction. The SEC has provided some nonexclusive methods to confirm that an individual is an accredited investor. These include reviewing copies of IRS forms to confirm income, bank and brokerage statements to confirm assets held, credit reports from at least one nationwide consumer reporting agency to confirm liability levels, and confirmations by third parties who are familiar with an investor (e.g., lawyers, broker-dealers or CPA s). Issuers should be aware that these verification requirements are more stringent than in the past: mere certifications contained in investor questionnaires will no longer be adequate.
New Rule 506(c) will take effect in mid- September, and issuers may then begin taking advantage of their new freedom to utilize general solicitation. The SEC has also proposed several new rules to accompany new Rule 506(c), including a rule requiring the filing of advanced notice, but these ancillary rules have not yet been adopted.
Although many businesses seeking to raise capital will feel liberated by new Rule 506(c) and gladly embrace the opportunity to advertise, for those businesses seeking to avoid the new accredited investor verification requirements, "old" Rule 506 will remain available and unchanged.
Bottom line: new Rule 506(c) is great news for businesses raising capital.
This information should not be interpreted as legal advice with respect to specific situations.