A company must adhere to securities laws when raising capital. As previously discussed, all offerings of securities, must either be registered with the SEC or exempt from such registration. Private companies have the most common exemption from securities under Rule 506(b). Even if you have met the basic requirements of the exemption, there are still nuanced requirements that can be overlooked and could affect your ability to qualify under the exemption. An issuer, its officers and directors can face severe penalties if they fail to follow Rule 506(b). The SEC and state regulators have the power to initiate investigations, civil and administrative actions, enter orders and impose substantial monetary penalties. They can also transmit evidence to U.S. attorney general, who can take criminal proceedings. Buyers who violate securities registration requirements are entitled to rescission rights according to both federal and state laws. This blog post provides a list of best practices to conduct a 506 (b) offering. It is bullet-pointed for your convenience.
Rule 506(b) Offering Procedures
Who Should Conduct an Offering. The offering should only be conducted by the officers, directors, and employees of the company issuing securities, or registered broker-dealer. If they claim to be able to raise money for your company, they must not be associated with a broker-dealer. This could legally put you and your company in danger.
Offeres. Only persons or entities who meet the requirements below may be offered investment opportunities.
- You believe they are accredited investors because they fall under one or more of the following categories:
- Business organizations with assets exceeding $5,000,000 that are not intended for investing in your company.
- Directors or executive officers of the company
- Individuals with a net worth of more than $1,000,000 or jointly with a spouse; This does not include primary residence.
- Individuals with income greater than $200,000 or joint income with spouse exceeding $300,000. Expecting the same income in this year’s income;
- These individuals may have IRAs
- Trusts of assets exceeding $5,000,000 are not created for the purpose to invest in your company. They must be directed by a sophisticated individual.
- entities in which all owners are one of these.
- Who fall within one of the following categories
- Ideal candidates are people who have a relationship with you in a business or personal capacity. To evaluate their financial situation and sophistication, you must have enough information.
- People with whom you don’t have a relationship are less desirable. However, you can introduce yourself to people through your personal network of sophisticated, experienced investors. You can then send them the offer materials by asking them to complete an “Investor Questionnaire”. You can avoid prohibited “general solicitation” by contacting fewer people.
What to Avoid
Avoid these things:
- Accepting investment documents that are incomplete or incorrect or accepting investments from investors even though they have not been accredited
- Accepting funds from potential investors before reviewing and receiving investment documents
- Cold calls, website communications or email blasts or newsletters are all acceptable methods of contacting the public about an offering of securities.
- Any materials other than those prepared by legal counsel for an offer of securities must not be used.
- Distributing materials about your company (such as annual reports) that may be construed to offer securities except for the permissible types of people described above is not allowed.
- Compensation of directors, officers or employees who find investors through a subscription;
- You cannot compensate anyone for finding investors or in connection to an investment, except if such person is a registered placement agent or broker-dealer with whom you have signed an agreement.
These procedures will ensure that your offering is eligible for the Rule 506 (b) exemption. You should also have the appropriate documentation in case of an audit by regulators.
- If your offering materials have a number (and it is a good idea to number each one), you should fill in the number for each package before you give them to potential investors. This number should be unique for each individual receiving the materials, regardless if they decide to invest. This means that the number should be unique to each person receiving the materials, regardless of whether they invest or not. You should not re-use numbers even if you never hear back from the person.
- All items should be included in the offer materials for each potential investor.
- The offering materials can be delivered in person, by mail, facsimile or email.
- Consider adding security protections to electronic files, such as encryption, password protection, watermarks, or statements regarding confidentiality, when you email the offering materials.
- Keep track of the number, offeree’s name, and transmittal date.
- Use client relationship management software (CRM) to track the transmission of offer materials to potential investors.
- The required disclosure filing Form D must be filed with SEC within 15 days of the first investment. Your counsel will usually prepare the Form for you, but they need to know about your subscription as soon as it occurs.
- Each state must file a copy of Form D within 15 days of the sale. This is usually done by the counsel of the issuer. However, they will need to be notified immediately if you have new investors.
- For certain changes, amendments to Form D should be filed. If any information on the Form D has changed, let your counsel know immediately.
- Annual amendments to Form D must also be filed, as long as the offering is ongoing.
- Keep track of all subscriptions.
- You should review the offering materials at least once a quarter, as well as when any major event occurs. Your counsel should inform you if there is any information that needs to be corrected or updated as soon as possible. You should consult your attorney if you are uncertain about which events or changes will require updating the offering materials.