raising capital post september 23

Raising Capital Under the New General Solicitation Rules

September 2013

Bo Sartain, CEO

© 2013 VentureDocs Inc., all rights reserved 1

General Solicitation prohibited unless issuer is “going public”

Securities Act Section 4(2) exempts sale of securities sold “not in a public offering”

Rule 506 of Regulation D, a “safe harbor” under Section 4(2)

Unlimited number of “accredited investors”Unlimited dollars that can be raised

Up to 35 non-accredited investors, but watch out, if you have non-accredited investors there are information disclosure requirements under Rule 502 (PPM) and the non-accredited

investors must meet “sophistication” requirements

Historical Overview


“Quiet” 506 Transactions

Old Securities Act Section 4(2) is now 4(a)(2)Old Rule 506 is now Rule 506(b)

No “general solicitation”But, for 506(b) transactions, it is likely that the Form D will be required in the future

(it has been optional) (this is a proposed rule)

The old rules are still in place (technically)

Two Ways to Raise Capital


“Noisy” 506 Transactions

New Section 506(c)General solicitation is allowed

All purchasers must be accredited investors. No exceptionsIssuer must take “reasonable steps” to verify that all investors are accredited

investorsSelf-certification (a questionnaire or representations and warranties) is not

enough

Effective Date: September 23, 2013

Two Ways to Raise Capital


Obvious General SolicitationsA website accessible to the general publicWidely disseminated email or social media

Print media, such as a newspaperTelevision, Radio

Not Obvious, but they are General SolicitationsA solicitation at a seminar where attendees have been invited by general

solicitation or general advertising, such as an unrestricted website

DANGER: Pitch Day/Demo Day Competitions (Rice Alliance, Tech Wildcatters, Texas Venture Labs) are general solicitations

What is a General Solicitation?


Solicitation of Angels and Angel Groups on Gust, AngelList, EquityNet, etc. ???

“An issuer that solicits new investors through a website accessible to the general public, through a widely disseminated email or social media solicitation, or through

print media, such as a newspaper, will likely be obligated to take greater measures to verify accredited investor status than an issuer that solicits new investors from a

database of pre-screened accredited investors created and maintained by a reasonably reliable third party.”

DANGER: Did the SEC just say that submitting offering materials through Gust or AngelList is a general solicitation?



Any General Solicitation makes the whole offering subject to the 506(c) rules

A perfectly good 4(a)(2) or 506(b) offering becomes a 506(c) offering if any general solicitation is made.

Integration under Rule 502(a)6-month look forward and backward

A perfectly good 4(a)(2) or 506(b) offering becomes tainted by a subsequent 506(c) offering if the two are integrated.

DANGER: What you do later may invalidate what you have done before



Facts and circumstances test/“principles-based approach”

Factors to considerThe nature of the purchaser and the type of accredited investor

The amount and type of information the issuer has about the purchaserThe nature of the offering, such as the manner in which the purchaser was

solicited

ExamplesHigh minimum investment makes it more likely they are accredited

Solicitation to the public at large versus a database of pre-screened accredited investors requires more verification steps

What are “Reasonable Steps”


Non-Exclusive Safe Harbor for IndividualsInvalidated if issuer has knowledge that an investor is not an accredited investor

Income TestInvestor has earned at least $200K (or $300K together with spouse) in each of the last 2 years and is expected to earn at least that much in the current

yearReview of IRS forms that report revenue (W-2, Form 1099, Schedule K-1 or

filed Form 1040)Written representation from such person that he or she has a reasonable

expectation of reaching the income level in the current year.

DANGER: There may be no way to rely on this safe harbor in the first quarter of any year before W-2s, 1099s, K-1s or 1040s are

prepared.



Non-Exclusive Safe Harbor for IndividualsNet Worth Test

Investor has a net worth of $1,000,000 excluding primary residenceA written representation that all liabilities necessary to make a net worth

determination have been disclosedAssets: review of bank statements, brokerage statements, other statements of securities holdings, certificates of deposit, tax assessments and appraisal

reports issued by independent third partiesLiabilities: review of consumer report from at least one of the nationwide

consumer reporting agenciesData may not be more than 3 months old



Non-Exclusive Safe Harbor for IndividualsReliance on Third Parties

Registered broker-dealer, SEC-registered investment advisor, a licensed attorney or a CPA

Written confirmation that such person has taken reasonable steps within the last 3 months to verify that the purchaser is an accredited investor.

Grandfather provision for existing investorsIssuers do not have to take reasonable steps to verify accreditation for

existing investors who self-certified before in 506 transactions



1. The issuer closes a new round with investors that the issuer contacted directly and with whom the

issuer has a prior relationship.2. Same facts as 1, but then the issuer then wishes

to finish out the round and does a quick pitch at the Rice Alliance.

3. Same facts as 1. 5 months later, the issuer launches a new round by making an

announcement on its website.

DANGER: It may be virtually impossible for startups to avoid general solicitation.

Examples


Disqualifies the transaction from Rule 506(b) and 506(c)

New Rule 506(d)Disqualification occurs if:

issuer, any predecessor of the issuer, any affiliated issuer, any director, executive officer, other officer participating in the offering, general partner or managing member of the issuer, any beneficial owner of 20% or more of the issuer’s outstanding voting equity

securities, or any promoter or placement agent (or their managers, officers and directors)has been convicted of a felony or misdemeanor involving securities, is subject to any

order or injunction involving securities, is barred from engaging in the business of securities, banking or insurance, has had a securities license revoked

Basically, disqualification occurs if anyone connected with the transaction or issuer has a history with a securities criminal conviction

or disciplinary action

“Bad Actor” Provisions under Dodd-Frank Act


Stay tuned, new proposed rules may:require filing an “Advance Form D” 15 days before any general solicitation is made for

506(c) transactionsrequire filing a Form D within 15 days after the first sale of securities in the 506(b) or

506(c) offering (This is already the rule)require filing a Form D within 30 days after the offering is completed or cancelled (for

506(b) and 506(c))require filing an updated Form D at least annually if the offering is ongoing

allow a 30 day cure period for 1 late form D filing in any offeringrequire specific legends and other disclosures to be added to all offering documents

require filing all offering documents used in a general solicitation with the SEC no later than the first day a general solicitation is made

increase the information required to be filed in Form D

DANGER: failure to comply will automatically disqualify an issuer from using Rule 506(b) and 506(c) for 1 year following the cure of any

failure to file a Form D or a breach of these new rules

Proposed Regulation D Rules


Assume that your offering will contain a general solicitation

Assume that offerings will be integrated together

“Best Practice” may be to file Advance Form D immediately if/when proposed rules become

effectiveEnsure company profiles on Angellist, Gust, etc. do not indicate your company is raising capital

(why take that chance?)

Takeaways


Contact:Bo Sartain

[email protected]


raising capital post september 23

Economy & Finance