Wednesday, November 13, 2013

SEC Rule 506 (c) Offerings Are Better than Crowdfunding and Traditional Private Placement Exemptions


By:  Jim Verdonik
I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW

There's been a lot written lately about the SEC's proposed crowdfunding rules and new Rule 506 (c).

But most of the articles don't address the bottom line issue:  Which exemption is best for most companies that are trying to raise capital?

Here's the bottom line answer:  New Rule 506 (c) provides much greater capital raising flexibility than both the proposed crowdfunding rules and traditional private placement exemptions.

Only Rule 506 (c) offerings have all the following advantages that affect your ability to communicate to a wide audience on a cost efficient basis:

- Allow you to use social media, advertising and other solicitations with the only limit being that you are not allowed to commit fraud.  Social media is a cost efficient tool for attracting investors if you know how to use it.

- Allow maximum flexibility about what you disclose to investors and how you disclose it, subject only to the requirement that you not commit fraud.

-  Do not require financial statements that have been reviewed or audited by independent accountants no matter how much money you raise. 

- Provide an exemption from state rules that require pre-sale filings and reviews by state securities administrators, which can cause delays and extra offering expenses.

- Allow you to raise any amount of capital.

- Have no post-sale filing requirements other than filing Form D with the SEC and some states.

The one downside to Rule 506 (c) offerings is that you must sell only to accredited investors and take reasonable steps to verify that all your investors are accredited.   See my blog post on July 18, 2013 that discusses the accredited investor verification process. 

Accredited investor verification is a small price to pay for all the advantages Rule 506 (c) offerings provide.

Financial statement requirements in crowdfunding offerings and Rule 506 (b) and 505 offerings that include non-accredited investors can double or triple your capital raising expenses.  Crowdfunding's requirement that you must continue to file reports with the SEC for an indefinite time period after you raise money is also a cost burden.  And you can use social media in crowdfunding offerings only if you limit yourself to a notice that is a lot like the traditional "tombstone" ads you see in the Wall Street Journal.  BORING doesn't sell in social media.  In return for all these limits, the crowdfunding rules will permit you to raise small amounts of money from many investors without worrying whether the investors are accredited.  That's not a great deal compared to the short-term and long-term costs of complying with the crowdfunding rules.

So, does crowdfunding offer no benefits?

As discussed above, Rule 506 (c) offerings give you great flexibility in what you say, how you say it and what social media and other advertising and solicitation tools you use.  Choices and alternatives are generally good things, but they can present problems.  Using social media effectively is a skill that not every business has.  If you are not effective in how you use social media, your sales effort will fail.  The one stop shop approach that provides all the technology and regulatory compliance will be attractive to some people. 

Some people like to do the work to renovate their own homes.  Others prefer to hire a contractor to do it for them.  They either lack the skills to do it themselves or they don't have the time.  For that they pay a higher price.  Some people will decide to pay the SEC's regulatory price required to use the proposed crowdfunding exemptions.

The primary benefits of crowdfunding platforms is that they will offer a clear pathway for investors and businesses to meet.  This will be particularly true of crowdfunding platforms that specialize by industry.  They will attract investors that are interested in that particular industry.

Think of it like cable TV channels.  If you want the news, you know what channels specialize in news.  The same goes for movies, history, travel and cooking.  Investors seeking certain types of deals will gravitate to crowdfunding platforms that specialize in their type of deal.  That's a valuable service. 

Of course, having the best of both crowdfunding platforms channel to investors and Rule 506 (c) flexibility is what most people will probably choose. 

There is no reason why you have to accept the restrictions of the SEC's crowdfunding rules to take advantage of crowdfunding platform services.  If you comply with Rule 506 (c)'s accredited investor verification rules, you will be able to do Rule 506 (c) offerings through crowdfunding platforms.  Indeed, until the SEC's proposed crowdfunding rules become effective, these hybrid offerings types of offerings will be the only deals you can do through crowdfunding platforms.

Crowdfunding platforms will be one of many types of technology and marketing services people operate to facilitate 506 (c) offerings.  That will allow businesses raising capital to use social media in creative ways to drive people to their crowdfunding platform offering instead of being limited to ineffective tombstone advertisements.  Another benefit of combining Rule 506 (c) with crowdfunding platforms will be that you can avoid the SEC's proposed requirement that you use only one crowdfunding platform.  Rule 506 (c) contains no such restriction.  So, you can use multiple channels to communicate with investors.

Combining crowdfunding technology with Rule 506(c) offerings will present some regulatory and technical challenges to the intermediaries who operate crowdfunding platforms, but it will offer many benefits to businesses raising capital.

Of course, no single exemption is best in every circumstance for every company trying to raise capital.

Here's a table that shows the requirements for eight different offering exemptions, including proposed crowdfunding rules and traditional Rule 506 (b) offerings.

Judge for yourself which type of offering exemption gives you the best deal:


 
SEC SECURITIES OFFERING EXEMPTIONS
 
 
 
Crowd Funding
(Proposed Regulations not in effect)
Rule 506 (c)
Rule 506 (b)
(if have all Accredited Investors)
Rule 506 (b)
(if include any non-accredited investors)
Rule 505
(if have all Accredited Investors)
Rule 505
(if include any non-accredited investors)
Rule 504
Section 4 (2)
Social Media and Other Advertising Permitted
Yes, but only limited advertising outside the intermediary's portal
Yes, limited only by anti-fraud rules
No
No
No
No
No
No
Exemption from State Securities Filings Before Sale
Yes (1)
Yes(1)
Yes (1)
No
No
No
No
No
Allows Sales to Non-Accredited Investors
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
Accredited investor Verification Required
No
Yes
No
No
No
No
No
No
Dollar Limits
$1 million in 12 months
No
No
No
$5  million
$5 million
$1 million in 12months
No
Specific Disclosure Rules Apply
Yes, very structured disclosure
No, only anti-fraud rules apply
No, only anti-fraud rules apply
Yes, very structured disclosure(2)
No, only anti-fraud rules apply
Yes, very structured disclosure
(2)
No, only anti-fraud rules apply
No, only anti-fraud rules apply
Audited Financial Statements Required
Yes unless less than $100,000 (3)
No
No
Yes(4)
No
Yes (4)
No
No
Required to file with SEC
Yes
Form D (5) (6)
Form D (5)
Form D (5)
Form D (5)
Form D(5)
Form D (5)
No
Post-Offering Reporting Obligations
Yes, burdensome post offering filings
Form D
Amendments
(5)
Form D Amendments
(5)
Form D Amendments
(5)
Form D Amendments
(5)
Form D Amendments
(5)
Form D Amendments
(5)
No
Integration
Risks with  other Offerings
Unclear (7)
Yes (7)
Yes (7)
Yes (7)
Yes (7)
Yes (7)
Yes (7)
Yes (7)
Limits on Amounts any Single Investor Can Invest
Yes.  Limits are based on investor net assets and income levels.
 No
 No
 No
Any investor can invest up to the $5 million total offering limitation amount.
Any investor can invest up to the $5 million offering limitation amount..
Any investor can invest up to the $1 million total offering limitation amount.
 No
 Number of Investors Permitted
 No limit
 No limit
 No limit
 No limit for accredited investors. Limited to 35 non-accredited investors
 No limit
 No limit for accredited investors. Limited to 35 non-accredited investors
 No limit
 Small number only.  Useful if they are all related to the business or to one another.

 

(1)   Post- sale filing requirements of states are not pre-empted.  Fraud provisions of state laws are not pre-empted.

(2)   Rule 502 (b) requires to the extent material to an understanding of the issuer, its business and the securities being offered the information required by Part II of Form 1-A of Regulation A, but special rules apply to public reporting companies and foreign private issuers.

(3)   Proposed rules require for offerings greater than $500,000, audited financial statements, but (i) for offerings $100,000 or less, issuers can substitute their income tax return and financial statements certified by the issuer's principal executive officer, and (ii) for offerings between $500,000 and $500,000, issuers can substitute reviewed financial statements.

(4)     Rule 502 (b) requires to the extent material to an understanding of the issuer, its business and the securities being offered three different audit requirements depending on the size of the offering: (i) for offerings up to $2,000,000, the financial statements required by Article 8 of Regulation S-X, except that only the balance sheet as of a date not more than 120 days before the offering begins must be audited, (ii) for offerings up to $7,500,000. audited financial statements that a "small reporting company" would be required to file in a registration statement on Form S-1, but if the issuer cannot obtain audited financial statements without unreasonable effort or expense, then only the issuer's balance sheet, which shall be dated within 120 days of the start of the offering, must be audited, and (iii) for offerings over $7,500,000, the financial statement required in a registration statement on the form that the issuer would be entitled to use, but if the issuer cannot obtain audited financial statements without unreasonable effort or expense, then only the issuer's balance sheet, which shall be dated within 120 days of the start of the offering, must be audited.  Special rules apply to issuers that are limited partnerships.

(5)   Rule 503 (a) requires filing Form D within 15 calendar days after the first sale.  Amendments must be filed to reflect changes and to correct mistakes.

(6)   Proposed rule change would require issuers in a Rule 506 (c) offering to file Form D 15 days before the first offer is made and to file advertising the same day the advertising occurs.

(7)  Integration poses the biggest risk for businesses that are active in capital raising.  Integration is a concept the SEC and state securities regulators use to combine what are nominally two or more securities offerings into one securities offering.  Integration can destroy your exemptions.  It is unclear how the SEC will deal with crowdfunding and other offerings that are either being conducted at the same time or within six months of one another.


If you would like to learn more about learning how to grow your business or other issues important to your success, you can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
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Monday, October 28, 2013

How Social Media is Changing How You Raise Capital in Public Private Placements


By:  Jim Verdonik
I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW

[This post is a longer version of an article I wrote that was published in Triangle Business Journal in October 2013l]
What happens when the irresistible force collides with the immovable object?
In this corner, sits defending champ and immovable object, the Securities and Exchange Commission – guardian since 1933 of the holy rule that you can't mix public offerings and private placements.
In the opposing corner, stands the challenger Social Media – the irresistible force that is mixing our public and private lives every day.
It used to be illegal to sell securities in private placements using social media tools like Twitter, Face Book and LinkedIn that most people use every day.
But the "Public Private Placement" was born on September 23, 2013.  Advertising of all kinds is now allowed in private placements under certain conditions.
What does the "Public Private Placement" mean for how you raise capital to grow your business?
Many "experts" predict the SEC will lock up public-private placements in a dungeon and throw away the key.  Mixing public and private upsets securities law fundamentalists.  For many in the securities industry, the SEC is the immovable object that can resist any force.
But I disagree.  What makes me think the SEC won't prevail in fighting public private offerings?
In April 2012 Congress and the President agreed to create public private placements in the JOBs Act.  WOW!  Isn't that astounding?  What power forged the bonds of rare bi-partisan agreement?  Simple agreement that:
·         Capitalism doesn't work without capital.
·         Keeping your securities offering a secret isn't a good way to raise capital.
·         Modern communications tools level the playing field to give everyone greater access to capital.
So, Congress and the President decided people can use technology to raise capital, even though that means mixing public communications with private placements.
In response, our immovable SEC has proposed new unworkable rules to fight Social Media's irresistible force, which gives everyone a direct inexpensive link to a world-wide audience. 

  • Waiting periods after you notify the SEC you intend to advertise.
  • Filing every communication with the SEC the same day you make them when Social Media campaigns by nature involve a conversation with many points of contact.
  • Requiring warning legends that are longer that all Tweets and many other forms of Social Media communications.

But Social Media isn't helpless.  It demonstrated the power to attract investors to take action, when two individuals used Twitter and Face Book to obtain $300 million of investor commitments to finance buying a business without paying brokers' commissions.  Of course, the SEC killed the deal before it closed, because this happened before public-private offerings were legal.
But that squashed deal speaks volumes about the power of social media to raise capital. 
  • Is it logical to assume that people struggling to raise capital will ignore that power?
  • Will America forego the opportunity to replace Goldman Sachs with Twitter?
  • Or will Wall Street remain a high priced gatekeeper to capital?
SEC rules can't squash Social Media, because humans are social beings.  It's our nature to want to know what other people are doing and how it affects us.  Businesses prosper and regulators make good rules when they channel the power of human nature rather than fight it.  
The SEC's wall between registered public offerings and private placements became outdated when Social Media combined private communications with a mass audience.  The Internet and Social Media broke down the old dividing lines between telephone calls and postal service that facilitated private communications on the one hand and television, radio and the press on the other hand that transmitted advertisements.
When the expectation of privacy died in our daily lives, the SEC's wall between public and private started falling down.  It makes no sense to insist on private business communications in a time when we all live our lives on a massive party-line conference call.
The power of individuals to find common interests with people across the planet and to exchange ideas freely at low cost in real time redefined your community.  Your new neighbors might be people you never met in person.  Your community might have members in three hundred cities around the world.  You might be a member of a hundred such communities or networks.  Each member of each community freely forwards your communications to others.  No one is shocked when this sharing occurs.
Traditional SEC rules allowed you to communicate with your old neighbors.  New SEC rules won’t work unless they allow you to communicate with your new neighbors.
Beyond that, it's silly to fight Social Media Public Private Placements, because Social Media brings private placements out of the shadows and into the light where everyone can see them.  Light deters fraud.  Attention makes it easier to detect and punish fraud.  High pressure sales draw criticism from a big audience that talks among themselves.  The more deals investors see; the more sophisticated they become and they share that sophistication with other community members.
Social media and the Internet have empowered consumers who buy cars, books and countless other items by facilitating comparison shopping.  The result is that people pay less for more and the overall quality of products has improved as sellers compete with one another for the business of for informed buyers.  Why would anyone assume the same thing won't happen with investors?
That's why I'm predicting a one-sided Social Media victory like high tide overwhelms children's sandcastles.  Eventually, the SEC will conclude that since it can't stop people from using ordinary tools to do things they think are important it should issue reasonable rules to channel that activity in positive directions.
So, why wait until the SEC surrenders?  Start thinking about how to conduct successful public private offerings by balancing:
  • Advertising effectiveness.
  • Budget
  • Avoiding fraud 
Big rewards await those who develop the best combination of these three factors.
Sending your business plan to sit in an unread pile at a venture capital fund's office  just doesn't make much sense anymore.  (Did it ever?)
Do you have the team it takes to succeed in this new capital raising environment?
Or are your advisers stuck in the past?
The race has begun.
What are you waiting for?
If you would like to learn more about learning how to grow your business or other issues important to your success, you can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW