Following is an Article Top 10 Things You Should Know About Regulation A that I collaborated on with Steve Dresner, the CEO of Dealflow.com. It is being reprinted here with the permission of Dealflow.com. Sign up for Steve’s Series D blog here.
Top Ten Things You Should Know about Regulation A
There’s been a lot of talk about Reg A lately. I must receive an email a day pitching a deal, a webinar, or a legal whitepaper. Heck, there was more lip service given to Reg A than crowdfunding at the CfPA Crowdfunding Conference last month.
Given all of the enthusiasm – and confusion – surrounding Reg A, I thought it was fitting to offer a “Cliff Notes” version of what’s most important for you to know. I try to limit the word count in this blog and my good friend Lou Bevilacqua was kind enough to oblige by creating this “Top 10 List” for the short-attention-span crowd (like yours truly).
10. Issuers can use a Regulation A offering statement to cover shares issued in a merger.
The final rules do not limit the availability of Regulation A for business combination transactions, but, Regulation A would not be available for business acquisition shelf transactions, which are typically conducted on a delayed basis.
9. Regulation A is a viable path to becoming exchange listed.
Regulation A issuers that meet the listing requirements of a national securities exchange like NASDAQ Capital Market or NYSE MKT may become listed companies upon the closing of their Regulation A offering. These issuers can use Form 8A, a short form Exchange Act registration statement, to become an Exchange Act reporting company. Also, if a Regulation A issuer follows this path, the limitation on the amount a non-accredited investor may invest will not apply.
8. Previous reporting companies can use Regulation A.
A reporting company that properly files a Form 15 can thereafter use Regulation A for its securities offerings if it is otherwise eligible to do so.
7. A subsidiary of a public company can use Regulation A.
Although an Exchange Act reporting company (other than a voluntary filer) cannot use Regulation A for its securities offerings, its privately held subsidiaries can. Regulation A may be a novel way for public companies to tap into their customer base in order to fund operating subsidiaries through the sale of minority interests in those subsidiaries.
6. An issuer headquartered in the U.S. or Canada with operations outside of the U.S. or Canada may still use Regulation A.
Only U.S. and Canadian issuers may sell securities under Regulation A. However, an issuer is considered to have its “principal place of business” in the United States or Canada for eligibility purposes if its officers, partners, or managers primarily direct, control and coordinate its activities from the United States or Canada.
5. Although state securities law is preempted in a Tier 2 offering, an issuer may have to make notice filings.
State securities administrators cannot require registration or qualification of securities sold in a Regulation A offering, but they may require an issuer to make notice filings. Many states do require notice filings.
4. Voluntary filers can use Regulation A even though they are SEC reporting companies.
Regulation A is reserved for private companies. Voluntary filers are companies that have filed an S-1 and have satisfied their reporting obligation under Section 15d of the Exchange Act, but continue to voluntarily file SEC reports. These companies are eligible to use Regulation A to offer securities even though they file reports with the SEC and their securities may already be traded on an OTC market.
3. PCAOB audit firms are necessary as a practical matter.
Unless an issuer wants its securities to trade on the OTC Pink market, it should obtain a PCAOB audit. To have your securities listed on a national securities exchange or quoted on the OTCBB, OTCQB or OTCQX, a PCAOB firm will need to get involved.
2. An issuer may conduct an ongoing Regulation A offering.
So long as a Regulation A issuer is current in its reporting obligations under Regulation A (annual, semi-annual and current event reports), it can continuously offer securities under the same qualified Regulation A offering circular for up to three years, but it must file post-qualification amendments to update financial statements each year.
1. An issuer can “build a bridge” to its Regulation A offering.
At the same time an issuer is testing the waters for its Regulation A offering, it may raise working capital under a separate 506(c) private placement to cover the expenses of the offering or for any other purpose. An issuer might even sell bridge notes that convert at a discount to the pricing of its Regulation A offering.
If you’ve got questions about this list, you should reach out to Lou directly at firstname.lastname@example.org. If you’ve got questions or comments that aren’t of a legal nature, feel free to contact me as well.
I’ll be moderating a webinar on Reg A with Lou on February 9 at 2pm ET. Sign up using this free registration link.
How the FAST Act Helps Entrepreneurs
On December 4, 2015 the FAST Act (Fixing America’s Surface Transportation Act) was signed into law. It’s important to know how the FAST Act helps entrepreneurs. Although the name of the Act doesn’t seem to have anything to do with securities law or entrepreneurs, hidden within the several hundred pages of the FAST Act are many provisions that modify the Jumpstart Our Business Startups Act (JOBS Act) to make it even better than it was before for entrepreneurs. The FAST Act facilitates capital raising for EGCs (Emerging Growth Companies), which is good for entrepreneurs. It also seeks to simplify disclosure requirements for reporting companies, codifies a previously informal exemption from registration for re-sales of securities and streamlines the registration process for smaller reporting companies. This article summarizes the important provisions of the FAST Act and explains how the FAST Act helps entrepreneurs.
The SEC has put out a summary of the FAST Act and has adopted Compliance and Disclosure Interpretations (CDIs). Both are very useful in gaining a full understanding of the FAST Act and how the SEC interprets it. Some of the provisions of the FAST Act must be implemented through SEC rule making or study while others became effective immediately upon adoption. We have noted below whether a particular provision of the FAST Act is effective or not.
Changes to the Offering Process
Change to Public Filing Requirement for IPOs
The JOBS Act permits EGCs to submit for confidential, non-public staff review a draft registration statement relating to an IPO. Under the JOBS Act an issuer was required to publicly file the registration statement and all previously submitted drafts no later than 21 days before the date on which the issuer begins its road show. The FAST Act reduces the 21 day period to 15 days. If an EGC does not conduct a road show, then the non-public drafts must be filed at least 15 days before the registration statement is declared effective. This provision of the FAST Act is immediately effective. This change should give EGCs more flexibility when they are determining when to launch their roadshow.
New Grace Period for Companies that Change EGC Status after Filing
If an issuer is an EGC at the time that it files its registration statement, but then sometime after filing, but before effectiveness, loses its EGC status, the FAST Act provides that the issuer will continue to be treated as an EGC until the earlier of the date on which the issuer consummates its public offering or the end of the 1-year period starting from the date that the issuer ceased to be an EGC. This provision of the FAST Act is immediately effective. This provision overturns prior SEC guidance and allows transitioning EGCs to continue to benefit from EGC status until their public offering is complete.
No Audit Required For Financial Statements that Will go Stale Anyway
The FAST Act allows an EGC to omit from its IPO registration statement any financial statements otherwise required if the EGC reasonably believes that the omitted financial statements will not be required to be included in the registration statement at the time of the contemplated offering. In other words, an issuer does not have to waste a lot of time and money to do an audit for a particular fiscal year if that issuer reasonably believes that at the time it starts selling securities, that year’s audit will not need to be included in the registration statement. For example, if an EGC makes its submission today, January 12, 2016, it would have been required to include audited financial statements for 2013 and 2014 and interim financial statements for the nine month period ended September 30, 2015. However, thanks to the FAST Act, if the EGC reasonably believes that it will not conduct its road show until after February 16, 2016, it may now exclude audited 2013 financial statements as long as it includes audited 2014 and 2015 financial statements in its red herring prospectus and in the registration statement at the time of effectiveness. Interim financial statements for the nine months ended September 30, 2015 and 2014 would also be required.
This provision of the FAST Act can be relied upon from and after January 3, 2016 and will prove very helpful to issuers who can now eliminate older periods that are not material to an understanding of their business. Historically, issuers would attempt to obtain waivers from the SEC permitting them to omit these older financial statements. The FAST Act has eliminated the need to obtain these waivers.
Making Disclosure More Simple
Summary Page for Form 10-K
Although issuers are not currently prohibited from including a summary box in their 10-Ks, the FAST Act requires the SEC, by June 1, 2016, to issue rules that permit issuers to include a summary page in their annual reports on Form 10-K. Each item in the summary must be cross-referenced to the more fulsome disclosure elsewhere in the report. We believe that legislators included this provision in the FAST Act to encourage issuers to include summary boxes in their 10-Ks. We believe that a practice may develop where annual reports on Form 10-K will begin to contain summary boxes similar to prospectuses. This practice will be good for investors who can more quickly get an overview of the annual report and then drill down on those provisions that require more study.
Overhaul of Regulation S-K
The FAST Act requires the SEC, by June 1, 2016, to revise Regulation S-K to further scale down or eliminate requirements relating to EGCs, accelerated filers, smaller reporting companies and other smaller issues, and eliminate duplicative, overlapping, outdated or unnecessary provisions of Regulation S-K. This requirement of the FAST Act is good for issuers and investors. More streamlined regulations that focus on what is important will facilitate business and investment.
The FAST Act also requires the SEC to carry out a study of the requirements of Regulation S-K to determine how best to modernize and simplify disclosure requirements, emphasizing a company by company approach without boilerplate or static requirements, and evaluate methods of information delivery and presentation that discourage repetition and disclosure of immaterial information.
New Resale Exemption
The FAST Act implements new Section 4(a)(7) of the Securities Act of 1933. The exemption applies to secondary sales of securities that are purchased by accredited investors. Before the FAST Act was enacted, a typical seller of restricted securities that could not rely on the safe harbor provided by Rule 144 because the holding period requirement was not met or for other reasons would rely on Section 4(1 1/2), which is not a section of the Securities Act at all. Instead, 4(1 1/2) is the shorthand for the reliance by a seller on two different sections of the Securities Act, i.e., Section 4(a)(1) and Section 4(a)(2). Neither of those sections apply specifically to the seller’s situation, but case law and practice permit the exemption where the purchaser is sophisticated and has access to relevant material information about the issuer. The FAST Act codifies Section 4(1 1/2) without eliminating it.
Under Section 4(a)(7) a resale is exempt from registration so long as:
- the purchaser is an accredited investor, as defined in Rule 501 of Regulation D;
- the seller (or any person acting on behalf of the seller) does not use general solicitation to offer or sell the securities; and
- if the securities are those of an issuer that is not subject to the reporting requirements of the Securities Exchange Act of 1934, then the seller and the prospective purchaser must obtain specified information from the issuer, including
— the company’s name and the name of any predecessor company,
— principal place of business,
— title and class of the security being offered and the current capitalization of the company,
— transfer agent details or details of any other person responsible for stock transfers,
— a statement of the company’s current business and products, which will be presumed current if it is as of a date that is no more than 12 months before the date of sale,
— the company’s directors and officers,
— information regarding brokers and dealers,
— the company’s most recent balance sheet and profit and loss statement and similar financial statements (not required to be audited) for the two prior fiscal years prepared in accordance with GAAP or IFRS if the company is a foreign issuer, and
— if the seller is an affiliate of the company, a statement regarding the nature of the affiliation accompanied by a certification from the seller that it has no reasonable grounds to believe that the company is in violation of the securities law.
Section 4(a)(7) will not be available, however, if:
- the seller is a direct or indirect subsidiary of the issuer,
- the company or anyone paid a commission for facilitating the sale is subject to the “bad actor” provisions of Rule 506(d) of the Securities Act of 1933;
- the company is in bankruptcy or receivership, a blank check, blind pool or shell company;
- the securities are part of an unsold allotment to an underwriter; or
- the class of securities has not been authorized or outstanding for at least 90 days.
Securities sold under the new 4(a)(7) exemption are “restricted securities” under Rule 144.
Finally, the FAST Act amends Securities Act Section 18 to preempt state blue sky requirements for re-sales conducted under the new exemption. Preemption means that Section 4(a)(7) securities are “covered” securities for blue sky purposes.
Letting Issuers Incorporate Future Information into S-1s by Reference
The FAST Act requires the SEC to amend Form S-1 by January 18, 2016 to allow smaller reporting companies to incorporate by reference in a registration statement on that form any documents that the company files after the effective date of the registration statement. This provision will save money for issuers because they will no longer have to file post-effective amendments each year to update their financial statements and disclosure. Unfortunately, issuer’s that want to conduct delayed shelf offerings must still be S-3 or F-3 eligible. But, after this provision of the FAST Act is implemented by the SEC, EGCs will be able to undertake other offerings under Rule 415 such as continuous offerings that are ongoing for a period of time after effectiveness and resale offerings.
Fixes Registration Threshold for Savings and Loan Holding Companies
The FAST Act corrects an error that was made in the JOBS Act. It amends Section 12(g) so that savings and loan holding companies are treated in the same way as banks and bank holding companies for the purposes of registration, termination of registration or suspension of their Exchange Act reporting obligations. This provision became effective upon enactment of the FAST Act.
Please contact us at email@example.com to learn more about the FAST Act and how it will affect your company
Raising capital in a mini-IPO under Regulation A can take between 4 and 6 months, which can be costly and leave many wondering how to fund the expenses of Regulation A offering. It might take longer depending on the extent and nature of SEC comments and how quickly the issuer can respond to them. Issuers cannot accept any funds in a Regulation A offering until their offering statement is qualified by the SEC which occurs at the end of the process. In the meantime, issuers must spend money on auditors, lawyers, transfer agents, EDGAR printers, and for marketing purposes. Basically, issuers have to spend a good amount of money with no guarantee that the Regulation A offering will be successful. This blog post provides a suggestion on how to fund the expenses of Regulation A offering.
One possible solution to the ‘how to fund the expenses of Regulation A offering problem’ is for the issuer to “build a Regulation A bridge.” A bridge offering is short-term financing used to cover working capital needs until a larger offering can be consummated. Bridge offerings are frequently used by startup companies to raise a relatively small amount of capital from friends and family in anticipation of a larger Series A Preferred Stock financing with a venture capital investor. This same bridge financing technique can be used to raise capital to cover the expenses of a Regulation A offering.
Issuers that plan to raise capital in a Regulation A offering can first sell securities in a private placement under Rule 506(c) of the Securities Act of 1933, as amended. Since general solicitation and general advertising are permitted under Rule 506(c), the 506(c) private placement can begin before the Regulation A offering and continue during the pendency of the Regulation A offering. The issuer does not have to file anything with the SEC before kicking off the Rule 506(c) private placement and funds received by investors may be deposited and used immediately. However, only accredited investors will be able to participate in a Rule 506(c) private placement and the issuer will have to take additional steps to ensure that the investors are accredited. These additional steps include, obtaining a copy of the investors tax return, W-2, 1099, K-1 or other IRS document to verify income, obtaining bank statements and information on indebtedness of the investor to verify net worth or obtaining a certification letter from a lawyer, CPA, broker dealer or registered investment adviser that confirms that the investor is accredited.
Ideally, an issuer that needs some capital to help cover the costs of a Regulation A offering would kick off the Rule 506(c) offering at the same time that it is testing the waters in the Regulation A offering. This way, the publicity relating to the Regulation A offering will help to create awareness of the concurrent Rule 506(c) private placement. For example, an issuer might desire to raise $30 million in a Tier 2 Regulation A offering and while it is testing the waters for that offering it could simultaneously solicit accredited investors for a $1 million Rule 506(c) private placement. It could market both offerings simultaneously, however, as the SEC noted in the final Regulation A release, the issuer should not include in the 506(c) general solicitation materials an advertisement of the terms of a Regulation A offering, unless that advertisement also includes the necessary legends for, and otherwise complies with, Regulation A.
An issuer could sell any type of security in the 506(c) private placement. It could be the same security that it intends to sell in the Regulation A offering or a different security. Taking a page from the startup bridge financing handbook, an issuer might consider issuing convertible bridge notes. As is the case with startup company bridge financing transactions, the convertible note could convert at a discount to the next financing round, which in this case would be the Regulation A financing. For example, the following terms might apply to the 506(c) private placement:
- Offering of up to $1 million of convertible notes
- Principal and interest on the convertible notes convert into the securities being sold in the Regulation A offering at, e.g., a 15% discount to the price per unit paid by investors for securities in the Regulation A offering
- Mandatory conversion upon closing of the Regulation A offering
- Interest rate of, e.g., 7% per annum
- One year maturity
- Voluntary conversion feature allowing the investor to convert at a set valuation if the Regulation A offering is not consummated prior to the maturity date
- Mandatory conversion if holders of a majority of principal amount of convertible notes agree to convert at maturity
- Premium if there is a sale of the Company prior to the conversion of the notes
One benefit of building a Regulation A bridge as compared to a bridge to a Series A Preferred stock offering is that the securities received by investors in the 506(c) private placement upon conversion of their convertible notes would be covered by the Regulation A offering statement and, therefore, would be freely transferrable and not restricted securities. The convertible notes themselves, however, would be restricted.
If you have any questions about how to build a bridge to your Regulation A offering or desire to discuss any other aspect of Regulation A or raising capital generally, please contact me for a free initial consultation at info@Bevilacquapllc.com or at 202-203-8665.
I have been fortunate to have had the opportunity to be involved with several private placements under Rule 506(c) since the rule became effective on September 23, 2013. Rule 506(c) permits the use of general solicitation and general advertising when selling securities in a private placement so long as the issuer takes reasonable steps to verify that all of the investors that purchase securities in the private placement are accredited. The reasonable steps that must be taken include obtaining tax returns, W-2s, 1099s, bank statements or letters from an investor’s accountant or lawyer as proof that the investor is accredited. I have found that this extra step of “taking reasonable steps to verify that an investor is accredited” can significantly delay the timetable for an offering or limit the potential pool of accredited investors because investors do not readily provide such sensitive information to issuers, and even when they do, it takes a lot of time and multiple requests before they hand the information over. As a result, I generally advise my clients to avoid general solicitation and general advertising if they believe that they can raise the capital they need without having to advertise their offering.
But, what about issuers that don’t want to rely on Rule 506(c) and instead want to conduct a traditional private placement under Rule 506(b)? It becomes critical for these issuers to know what the definition of “general solicitation” is because “general solicitation” cannot be employed in a traditional Rule 506(b) offering.
In traditional Rule 506(b) private placements, the manner of offering is limited by Rule 502(c). That rule generally provides that in a Rule 506(b) private placement neither the issuer nor any person acting on its behalf may offer or sell the securities by any form of general solicitation or general advertising. The rule provides some examples of what is meant by general solicitation and general advertising. Those examples include the following:
- Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and
- Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
The recent Citizen.vc no-action letter and related SEC compliance and disclosure interpretations (CDIs) provide some guidance about what is and what is not a general solicitation for issuers engaging in traditional private placements under Rule 506(b).
The Citizen.vc No-Action Letter
The Citizen.vc no-action letter addresses the situation where an issuer desires to use a password protected web page (the Site) to sell securities under Rule 506(b) without the use of the Site being deemed a “general solicitation” and thereby being subject to the additional “investor verification” requirements imposed by Rule 506(c). Citizen VC, Inc. (CVC) is an online venture capital firm. It creates special purpose vehicles (SPVs). Each SPV invests only in one issuer (a Portfolio Company) that is identified by CVC and none of the SPVs are blind pool investment vehicles. The SPVs are organized and managed by a manager controlled by CVC. Interests in the SPVs (Interests) are offered to persons who have become members (Members) of the Site. CVC has developed policies and procedures that it uses to establish a substantive relationship with a visitor to the Site before it allows such visitor to become a Member.
In the CVC no-action letter, the staff of the Securities & Exchange Commission (the staff) concurred with CVC’s conclusion that the policies and procedures described in its letter create a substantive, pre-existing relationship between CVC and prospective investors such that the offering and sale on the Site of Interests in SPVs that will invest in a particular Portfolio Company will not constitute general solicitation or general advertising within the meaning of Rule 502(c) of Regulation D. The staff stated that the quality of the relationship between an issuer (or its agent) and an investor is the most important factor in determining whether a “substantive” relationship exists. The staff noted that a “substantive” relationship is one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor. The staff focused on the fact that CVCs policies and procedures are designed to evaluate the prospective investor’s sophistication, financial circumstances and ability to understand the nature and risks of the securities to be offered. The staff also agreed that there is no specific duration of time or particular short form accreditation questionnaire that can be relied upon solely to create such a relationship.
The staff stated that the determination of whether an issuer has sufficient information to evaluate, and does in fact evaluate, a prospective offeree’s financial circumstances and sophistication will depend on the facts and circumstances. The staff focused on the fact that the relationship with new Members will pre-exist any offering and that a prospective Member is not presented with any investment opportunity when that Member is in the process of being qualified to join the platform. Any investment opportunity would only be presented after the prospective investor becomes a Member. The staff also focused on the fact that the SPVs are not blind pool investment vehicles.
For venture capital funds, portals and others that desire to offer and sell securities behind a password protected portion of their website, the key will be the policies and procedures that they adopt. These funds and portals should adopt policies and procedures similar to those adopted by CVC, which will likely be viewed in the industry as best practices for password protected securities offerings. In the case of CVC, a visitor that wishes to investigate the password protected sections of the Site accessible only to Members must first register and be accepted for membership. In order to apply for membership, CVC requires all prospective investors, as a first step, to complete a generic online “accredited investor” questionnaire. According to CVCs letter, the satisfactory completion of the online questionnaire is only the beginning of CVCs relationship building process. Once a prospective investor has completed the online questionnaire and CVC has evaluated the investor’s self-certification of accreditation, CVC will initiate the “relationship establishment period.” During this period, CVC will undertake various actions to connect with the prospective investor and collect information it deems sufficient to evaluate the prospective investor’s sophistication, financial circumstances, and its ability to understand the nature and risks related to an investment in the Interests. These activities include
- contacting the prospective investor offline by telephone to introduce representatives of CVC and to discuss the prospective investor’s investing experience and sophistication, investment goals and strategies, financial suitability, risk awareness, and other topics designed to assist CVC in understanding the investor’s sophistication,
- sending an introductory email to the prospective investor,
- contacting the prospective investor online to answer questions they may have about CVC, the Site, and potential investments,
- utilizing third party credit reporting services to confirm the prospective investor’s identity, and to gather additional financial information and credit history information to support the prospective investor’s suitability,
- encouraging the prospective investor to explore the Site and ask questions about the CVC’s investment strategy, philosophy, and objectives, and
- generally fostering interactions both online and offline between the prospective investor and CVC.
Additionally, prospective investors are advised that every SPV offering will have a significant minimum capital investment requirement for each investor, which will be not less than $50,000 per individual investment, and in some offerings significantly higher.
It is also important to note that CVC’s publicly accessible homepage contains only generic information about CVC and no information about any of the current SPVs, Portfolio Companies, investment opportunities or offering materials.
Citizen.vc Related CDIs
Shortly after issuing the CVC no-action letter, the staff issued related compliance and disclosure interpretations (CDIs). Following is a summary of the CDIs.
- The use of an unrestricted, publicly available website to offer or sell securities constitutes a general solicitation for purposes of Rule 502(c). However, Rule 506(c) — which does not require compliance with Rule 502(c) — is available to issuers when offering or selling securities through unrestricted, publicly available websites or other forms of general solicitation.
- An issuer can widely disseminate information not involving an offer of securities without violating Rule 502(c). The example given by the staff is factual business information. The SEC stated that factual business information that does not condition the public mind or arouse public interest in a securities offering is not an offer and may be disseminated widely. Information that involves an offer of securities through any form of general solicitation would contravene Rule 502(c).
- According to the staff, what constitutes factual business information depends on the facts and circumstances. Factual business information typically is limited to information about the issuer, its business, financial condition, products, services, or advertisement of such products or services, provided the information is not presented in such a manner as to constitute an offer of the issuer’s securities. The staff stated that factual business information generally does not include predictions, projections, forecasts or opinions with respect to valuation of a security, nor for a continuously offered fund would it include information about past performance of the fund.
- An offer of securities in a Regulation D offering to a prospective investor with whom the issuer, or a person acting on the issuer’s behalf, has a pre-existing, substantive relationship does not constitute a general solicitation in contravention of Rule 502(c). The existence of such a pre-existing, substantive relationship is one means, but not the exclusive means, of demonstrating the absence of a general solicitation in a Regulation D offering. Accordingly, an offer of the issuer’s securities to the person with whom the issuer, or a person acting on its behalf, has such a relationship would not constitute a general solicitation and, therefore, would not be in contravention of Rule 502(c).
- There are some circumstances such as through an investor club or angel network under which an issuer, or a person acting on the issuer’s behalf, can communicate information about an offering to persons with whom it does not have a pre-existing, substantive relationship without having that information deemed a general solicitation. The staff stated that is aware of long-standing practices where issuers and persons acting on their behalf are introduced to prospective investors who are members of an informal, personal network of individuals with experience investing in private offerings. The staff acknowledged that groups of experienced, sophisticated investors, such as “angel investors,” share information about offerings through their network and members who have a relationship with a particular issuer may introduce that issuer to other members. Issuers that contact one or more experienced, sophisticated members of the group through this type of referral may be able to rely on those members’ network to establish a reasonable belief that other offerees in the network have the necessary financial experience and sophistication. The staff noted that whether there has been a general solicitation is a fact-specific determination. In general, the greater the number of persons without financial experience, sophistication or any prior personal or business relationship with the issuer that are contacted by an issuer or persons acting on its behalf through impersonal, non-selective means of communication, the more likely the communications are part of a general solicitation.
- Persons other than broker-dealers, such as registered investment advisers, may be able to form a pre-existing, substantive relationship with a prospective offeree as a means of establishing that a general solicitation is not present in a Regulation D offering. The staff stated that as fiduciaries, such advisers owe their clients the duty to provide only suitable investment advice. To fulfill the obligation, an adviser must make a reasonable determination that the investment advice provided is suitable for the client based on the client’s financial situation and investment objective, such that a substantive relationship could exist.
- A “pre-existing” relationship is one that the issuer has formed with an offeree prior to the commencement of the securities offering or, alternatively, that was established through either a registered broker-dealer or investment adviser prior to the registered broker-dealer or investment adviser participation in the offering.
- There is no minimum waiting period required for an issuer, or a person acting on its behalf, to establish a pre-existing, substantive relationship with a prospective offeree in order to demonstrate that a general solicitation is not involved. However, other than in the case of the limited exception relating to private funds, the issuer must establish such a relationship prior to the commencement of the offering, or, if the relationship was established through either a registered broker-dealer or investment adviser, the relationship must be established prior to the time the registered broker-dealer or investment adviser began participating in the offering.
- The staff explained that a “substantive” relationship is one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor. Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship.
- In answering the question of whether someone other than a registered broker-dealer or investment adviser can form a pre-existing, substantive relationship with a prospective offeree as a means of establishing that a general solicitation is not involved in a Regulation D offering, the staff stated that the presence or absence of a general solicitation is always dependent on the facts and circumstances of each particular case. Thus, there may be facts and circumstances in which a third party, other than a registered broker-dealer, could establish a “pre-existing, substantive relationship” sufficient to avoid a “general solicitation.” However, in the absence of a prior business relationship or a recognized legal duty to offerees, the staff believes it is likely more difficult for an issuer to establish a pre-existing, substantive relationship, especially when contemplating or engaged in an offering over the Internet. Issuers would have to consider not only whether they have sufficient information about particular offerees, but also whether they in fact use that information appropriately to evaluate the financial circumstances and sophistication of the prospective offerees prior to commencing the offering. Issuers may therefore wish to consider whether conducting the offering under Rule 506(c) would provide greater certainty that an exemption may be available for the offering.
- Whether a demo day or venture fair constitutes a general solicitation for purposes of Rule 502(c) is a facts and circumstances determination. Of course, if a presentation by the issuer does not involve an offer of a security, then the requirements of the Securities Act are not implicated. Where a presentation by the issuer involves an offer of a security, the presentation at a demo day or venture fair may not constitute a general solicitation if, for example, attendance at the demo day or venture fair is limited to persons with whom the issuer or the organizer of the event has a pre-existing, substantive relationship or have been contacted through an informal, personal network such as an investment club or angel network. If potential investors are invited to the presentation by the issuer or a person acting on its behalf by means of a general solicitation and the presentation involves the offer of a security, Rule 506(c) may be available if the issuer takes reasonable steps to verify that any purchaser is an accredited investor and the purchasers in the offering are limited to accredited investors.
If you have any questions about how to establish a substantive pre-existing relationship with an investor or whether your securities offering constitutes a general solicitation or not, please feel free to contact me at firstname.lastname@example.org or by phone at 202-203-8665.
ESTIMATED TIME TO COMPLETE STEP
Prepare solicitation materials to “test the waters.”
2 days to 2 weeks or longer depending on how extensive the solicitation materials are and what type of disclosure the issuer has prepared in the past.
Issuer begins soliciting non-binding indications of interest (i.e., “testing the waters”) from both accredited and non-accredited investors. Issuer may utilize general solicitation and general advertising and may solicit interest either prior to or after the filing of an offering statement on form 1-A.
The length of the “testing the waters” solicitation period is up to the issuer. We expect issuers will take 2 to 4 weeks to determine whether there is sufficient interest in an offering to make it worth the time and cost of preparing and filing an offering statement on Form 1-A.
Prepare offering statement on Form 1-A and file offering statement once draft is finalized. Note that the initial filing of the Form 1-A may be done on a confidential basis.
The preparation of the offering statement will likely take between 4 and 8 weeks to complete or longer depending on the efforts of the working group and whether audited financial statements are already prepared and the timing of their preparation if not prepared.
Some issuers will begin preparing the offering statement immediately even before determining through testing the waters whether there is sufficient interest in the offering. Other issuers will wait to see if there is sufficient interest in the offering before incurring the cost of preparing an offering statement, including audited financial statements.
Receive comments of the Staff of the SEC and respond to same until the Staff clears the offering statement and indicates that the issuer may request a notice of qualification.
10 to 20 weeks
Complete sales under qualified offering statement. Note that sales may be done on a continuous basis over a period of time, e.g., six months or one year, if desired by the issuer. This timeline, however, assumes that the issuer desires to close the offering as soon as it can sell the requisite number of securities.
Ideally, during the pre-qualification period, the issuer and its broker-dealer intermediary will have lined up interest from potential investors so that the offering can conclude immediately upon qualification. However, in some cases, especially where no intermediary is used, this post qualification process may be dragged out for several weeks.
Market maker files Form 211 Application and same is cleared. Company receives stock symbol and security becomes eligible for quotation on the Pink OTC marketplace.
30 to 60 days
Issuers that desire to trade on the OTCQX marketplace or OTCQX premier must apply for manual listing exemption on Standard & Poors or Mergent.
7 to 14 days
If the issuing company desires to begin trading on the OTCQX marketplace, it must identify a Designated Advisor for Disclosure (DAD) (U.S. company) or Principal American Liaison (PAL) (Canadian company) and prepare an OTCQX listing application. Once prepared, the DAD or PAL will submit the application along with its letter of introduction. The issuer will commence trading on the OTCQX marketplace upon the conclusion of this process.
30 to 40 days
|TYPE OF SERVICE||ESTIMATED COST|
|Investment Banking Fees|
|The investment bank solicits investors on a best-efforts basis, conducts a thorough due diligence review of the issuer and assists the issuer with the preparation of the solicitation materials, including the offering statement.||Commission of between 6% and 10% of total amount raised and warrants to purchase 6% to 10% of total securities offered in the offering. Payable at closing.
Expense reimbursement of between $10,000 and $40,000.
|Legal fees associated with the drafting of the offering statement on Form 1-A, responding to SEC Staff comments, preparing response letters and amendments to Form 1-A, etc. until SEC issues a notice of qualification.||$45,000 – $150,000
Cost depends upon law firm used and nature of issuer’s operations (e.g., international operations and multiple subsidiaries would increase costs). Larger law firms may charge more than $150,000.
|Assistance with Form 211 Application and responding to FINRA comments.
|$5,000 – $20,000
|Assistance with OTCQX listing application if the issuer desires to “uplist” from OTC Pink to OTCQX.||$2,000 – $10,000|
|Two years audited financial statements||$25,000 – $150,000
Cost depends upon audit firm used and nature of issuer’s operations (e.g., international operations and multiple subsidiaries would increase costs). Larger audit firms may charge more than $150,000.
The auditor must maintain independence and if the company’s CFO requires CFO support services a separate firm or consultant would be obtained to provide these services at an added cost.
|EDGAR Printer Fee||$2,500|
|DTC Eligibility Fee|
|Note that this expense may be deferred. This expense is incurred after trading has commenced on OTC Pink or OTCQX.||$13,000|
|Transfer Agent Fee||$5,000|
|Standard & Poors or Mergent Manual Exemption Fee|
|These costs are incurred only if the issuer desires to “uplist” to the OTCQX.||Mergent Fees
Initial regular listing processing fee (Published within 10 business days) $3,700
Initial expedited listing processing fee (Published within 3 business days) $5,500
Annual renewal listing fee ($995 for U.S. Company and $1,290 for Non-U.S. Company).
*Prices effective through December 31, 2015.
Estimated fees below:
Initial first year fee – $4,800
On going annual fee – $1,465
|DAD and PAL Fee|
|A DAD or PAL is either a qualified investment bank or qualified securities attorney. OTCQX maintains a list of qualified DADs and PALs on its website.
The role of the DAD/PAL is to provide professional guidance to the issuer on creating investor demand, assist companies in discerning the information that is material to the market and should be disclosed to investors, and provide a professional review of the company’s disclosure.
|Investment Bank DAD or PAL
Price range depends on extent of services to be provided by the investment bank in addition to the DAD or PAL service.
$25,000 to $100,000 annually
Securities Law Firm DAD or PAL
$4,000 to $10,000 annually
|OTCQX Listing Fee|
|$5,000 application fee
$15,000 annual fee.