Companies seeking capital from investors should always put their best foot forward. Fundraising for early stage companies is challenging under the best of circumstances. When raising capital through the issuance of securities, privately held companies are covered by many of the same securities laws as public companies. However, these private companies may qualify for exemptions from many burdensome regulatory requirements by conducting valid “private placements” in compliance with the Federal securities laws. Working with an experienced securities attorney is an important step towards ensuring proper compliance and will also help prospective investors get more comfortable with your company.
Although there are a number of exemptions, startup companies selling securities such as shares of stock, convertible notes, SAFEs (Simple Agreement for Future Equity) and even cryptocurrency tokens frequently rely on one of the Federal exemptions from SEC registration provided under Regulation D, specifically SEC Rules 506b or 506c.
Under Rule 506b, securities may be offered to an unlimited number of accredited investors and may be sold to no more than 35 purchasers that do not qualify as accredited investors. The term “accredited investors” is defined in Regulation D and can include individuals, companies, trusts and banks. Investors that qualify as accredited investors are deemed to have sufficient sophistication and bargaining power to ensure they are aware of the risks they are taking on, can gain access to the information they need to make their investment decision and can bear a complete loss of their investment. Rule 506c allows securities to be offered to an unlimited number of accredited and unaccredited investors, however only accredited investors may purchase the offered securities. Also, under Rule 506c, issuers are required to take reasonable steps to verify that all purchasers are accredited investors.
One of the other requirements under Regulation D is that a “Form D Notice of Exempt Offering of Securities” must be filed electronically with the SEC via the EDGAR system. This is a notice filing and is not subject to comments from the SEC, however, as a publicly filed document, the Form D announces the company’s financing plans to the world. Form D disclosures include the amount the issuer is seeking to raise in the offering, the amount sold prior to the filing, the names of the issuer’s officers and directors and certain other information. A number of third parties track Form D filings, including certain news sites/websites, and company management should be prepared to be contacted after a filing by a range of individuals including reporters and service providers looking to sell their services.
As a technical matter, the Form D filing is not required to qualify an offering as a valid private placement under Regulation D. The filing requirement is an independent requirement under Regulation D and the failure to file or a late filed form does not prevent a company that is otherwise in compliance with the requirements of Rule 506b or Rule 506c from qualifying for the Federal exemption. However, it is still important for companies to make these filings – not only does a proper filing demonstrate good compliance practices, but it will keep the company on the right side of the SEC. Also, Form D notice filings are frequently required by individual States (though a discussion of State law compliance is beyond the scope of this article).
While some early stage investors will have a light touch and won’t spend much time on due diligence looking at a company’s books and records and questioning its compliance practices, others may. If a company is not careful about its securities law compliance, it can create problems that could have been easily prevented. Companies want to avoid red flags and reduce friction and distractions during a financing.
By demonstrating your awareness of applicable securities laws and through your company’s compliance with SEC requirements, you will actually be helping your investment case by providing comfort to prospective investors and demonstrating a pattern of compliance and competency – all good things from an investor’s perspective.
Scott Kaufman is a partner at Sullivan & Worester LLP and leads the firm’s Emerging Companies & Venture Capital practice in New York. He represents entrepreneurs, technology and life science companies and investors in venture financings, M&A and other corporate transactions. He also represents clients in private and public securities offerings and advises on SEC compliance matters, including with respect to cryptocurrency token distributions. Additionally, Scott works with many Israeli clients through ZAG-S&W, Sullivan & Worcester’s joint venture with Israel-based Zysman, Aharoni, Gayer & Co. He has significant experience advising Israeli hi-tech companies in connection with their business transactions in the United States.
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