The Securities and Exchange Commission (SEC) recently announced new rules allowing “general solicitation” of investors in private offerings. The intent is to provide businesses, including health care companies, a potential middle road between a public offering and a private offering.
Companies raising capital in a private placement have often relied on Rule 506(b) to Regulation D under the Securities Act of 1933 to avoid the expense of a public offering. Among other restrictions, Rule 506(b) prohibits any general solicitation of investors, thereby limiting its utility to many companies.
In 2012, however, Congress directed the SEC to create a rule permitting general solicitation in an offering under Regulation D. The result is new Rule 506(c). Unfortunately, however, although the new rule may benefit established companies looking to raise large amount of capital from private investors, it may not help small companies.
The New Rule
While Rule 506(c) does not contain a general solicitation prohibition, it does impose additional conditions not included in Rule 506(b). Specifically, an issuer relying upon Rule 506(c) must take “reasonable steps to verify” that all purchasers in the offering are accredited investors, and must also comply with additional filing requirements that the SEC has proposed.
Also included among the proposed rules is an obligation to file their Form D with the SEC at least 15 days before conducting a private offering. The pre-offer filing requirement is a material change from the Rule 506(b) 15-day post sale requirement and could be a burden on many early stage companies that often participate in investor demonstration days that are used in order to introduce these companies to angel and other early stage investors.
Whether the SEC will take the position that demonstration days constitute a general solicitation is not clear, but early indications are that they may take such a position.
In contrast, existing Rule 506(b), the most-used private offering exemption under Regulation D (which remains unchanged and available to issuers), prohibits general solicitation but permits an offering to include up to 35 non-accredited investors as purchasers, allows issuers to rely on the self-certification of the investors accredited investor status, and requires the Form D to be filed within15 days following the first sale of a security.
Rule 506(c) shines a new but not much brighter light on the issue of what constitutes “general solicitation” or “general advertising.” Although this has always been an issue for private offerings, the SEC's previous guidance has been that the terms would include advertising through newspapers, magazines, TV, radio, and unrestricted websites, and presenting at seminars where invitations were extended through such media. This guidance pre-dates the dramatic growth in various channels to reach prospective investors, and Rule 506(c) fails to provide additional clarity. Consequently, it remains uncertain, for instance, whether presenting at a pitch competition or posting business information on unrestricted portions of investment-related websites would constitute general solicitation.
The hope, however, is that the cries from many in the angel and early stage investor community will encourage the SEC to consider these issues and provide more guidance on the matter. If not, small and early stage companies are left in a quandary: if they use demonstration days or pitch competitions they may be involved in a general solicitation that would prohibit them from using Rule 506(b), and they could only rely on Rule 506(c) if they pre-filed.
Another concern is the new rule’s requirements for verification of purchasers’ accredited investor status. Under Rule 506(c), issuers in general solicitation private offerings must obtain further information from their purchasers, such as financial statements, tax returns, or certifications from the purchasers’ professional advisers. Individual angel investors may not be willing to disclose such sensitive personal information, which limit the new rule’s viability alternative for small capital raises.
Issuers looking to make large private offerings, on the other hand, would appear to benefit the most from new Rule 506(c). Advertising through magazines, websites, newspapers, etc., could attract more investors who are willing to comply with the new verification requirements, and could provide a way to raise more money than could reasonably be raised without general solicitation in a traditional 506(b) offering. This could provide an alternative to venture capital or private equity financing, and quite possibly at a lower cost for the capital.
Issuers considering this method, however, need to remember that any Rule 506(c) offering is still subject to the requirement of full disclosure, and that if they end up with 500 owners of any class of its securities they would trigger certain reporting requirements to the SEC.
Impact on Health Care Companies
For larger, more mature health care companies, new Rule 506(c) will provide increased access to capital. A medical device manufacturer, for example, would be able to advertise through broader media and to a wider range of potential purchasers. Smaller, start-up companies might receive some benefit from the new rule, but may be presented with more legal concerns than business opportunities, especially if onerous additional filing rules are adopted as proposed.
The new Rule 506(c) is a well-intentioned effort to facilitate greater access to investment capital. But as always, the law of unintended consequences arises, and the restrictions built into the new rule may keep it from benefiting the small businesses that that may need it the most.