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Jumpstarting Private Securities Offerings: Internet-Based Advertising and General Solicitation Under Rule 506(c)

May 6, 2016

The world of investing in privately held companies has changed significantly in the last two and a half years.  The Securities and Exchange Commission ("SEC") traditionally prohibited a company issuing equity or debt securities in a private offering from general solicitation of potential investors.  This restriction prohibited issuers from advertising, marketing and sales of private offerings in newspapers, magazines, industry publications and on the internet.  
 
This is no longer the case.  Beginning in 2013, the SEC relaxed these prohibitions by enacting Rule 506(c) under Title II of the Jumpstart Our Business Startups Act ("JOBS Act").  Under Rule 506(c), issuers may raise unlimited funds in a private offering, exempt from SEC registration, via general solicitation and advertising directed to potential investors, so long as all investors in the offering are "accredited investors."  The definition of "accredited investors" has not changed.  It includes:
 
A natural person who has either:
  • Annual income in excess of $200,000 ($300,000 jointly with spouse) in each of the two (2) most recent tax years and a reasonable expectation of earning the same income in the current year; or
  • Individual net worth (or jointly with spouse) in excess of $1 million (not including primary residence).
Institutional investors such as banks, insurance companies, certain employee benefit plans (as defined by ERISA), tax exempt charitable organizations and other entities with assets in excess of $5 million; and
 
Directors, executive officers and general partners of an issuer.
 
However, under 506(c), the SEC now places the burden on issuers to take "reasonable steps" to verify that potential investors are "accredited."  The issuer must make an inquiry based on a number of factors, including the nature of the investor and the type of accreditation claimed, the amount and type of information the issuer has received about the investor, and the nature and terms of the private offering (including the manner in which the investor was solicited and the minimum investment sought).  The SEC has stated that merely requiring a potential investor to check a box on a questionnaire or sign a form, absent other information, is insufficient to satisfy the "reasonable steps" verification obligation.
 
In the two and a half years that Rule 506(c) has been effective, the ability to publicly advertise private offerings has allowed issuers to tap a wider investor pool and reach a larger target securities market.  The SEC has reported that nearly 3,000 privately held companies have raised approximately $26.7 million under Rule 506(c) through the end of 2015.  These numbers are anticipated to grow steadily as methods of verifying investors become more standardized and the use of internet-based platforms for marketing and conducting private offerings become more commonplace.  
 
Rule 506(c) offerings are of particular interest to real estate developers and other private companies which have a need for outside capital because the cost of capital is much lower than with institutional lenders or investors.  The relaxed rules regarding general solicitation and advertising and subsequent rapid advances in internet-based securities platforms provide a faster and more direct and efficient way to reach a larger investment base and eliminate middlemen than traditional private offerings.  Investors, too, benefit under Rule 506(c) because they can now compare a multitude of offerings across different industries and geographical locations.  Individual minimum investments in 506(c) offerings tend to be relatively small, permitting investors to access large scale development projects or investments that might otherwise be unavailable.  
 
For more information, please contact Stephen Ritner (sritner@zarwin.com) or Anya Morrison Davis (amorrison@zarwin.com).
 

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