Should I raise funding for my startup privately using 506(b) or publicly using 506(c)? This has been a question plaguing many startups since implementation of Title II of the JOBS Act. For some background on the issue you can, check out our General Solicitation Cheat Sheet.
Do you try to stick to the old way under 506(b) and not use general solicitation, but severely restrict your ability to market your transaction (i.e. no demo days, no social media, no email blasts, etc.) or do you use 506(c) with general solicitation and deal with heightened accredited investor verification, which may scare off potential investors?
The following guest post by Anna Pinedo at Morrison Foerster suggests a solution. It may be possible to first do a 506(b) privately, close the transaction and then do a separate 506(c) offering with general solicitation. In this way, you could use self-certification for the investors where you have a pre-existing relationship, but you could also subsequently reach new investors using general solicitation. The key test is avoiding “integration” of the two offerings as Anna discusses below.
The Integration Conundrum
Lawyers tend to be instinctively cautious individuals, and often find it troubling not to have definitive answers to questions posed by clients. It’s therefore should come as no surprise that lawyers tend to be somewhat frustrated by thorny securities integration questions. The securities laws provide a number of transaction-based exemptions from the registration requirements applicable to public offerings. The SEC always seeks to ensure that an issuer will not be able to circumvent the registration requirements by conducting a series of separate, maybe smaller or more limited, offerings (each of which may qualify for an exemption) and therefor avoid registration. Several valid, exempt private placements, if they are conducted in close proximity to one another, may be integrated and viewed by regulators as a single offering. However, the whole financing, even if integrated, might still be considered a valid private placement. Similarly, a series of private placements may not be integrated if each discrete transaction meets the requirements for a valid private placement and is truly separate in terms of its purpose, investors, terms, etc. There are also related questions that arise when private placements and public offerings occur in close proximity to one another. For example, an issuer contemplating a private placement in close proximity to a public offering should consider whether the public offering may have been a “general solicitation” that renders the private placement exemption unavailable for the new financing. To provide some clarity, over time, the SEC has established various integration “safe harbors” that specify the circumstances under which transactions would not be integrated. These safe harbors have proven helpful, but do not provide all the answers.
Now, of course, with the JOBS Act, the lines between private and public offerings have been blurred, and we have private offerings that are really private (Rule 506(b) offerings) and “private” offerings that are not at all private (Rule 506(c) offerings) given that general solicitation may be used. The fact that general solicitation may be used in an exempt offering also muddies the waters as it relates to “gun-jumping” if the issuer plans to follow up a Rule 506(c) deal with a registered public offering. In promulgating the final rule eliminating the ban on general solicitation, the SEC did not address the existing integration safe harbors or provide much guidance on Rule 506(b) and Rule 506(c) offerings occurring in close proximity to one another. Recently, the SEC provided some interpretative guidance on a few issues relating to Rule 506(c), so we would expect that there will be more to come.
In the meantime, we attempt to provide our own answers to some integration questions in two alerts:
Here are a few highlights:
Can an issuer conduct a contemporaneous Rule 506(b) offering and Rule 506(c) offering?
Generally, no. If the issuer offers the same security, it would not be possible to prevent the general solicitation used in connection with Rule 506(c) from tainting the contemporaneous Rule 506(b) offering. However, it may be possible to conceive of contemporaneous offerings if the issuer offered different securities, such as a non-convertible preferred stock in one offering and common stock in the other offering, and if the investors in the two offerings were different—for example, preferred stock being offered to an existing venture or private equity investor (or other investors with which the issuer has a pre-existing substantive relationship), while common stock is being offered to a broader range of investors in a separate offering using general solicitation. Rule 502(a) of Regulation D sets forth the traditional “five factor” test that issuers should consider in determining whether offers and sales should be integrated for the purposes of the exemptions under Regulation D.
Can an issuer conduct a Rule 506(c) offering followed by a Rule 506(b) offering?
Yes, once a Rule 506(c) offering has been completed, the issuer should be able to conduct a Rule 506(b) offering. There should be no contingencies that would tie one offering to the other or “link” the two offerings in any way. In fact, it may be helpful (although, depending on the circumstances, not necessary) to offer different securities in the two separate offerings. As always, with offerings taking place in close proximity to one another, it will be important to undertake an integration analysis. Given that the Rule 506(c) offering involved general solicitation, it will be prudent to let some period of time elapse between the two offerings so that the communications made in connection with the Rule 506(c) offering have become stale. Similarly, it will be helpful to identify the class of investors that are being approached in the Rule 506(b) offering. Given the absence of general solicitation, it will be useful to document whether, for example, the 506(b) investors are existing long-term investors in the company who wouldn’t have been drawn to the company by a solicitation, or clients of a broker-dealer retained by the company to act as a placement agent in the capital raise.
Of course, a Rule 506(c) offering can follow a completed Rule 506(b) offering—this is the “easier” scenario given that in the Rule 506(b) offering the issuer has limited its communications and has not used general solicitation to offer securities to prospective investors. The terms of the securities offered in the Rule 506(b) offering may be the same as those offered in the Rule 506(c) offering. In any case, it is helpful to ensure that special attention is paid to documenting the transactions. For example, the issuer should ensure that it has made the requisite Form D filings for each offering. The purchase agreements used for the two offerings should be distinct. Rule 502(a) of Regulation D provides a safe harbor from integration of Regulation D offerings made six months before or six months after an offering.
Can an issuer begin an offering as a Rule 506(b) offering and modify the offering, making it a Rule 506(c) offering?
Presumably, an issuer could begin a private offering as a Rule 506(b) offering, and change course and rely on Rule 506(c). On the other hand, an issuer would likely not be able to switch course from a Rule 506(c) offering to a Rule 506(b) offering given the presence of general solicitation or general advertising in connection with the Rule 506(c) offering.
This post was written by James Han on December 2, 2013
The General Solicitation Conundrum Solved?