The New ABCs of Private Placements: 506(b) and 506(c)

The same kind of change that swept through the mutual fund industry, making investing in a fund a quick and easy process, and bringing billions more dollars into the industry, is now impacting the world of private placements. The rules of private placements have changed, yet many issuers are still mainly operating by the old playbook, leaving valuable options on the table.

It’s been years since the JOBS Act created Rule 506(c) of SEC Regulation D, allowing private placement issuers to use “general solicitation” to raise money from qualified investors. According to 2014 data by the SEC, more than $14 billion has already been raised by early adopters who have taken advantage of the opportunity to publicly advertise their offerings. And yet a lot of issuers are still sitting on the sidelines.

It’s understandable why some issuers are reluctant to give the new Rule 506(c) a try. Raising capital is a high-stakes game. With millions of dollars involved, no one wants to make a misstep. But this hesitation is unnecessary. Rule 506(c) gives issuers the opportunity to reach a much broader audience and potentially reduce their cost of raising capital. It also gives a whole new group of investors the chance to participate in private placements.

The differences between the new Rule 506(c) and the old Rule 506(b) are actually very straightforward — and new technology-based platforms and services have emerged that will help ensure compliance with either rule. The bottom line is that issuers now have a choice between two different methods of reaching investors, and every issuer ought to seriously consider both options.

Allow me to break down the new and improved Rule 506 — I promise that it isn’t as complicated as you may think. Let’s start with the part you already know. The “oldie but goodie” method is now called Rule 506(b) and is familiar to most of us in this industry. Companies using this rule can sell securities to any number of accredited investors, and a handful of other buyers. They don’t have to verify investors’ accredited status themselves, but they must not advertise the offering publicly in what’s known as “general solicitation.” They take great care to only offer their securities to buyers they already know and believe to be accredited.

Easy enough, right? Now, here’s the part that’s probably less familiar to you. The new Rule 506(c) allows issuers to advertise their offerings. There need not be a prior relationship with the investors who buy their securities. They can publicly promote the fact that they’re raising capital to anyone who will listen. BUT, they do have to verify that anyone who actually invests is an accredited investor, and investors must prove they are accredited to participate in the offering.

There’s a lot of upside for both issuers and investors with this new rule. When issuers advertise their offering, they broaden their reach. They can raise more money, faster, by appealing to a wider range of investors. They don’t have to rely on their own Rolodex — and I use that antiquated term on purpose — or the traditional gatekeepers to help them find suitable investors. Now they can make their case directly to the market and let the strength of the offering speak for itself.

From the investor’s perspective, an advertised 506(c) placement is a huge new opportunity, too. Investors can more easily search for placements that suit their needs, and they don’t have to have any kind of insider connections to uncover the best offerings. It’s much more a level playing field now.

Yes, the new rule does have some teeth, too. The new, stricter requirement to verify investors’ accredited status is holding many issuers back from taking advantage of this opportunity to reach more investors more easily. But it doesn’t have to. When you think about it, there has always been a burden on the issuer to know their investor. So, the solution to this problem is finding an efficient and reliable way to verify the investor — an issue that we at Venovate have solved by verifying each investor’s accredited status, and providing proof of that verification to the issuer. It’s a process that has been vetted by top securities lawyers to make sure it is fully compliant.

This is the 21st century. New online marketplaces make it easy for issuers to offer transparency, by placing due-diligence documents online for investors to search through. They ensure compliance with whichever rule the issuer chooses. The entire process is done online, making it efficient and secure. There’s no need for the process of raising capital to be cumbersome and complicated. Issuers can now choose the type of offering that works best for them — and be sure they’ll be fully compliant with whichever rule they choose.

So, as times have changed, issuers who don’t at least consider the new Rule 506(c) are leaving valuable options on the table. It’s as simple as that. Finding investors for a new capital raise can be that simple, too — if you work with an expert who can make the entire process as easy as ABC.

And speaking of the A — I’ll address proposed changes to Title IV’s Regulation A+ in my next article here, so stay tuned.

Raising Capital using a Regulation A+ Mini-IPO

Regulation A+ allows the public to invest in private companies. Startups can use a Mini-IPO under Reg A+ to turn their customers into investors.

Reg A Background

On April 5, 2012, President Obama signed a landmark piece of bi-partisan legislation called The JOBS Act into law. The JOBS Act greatly expanded entrepreneurs’ access to capital, allowing them to go to the crowd and publicly advertise their capital raises.

Initially, private companies could only crowdfund from accredited investors, the wealthiest 2% of Americans. On June 19, 2015, three years after the JOBS Act was initially signed into law, Title IV (Regulation A+) of the JOBS Act went into effect. For the first time, Title IV allows private growth-stage companies to raise money from all Americans.

What is Regulation A+?

Reg A+ of Title IV of the JOBS Act is a type of offering which allows private companies to raise up to $50 Million from the public.

Like an IPO, Reg A+ allows companies to offer shares to the general public and not just accredited investors. Companies looking to raise capital via Reg A+ will first need to file with the SEC and get approval before launching a mini-IPO. However, the fees associated with a Reg A+ offering are much lower than a traditional IPO and the ongoing disclosure requirements are much less burdensome, effectively making a Reg A+ offering a mini-IPO.

How is Reg A Different from a Reg D Offering?

The key difference between Reg A and Reg D is that companies raising under Reg D can only accept investments from Accredited Investors while those conducting a Reg A offering are able to accept funds from both accredited and non-accredited investors.

Why Would I Do a Reg A+ Offering?

Reward Early Adopters

Startup companies who are entering the growth stage often owe a large part of their success to their early adopters. By pursuing a Reg A+ offering, a company is inviting its users to share in that success. Offering customers a financial stake rewards early adopters for the role they played in the company’s growth.

Galvanize the User Base

By inviting its early adopters to participate in a Reg A+ offering, a company can help turn users into brand evangelists. Research shows that customers who have a vested interest in the future of a business are more likely to recommend that company to others and increase the amount they spend with the company.

Retain Control of Your Company

Reg A+ allows entrepreneurs to raise a large sum of capital from a large pool of investors. By raising small amounts from many investors, an entrepreneur can spread out ownership of the company more broadly. Oftentimes, institutional investors require a certain level of control alongside their investments which can even result in an entrepreneur getting kicked out of their own company. In a typical Reg A+ offering, a company will not need to cede board seats or agree to other potentially adverse mechanisms that are typical when raising venture capital or private equity.

Efficient Process for Raising Capital

Conducting a Reg A+ offering allows companies to tap into an eager and engaged source of capital. By bringing these investors online, startups can potentially secure funding quickly and efficiently. The Testing The Waters process allows a company to assess whether there is investor demand for an offering by soliciting indications of interest before deciding whether to proceed with a Reg A+ offering.

Who is Reg A+ Right For?

Companies Looking to Raise Between $3 — $50 million

Because of the costs associated with conducting a Reg A+ offering, Reg A+ is most likely not worth it for smaller fundraises of under $3 million. Currently, for most seed and bridge rounds, an old-fashioned raise from accredited investors still makes more sense.

Consumer-Facing Companies with Clear Value Propositions

People looking to invest in companies raising via Reg A+ will be most inclined to invest in companies with products or services that they use themselves or which deliver a clear value proposition to the average consumer. Consumer-facing companies with well-defined product/service offerings resonate well with the average investor and are well positioned for Reg A+.

Companies with Large & Engaged User Bases

A company’s customers can serve as a natural source of investments in a Reg A+ offering. A large, enthusiastic user base will be more likely to invest in a company, drive initial investment momentum, and be able to help a company quickly fill its round.

Companies That Want To Make a Large Splash

Mini-IPOs are about more than just raising capital. In addition to fundraising, Reg A+ offering as a chance to engage customers and build large-scale publicity and brand awareness. The best Reg A+ offerings are managed and promoted like a significant product launch. Such an approach helps make the offering a key marketing opportunity to build a company’s brand and reputation. When executed correctly, a Regulation A mini-IPO can also be a robust customer acquisition channel, just as with a “typical” product launch.

The Mini-IPO Process

1. Testing the Waters

Before committing to a mini-IPO, companies are permitted to test the waters (this is optional). This enables companies to gauge the potential success of a Reg A+ offering and make an educated decision on whether or not to move forward prior to spending time and money on the SEC approval process. Testing the waters is completely free on 64-Corp , simple and in no way obligates a company to actually launch a Reg A+ offering.

During a testing the waters campaign, companies invite potential investors (including customers) to make indications of interest. These are the dollar amounts that a potential investor would be interested in investing if the company decided to pursue a Reg A+ offering.

2. Qualification Process

After a company has decided to pursue a mini-IPO, they will need to spend the first month drafting a Form 1-A with the help of 64-Corp (and obtain reviewed or audited financials).

After filing the Form 1-A, 64-Corp will work with the company over the next 2–3 months to turn any comments from the regulators and then file the final prospectus after being “qualified” by the regulators.

3. Launch

Once regulatory qualification has been received the company may launch its Mini-IPO. 64-Corp’s online platform has been engineered to seamlessly accept investments online, including verifying investor identities, performing anti-money-laundering checks on investors, facilitating investment document execution, funds transfer and regulatory compliance.

SeedInvest will also work with the company to market its fundraise by employing a three-tiered strategy to promote the round and secure investments:

  • Target the company’s customers and the 64-Corp investor network to build initial momentum and excitement
  • Target early-adopters, the company’s extended network and affinity groups
  • Target the public through robust press, advertising and digital campaigns

Throughout the Reg A+ offering, 64-Corp will work in tandem with the company to effectively communicate with investors, manage investor relations, and support the operations of the campaign.

4. Completion of the Offering

SeedInvest automates the entire closing process and ensures that all legal and regulatory obligations are met.

Tier I vs. Tier II Offerings

Companies pursuing a mini-IPO can choose between two types of Reg A+ offerings, Tier 1 and Tier 2.

Reg A offerings can use Tier 1 or Tier 2

Concerns about Reg A

What are the downsides of utilizing a Mini-IPO?

  • Legal and accounting fees can potentially be higher than under a traditional raise from accredited investors.
  • Regulatory approval prior to closing investments will most likely take 2–3 months.
  • More investors (although this can also be a benefit as long as it’s managed appropriately).
  • Tier II raises will be subject to ongoing public reporting (although this can be a benefit for companies planning to potentially exit through a full-blown IPO down the line).

What if my testing the waters campaign fails?

The testing the waters campaign is an opportunity for users to express their interest and the indications are non-binding. So long as you communicate to your customers that you are just considering a Mini-IPO, they will understand if you decide not to proceed. If you receive less interest than anticipated or decide not to proceed for any other reason, you can easily explain to your users that you will be raising capital in another way, and/or that they may have other chances to invest in the future.

What will my existing investors think about a Reg A+ round?

Existing investors may be initially skeptical of a Reg A+ offering simply because it is new and non-traditional. It is important to remember the following details about Mini-IPOs:

  • Most companies simply test the waters first to make sure there is sufficient investment interest prior to approaching their board of directors for approval to launch a mini-IPO.
  • Reg A+ can be part of a larger round. Companies might decide to raise 70% of their round from venture capitalists and hold back the remainder for their customers/users.
  • Mini-IPOs are about more than just fundraising. They are an opportunity for a company to make a large marketing splash and create an army of brand ambassadors.

At what point do I have to commit to holding a Reg A+ offering?

A company doesn’t need commit to a Reg A+ offering until after they conduct a testing the waters campaign. A company can test the waters for free through SeedInvest to determine investment interest and has no obligation to move forward.

How is this similar and different to going public?

Regulation A+ actually has more similarities to traditional fundraising under Regulation D than to an IPO, except that it allows companies to raise capital from all investors and requires a degree of regulatory review.

The SeedInvest team works closely with companies raising funds through a Regulation A Mini-IPO

Working with 64-Corp to raise using Reg A

64-Corp works with companies to pull together its offering materials, to navigate the regulatory approval process and to ensure that their fundraises are conducted in a regulatory compliant manner. In addition, 64-Corp’s online platform has been engineered to seamlessly accept investments online.

Streamlined Process and Platform

64-Corp’s comprehensive, robust platform has been built to support Reg A+ in its entirety. SeedInvest’s state-of-the-art platform facilitates the process of closing investments from thousands of investors by verifying investor identities, performing anti-money-laundering checks on investors, facilitating investment document execution, funds transfer and regulatory compliance

Navigating Rules and Regulations

The rules and regulations surrounding Reg A+ offerings can seem daunting at first. The 64-Corp team has a comprehensive understanding of the financial regulations surrounding Regulation A+. Our team was part of the movement in 2011 and 2012 which ultimately resulted in the passage of the JOBS Act on April 5, 2012 and have worked closely with regulators to implement the changes in security laws. Since Title IV of the JOBS Act went into effect on June 19, 2015, we have been the primary source for information surrounding the emerging mini-IPO process.

Glossary of Terms

Maximum Offering: This is the maximum amount that a company can raise in any 12 month period.

Investor Types: These are the investors who are allowed to participate in an offering. There are no restrictions on who can invest in a company raising under Reg A+.

Individual Investment Limits: This is the maximum amount an individual investor can invest in a company raising under Reg A+.

General Solicitation: These are the restrictions on a company advertising its raise to the public. There are no restrictions to whom a company raising under Reg A+ can advertise.

Offering Documents: These include the prospectus and the subscription agreements.

Ongoing Disclosure: These are the filings required after a Reg A+ offering.

Ability to Terminate Ongoing Reporting Requirements: This is the point at which a company must no longer comply with ongoing reporting requirements.

Transfer Restriction: These are the limits placed on selling shares bought through a Reg A+ offering. Reg A+ shares can be fully transferable immediately but there is currently not a liquid secondary market for Reg A+ shares.

State Pre-Emption: This allows a company to by-pass review by the states to launch a Reg A+ offering, going solely to the SEC.

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