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Aug. 16 — Some companies have embraced a new Securities and Exchange Commission registration exemption allowing advertising and general solicitation, but most issuers are still relying on historical exemptions to sell unregistered securities.
“We've seen very modest use” of the exemption, Anna T. Pinedo, Morrison & Foerster LLP partner and securities specialist, told Bloomberg BNA.
Companies that have used the SEC rule, however, are quick to point out its many benefits—including that they can raise unlimited amounts of capital from a limited number of wealthy, motivated investors.
The 2012 Jumpstart Our Business Startups Act was enacted to help startups and other early-stage companies raise capital. Title II of the law directed the SEC to lift the ban on general solicitation and advertising for certain private offerings.
In July 2013, the agency implemented Title II by adopting Rule 506(c) under 1933 Securities Act Regulation D (133 SLD, 7/11/13). Effective Sept. 23, 2013, the new rule allowed companies to engage in general solicitation or advertising in connection with unregistered securities offerings, provided the securities were sold to accredited investors.
Use of the exemption has been muted. According to SEC data, as of the end of 2015, only about 2 percent of eligible non-registered offerings were actually made under Rule 506(c).
Proponents of Title II, however, say the prospects for use of the regulation are bright. They maintain that any initial reluctance may stem from uncertainty about how the SEC will monitor its use.
For companies, Rule 506(c) has provided a new avenue to raise unlimited amounts of capital. For intermediaries—matchmakers pairing accredited investors with companies seeking capital—it has created new businesses and business models from scratch.
And for lawyers? “A great deal of my work is representing portals and trying to figure out their relationship to issuers, dealers, and all of these new webs of relationships,” Flaster Greenberg PC securities specialist Markley S. Roderick told Bloomberg BNA.
Advertising and the ability to solicit accredited investors could materially increase the appetite for unregistered offerings because of the relatively large number of wealthy, accredited investors who have never participated in an unregistered securities offering.
About 10 million U.S. households meet the SEC's accredited-investor requirements, but only about 2 percent of them have ever made a venture investment, Jonathan Medved, chief executive officer of intermediary company OurCrowd, told Bloomberg BNA.
Before Rule 506(c), companies and any intermediaries helping them raise capital could only discuss investment opportunities with accredited investors with whom they already had a relationship. With the rule, companies are able to solicit investments from a “crowd” of accredited investors via the internet and seek to build new investment relationships.
As a registered broker-dealer, San Francisco-based CircleUp Network Inc. can charge transaction fees to companies raising money using its internet portal. Being registered may mean additional costs, Rory Eakin, CircleUp founder and chief operating officer, told Bloomberg BNA.
However, it also helps assure investors that their funds are being monitored by federal regulators and that CircleUp is in compliance with securities laws and rules. CircleUp doesn't retain custody of investor funds, which helps it avoid additional regulatory requirements, Eakin said.
Israel-based OurCrowd isn't a registered broker, so it typically takes a 2 percent management fee for the first four years and then 20 percent of profits. OurCrowd also may invest along with its accredited investors as well as venture capital firms such as Khosla Ventures and Innovation Endeavors and companies such as General Electric Co. and 3M Co., Medved said. “We're really a hybrid of venture and crowdfunding,” he said.
At CircleUp, most deals are funded by no more than 50 individuals, Eakin said. For companies, dealing with a limited number of investors willing to invest hundreds of thousands of dollars in a startup as opposed to potentially thousands of individuals investing relatively small sums is a key benefit of using Title II.
Another benefit: under Rule 506(c) a company can raise an unlimited amount; companies raising capital under Title III crowdfunding are limited to $1 million within a 12-month period and individuals face limits on the amount they can invest.
Issuers don't need to use an intermediary to solicit accredited investors to buy their unregistered securities. Nonetheless, several issuers told Bloomberg BNA that the fees associated with hiring an intermediary were worth the extra expense.
Despite intermediary costs, “for me it was absolutely worth it. We've got so many benefits besides just the raise,” Smári Ásmundsson, founder and chief executive officer of yogurt producer Smári Organics, told Bloomberg BNA.
Ásmundsson used CircleUp to raise capital for his yogurt company and said he plans to use the firm again when his company needs additional capital.
Financing isn't the only reason companies are turning to intermediaries to help them raise start-up or growth capital. Intermediaries often work actively with the companies they promote to facilitate corporate networking or suggest third-party vendors.
Jeremy Morgan, chief executive officer of fast-casual restaurant company Tava Indian Kitchen, told Bloomberg BNA that at first, he wasn't interested in raising money through an intermediary. The concept sounded too much like a fund-raising campaign by an intermediary like Kickstarter, a portal that rewards investors with merchandise or other benefits, not with equity, he said.
Morgan changed his mind, however, after being introduced to a CircleUp executive and learning about the company's operations. CircleUp offered the chance to be introduced to new accredited investors interested in restaurants. The conversations he had with investors he met through CircleUp were virtually identical to the conversations he had with investors he met on his own, said Morgan, who raised $4.5 million in eight months using CircleUp.
His company currently operates restaurants in San Francisco and Palo Alto, Calif. and has plans to open a third restaurant in California and a fourth in Colorado. Building restaurants is capital intensive, and while Morgan said his experience with CircleUp has been positive he hopes to attract institutional investors once his operations include a dozen or more outlets.
Some issuers have gravitated toward the exemption. Between Sept. 23, 2013, when Rule 506(c) entered into force, and Dec. 31, 2015, 398 continuing Regulation D offerings switched to Rule 506(c) offerings, and 447 new Rule 506(c) offerings were initiated by issuers that previously used Rule 506(b), SEC data showed.
Still, Morrison & Foerster's Pinedo said she thinks issuers of unregistered equity securities will continue to prefer Rule 506(b) over new Rule 506(c), even though they won't be able to advertise and solicit for investors. Indeed, of the combined Rule 506(b) and Rule 506(c) offerings between September 2013 and Dec. 31, 2015, just 4.5 percent opted for Rule 506(c), SEC data reported.
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