Wednesday, September 30, 2015

Placement Agents: Part II: When Should You Use a Placement Agent, and How to Pick the Right One?

At this point, having discussed the services a placement agent can provide, the kinds of compensation used, and other important terms to keep an eye on when negotiating for the services of a placement agent, there is still the threshold matter of determining whether using placement agents makes sense (and when it doesn’t) in the first place. In addition, how to decide which specific placement agent to use?

The first thing to keep in mind is that placement agents are much more common in later-stage financing rounds. Placement agents are almost never used in seed rounds or early-stage financing. One reason for this is that the universe of potential early-round investors (e.g., VC firms and funds) is much smaller and, for lack of a better word, self-contained. In addition, pertinent information, such as what sorts of companies particular VCs invest in and at what dollar amounts, is often publicly available to a much greater extent than for later-stage investors. On a practical level, companies in the early fundraising stages may also be less willing or able to pay the significant commissions demanded by placement agents for their services. This does not mean, of course, that it is never helpful or necessary to use a placement agent in an early-stage fundraising round, but they are used much more commonly—and are in general much more helpful—in later-stage rounds by companies with some kind of established track record.

That being said, if an issuer feels that it can be successful in raising capital without employing the services of a placement agent (for example, perhaps it has only a few major investors who are willing to fully finance a later round), then there is nothing which requires that a placement agent be used. Any money not paid out to placement agents as commissions in a private placement is money the company retains for its own use.

Sometimes, however, using a placement agent is necessary or helpful. For example, if the company is contemplating multiple rounds of private placements over an extended period of time, hiring a placement agent that can introduce the company to a significant number of potential investors (and who may be willing to invest in multiple financing rounds) could be very beneficial. Obviously, if the company has had difficulty raising capital in the past or is facing low interest in the present, hiring a placement agent may be helpful. If conditions in the broader economy are difficult, the services of a placement agent may also be necessary. In the end, the decision whether to hire a placement agent will depend on the circumstances.

If you are considering using a placement agent, you will want to do your homework, as with any potential partner. From a legal standpoint, the most crucial requirement is that you only use a registered BD as a placement agent. This is because any BD acting as a placement agent will be deemed to be “participating” in the offering, and according to both SEC and FINRA regulations, only registered BDs are allowed to so participate. A company should be particularly wary of so-called “finders”, which are not registered BDs. A “finder” may offer to introduce companies to investors, but nothing else—they do no assist with the PPM, do not talk to investors on behalf of the company, etc. It is very important to keep in mind, however, that both the SEC and FINRA define “participation” very, very broadly, and if they find that non-registered persons have participated in the offering, the penalties can be severe, including, for example, “rescission” (i.e. returning any money accepted back to investors).

After making sure that the placement agent you use is a duly-registered BD, there are additional considerations to keep in mind. Some placement agents, for example, may specialize in certain kinds of companies (e.g. software companies or pharmaceutical companies), certain kinds of offerings or transactions (e.g. debt or equity offerings), certain kinds of investors, or certain regions (whether within the United States or with overseas investors). You should ask potential placement agents to put you in contact with other companies who have used their services in the past (though note that the particular terms, such as compensation, are likely covered by confidentiality). Information, as always, is power, and the more information your company can obtain about your potential placement agent partner, the more confident you can be that the placement agent you are partnering with will help you achieve your company’s goals.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Tuesday, September 29, 2015

Placement Agents: Part I: What Are They, What Do They Do and on What Terms?

Raising money for private companies can be a frustrating and stressful experience. Without the kind of access to the investing public that a public company enjoys, and given the kinds of restrictions on who can invest in many types of private placements, finding appropriate investors can be a daunting proposition. It can also be expensive, not only in terms of money but especially in terms of the time and effort required, time that you and your employees might otherwise put towards finding new clients, improving business processes, or creating new products.

For those who want assistance in the fundraising process, one option is to engage a registered broker-dealer to act as a placement agent for the offering. This blog will discuss the role of placement agents in the fundraising process.

What is a placement agent and what can they do?

Essentially, a placement agent is a registered broker-dealer (a “BD”) that assists the company offering the securities (the “issuer”) by connecting it with qualified investors who may be interested in purchasing the issuer’s securities. One of the primary benefits of using a placement agent is the ability to quickly gain access to potential investors with whom the placement agent enjoys a pre-existing relationship. Out of its long list of qualified investors, the agent can help identify those potential investors who are likely to be interested in this particular investment opportunity. This ability to identify qualified potential investors and target those most likely to invest improves the chances that the company will be successful in raising the levels of capital it is seeking. In addition, reliance on the agent’s pre-existing relationships with investors helps the issuer avoid violating restrictions on general solicitation and advertising if conducting Rule 506(b) private placement.

A related function of the placement agent in a private placement is to assist the issuer in preparing and distributing its private placement memorandum (a “PPM”) to potential investors. The PPM is an informational document provided to potential investors, and fulfills a similar function as does a prospectus in a registered public offering (this document is sometimes also referred to as an “offering circular” or “offering memorandum.”) The PPM will include material information about the company, such as its history and description of the company’s business, financial disclosures, and investing risks. Like a prospectus, the PPM serves a dual role as both a marketing document and a liability reduction document, and is thus of tremendous importance in the private placement. Having the assistance of a reputable placement agent in drafting this document can be of great benefit for the company.

Related to assisting the company in preparing the PPM, the placement agent can also provide assistance more generally with its marketing and capital-raising efforts. For example, the placement agent can provide assistance in preparing and putting on investor “road shows”, drafting communications like press releases or investor updates, and similar activities. Not all BDs acting as placement agents will offer the same services, of course, and the specific services required by an issuer for any single capital raise will vary; the particulars of any agreement between the issuer and its placement agent can be negotiated and developed when the issuer decides to contract with the placement agent for its services. On that note, I will next discuss the issue of placement agent compensation, as well as some of the common areas of negotiation which tend to arise when negotiating the contract for placement agent services (usually called the “placement agency agreement” or “engagement letter.”) Often, placement agents will have pre-drafted forms of these agreements. Some terms, such as indemnification and liability limitations, are generally non-negotiable, whereas terms like compensation, exclusivity, and the length of the tail provision, are negotiated based on deal specifics.

Placement Agent Compensation

By far the most common form of compensation a BD serving as placement agent will take is in the form of commissions, much like an underwriter in a registered public offering. The commission percentage charged on any particular deal is negotiable, naturally, but in general will range from around 7% at the lower end to about 15% at the higher end. This commission is charged on the total amount raised, which depends in turn on how many shares the agent can place with investors. For example, if the placement agent succeeds in placing 100,000 shares at $1 per share with its investors, and its commission is 8%, its compensation will be $8,000. Some common variations to a static percentage rate might include a tiered structure (for example, the agent might earn 7% for the first 100,000 shares placed, 10% for the next 200,000, etc.) or a rate that depends on the overall success of the private placement (e.g. the BD receives 9% if the placement raises $1 million or less, but 11% if it raises more than that.) Again, commission compensation will be a basic negotiating point in any placement agency agreement.

In addition to commission fees, placement agents will sometimes request equity compensation, most often in the form of options or warrants to purchase shares at a particular price. Outright allocations of shares is less common, although not unheard of (sometimes, for example, when the capital raise has been particularly successful, the company will give the BD a small number of shares in the form of a “success fee,” although contractually this is often left to the company’s discretion.)

If the private placement is to take place over an extended period of time, and particularly if the placement agent will also be providing some of the more general services alluded to in the above section, compensation may also include an initial retainer fee or monthly service fees. Like commission-based compensation, these amounts are negotiable. If these fees are included as compensation, one possibility, for example, might be to structure the contract such that these fees will be offset against commission compensation.

“Best Efforts” Offerings

Placement agents, like underwriters in a public offering, are primarily compensated based on the commission model. A major difference between the two is that underwriters in public offerings are almost always engaged with on a “firm commitment” basis, whereas placement agents in private placements almost always work on a “best efforts” basis. Simply put, this means that the placement agent does not guarantee that it will be successful in placing all of the issuer’s shares, or even a particular number of shares, and it does not agree to purchase itself any shares it cannot place with investors. (In a “firm commitment” underwriting, on the other hand, the underwriter promises that it will purchase for its own account any shares it cannot place with investors.) Instead, it only promises to use its “best efforts” to place as many shares as it can (ideally, of course, it will place all of them, because the more it can place, the greater its commission compensation.)


Issuers may wish to engage the services of several placement agents in a single offering (similar to using an underwriting “syndicate” for a public offering.) This raises the issue of exclusivity. Simply put, if an issuer engages with a placement agent on an exclusive basis, the company is agreeing that it will not use any other placement agent for that offering. If the agreement is non-exclusive, the company may use other placement agents for that offering. In that case, it is imperative to maintain accurate records as to which agents are responsible for which investors. Generally, if multiple placement agents are used, the company will likely want to engage each on roughly equal terms (particularly in terms of commission rates), primarily to avoid engendering any bad blood. Neither exclusivity nor non-exclusivity is objectively better than the other, and will depend, as with other aspects of the agreement, on the particulars of the offering.

The Tail Provision

Often, the agreements between issuer and placement agent are terminable by either party with or without cause, provided sufficient notice is provided. Because of this, placement agent will virtually always insist on what is known as a “tail” provision that says that even if its services are terminated prior to the closing of the offering, the placement agent will be entitled to compensation if an offering takes place within a specified time period. The amount of compensation is generally what the agent would have been entitled to if its services had not been terminated (i.e. if the company sells to investors originally introduced to it by the placement agent, it will be entitled to its commission compensation for those investors.) The purpose of this provision is, essentially, to protect the agent from an unscrupulous issuer exploiting its connections with investors but terminating the relationship prior to the actual offering so as to avoid being required to pay the placement agent its commission fees. It is virtually impossible to eliminate the tail provision from the placement agent agreement, but the particulars, such as the length of the tail or what counts as a successful closing, may be amenable to negotiation to some extent (for example, if the issuer cancels one offering, then launches another one within the time frame and makes an offer to an investor originally introduced in the prior, canceled offering by the terminated placement agent, is it still entitled to compensation?) As a practical matter, the company will prefer the shortest possible tail, while the placement agent will want one as long as possible. In my opinion, any tail of over 1 year is entirely unreasonable, and in no event should an issuer agree to an open-ended tail, which is not unheard of in agreements drafted by placement agents.)

Additional Provisions

Terms related to compensation, exclusivity, and the tail provision are commonly negotiated terms, but they are of course not the only important provisions of the placement agent agreement. Representations and warranties are very important as well; the placement agent will want to ensure that any information the company is providing to it is accurate, while the company will want to make sure that the placement agent is legally permitted to provide the services it is offering (i.e. that it is duly registered with the SEC, FINRA, and any applicable state agencies), that it does not have any “bad actors” participating on the deal, that it has a pre-existing relationship with any investors it is contacting in connection with the deal (and that it certifies to the company that such investors are qualified to participate in the offering), etc.

In summary, with regards to the placement agency agreement and its terms, the company should be sure to make use of the services of an experienced attorney.

In the next blog, we will discuss whether issuers should use placement agents, and how to choose the right one.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Thursday, September 17, 2015

Citizen VC No-Action Letter - the SEC Guidance on Online Private Placements

As a follow up to my previous blog post where I discussed the new CDIs relating to the definition of "general solicitation" in private offerings conducted under Rule 506(b), I decided to discuss the recently issued SEC no-action letter to Citizen VC.  This no-action letter is all about the application of the new SEC guidance regarding general solicitation in practice.  This can serve as a useful tool for conducting private placements over the Internet.

The main question was the establishment of a "substantive pre-existing relationship" between CitizenVC and prospective investors that would allow the issuer to conduct Rule 506(b) private placements without engaging in general solicitation.  The definitions of "substantive" and "pre-existing" were recently clarified by the SEC (CDI Questions 256.26-31).  According to the SEC (CDI Questions 256.29 and 30), a "pre-existing" relationship is one that is established prior to the commencement of the offering.  There is no minimum waiting period so long as the relationship was established before the offering started.  According to the SEC (CDI Question 31), a "substantive" relationship is one where the issuer "has sufficient information to evaluate, and does in fact, evaluate, a prospective offeree's financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor."

Now, let's take a look at the facts described in the CitizenVC request for the no-action letter.

CitizenVC is an online venture capital firm that offers LLC membership interests in SPVs formed for the purpose of investing into emerging growth companies.  The offering is done through their website.  CitizenVC intends to conduct the private placements under Rule 506(b) that does not allow the use of general solicitation.  To avoid general solicitation, CitizenVC first seeks to establish substantive relationships with its prospective investors.

First, the CitizenVC website that is viewable by the general public does not contain any information that could be viewed as an "offer".  There is no information about the current SPVs, portfolio companies, investment opportunities or offering materials.  This is consistent with the SEC guidance (CDI Questions 256.23-25) that states that the use of a publicly available website that contains an offer of securities constitutes a general solicitation.  To avoid this, the issuer should only disclose "factual business information that does not condition the public mind or arouse public interest in a securities offering" by that issuer.

Second, all visitors to the site that are interested in becoming a member of an SPV must complete an online accredited investor questionnaire.  Only those members who self-certify themselves as "accredited" will eventually receive a password that will allow them to access restricted portions of the site.

Third, CitizenVC implements its pre-set procedures (that contain six separate steps) to establish a substantive relationship with the prospective investor, including (1) contacting the prospective investor offline to discuss their experience and sophistication and to answer questions; (2) sending an introductory email; and (3) using third party credit reporting services to confirm identity and gather additional financial information and credit history information.  Once CitizenVC is satisfied that the prospective investor has sufficient knowledge and experience in financial and business matters and that a substantive relationship has been created, it will admit him or her as a member of the website and send a password to the "member only" areas of the website that contain investment opportunities.

Once enough members indicate interest in an opportunity, CitizenVC will create an SPV to aggregate such members' investments.  Members will be given subscription materials that will contain additional risk disclosures and detailed accredited investor certifications and representations.

The most important aspect of this no-action letter is that the issuer has no minimum waiting period to establish a substantive relationship with a prospective investor.  For CitizenVC, it is the question of quality of such a relationship rather than its duration.  Completion of a "check the box" accredited investor questionnaire alone does not establish such a relationship.  On the other hand, a 30-day waiting period is also not necessary (See Lamp Technologies No-Action Letter).  As the SEC confirmed in its response to CDI Question 256.31, a "substantive" relationship is established when the issuer "has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree's financial circumstances and sophistication."  That may take a week or a month, depending on the circumstances.

In conclusion, the CitizenVC no-action letter offers an excellent step-by-step guide on how to conduct online private placements in compliance with the requirements of Rule 506(b).  All issuers currently structuring their investment platforms should closely study and analyze this example.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.

Wednesday, September 16, 2015

General Solicitation Restrictions for Private Placement Issuers

On August 6, 2015, the Securities and Exchange Commission (the "SEC") issued a number of Compliance and Disclosure Interpretations ("CDIs") related to the issue of “general solicitation” (or “general advertising”) as it pertains to issuers seeking to raise capital in private placements in a Rule 506 transaction. As this blog has discussed elsewhere, Rule 506 under the Securities Act of 1933 allows companies to raise unlimited amounts of capital without having to register the securities with the SEC. Under Rule 506(b), these securities may only be sold to “accredited investors” (a category generally restricted to high net worth individuals and large institutional investors such as investment banks, pension funds, insurance companies, etc.) and to a limited number (no more than 35) “sophisticated” non-accredited investors. Traditionally, this limit on investor participation has been bolstered by a complete ban on the use of “general solicitation” by issuers (or their agents, such as registered BDs acting as placement agent) offering Rule 506 securities to investors. This restriction on general solicitation is found in Rule 502(c) (To avoid any confusion, Rule 502(c) will henceforth be referred to simply as Rule 502 to differentiate it from Rule 506(c)). The rule does not define the term “general solicitation” or “general advertising”, though it does offer a non-exhaustive list of what would be considered to be so, including the use of “any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio.”

The JOBS (Jumpstart Our Business Startups) Act amended Rule 506 by adding a new Section 506(c), which did away with this restriction on general advertising for issuers relying on this new Section 506(c), while also imposing more stringent requirements on who could actually invest (i.e. all of the actual purchasers must be accredited investors; even the most sophisticated non-accredited investors are barred from participation) as well as the steps an issuer or its agent had to take to ensure that such investors are, in fact, accredited. One reason for this amendment was that the prior complete ban on general solicitation for all Rule 506 private placements was seen as a barrier to the ability of some companies, particularly startups and smaller companies, to raise the capital they needed.

This amendment has, therefore, largely been welcomed. At the same time, however, there has been some concern that, given that companies now could engage in general solicitation (so long as they complied with the other requirements of Rule 506(c)), the SEC would begin to take a stricter enforcement approach regarding what they would consider to be general solicitation for companies choosing to raise capital under the “old” Rule 506(b). (Note that “old” here is merely used to differentiate Rule 506(b) from Rule 506(c); the availability of Rule 506(b) has not been eliminated by the new amendment.) The eleven CDIs issued by the SEC on August 6th were, in part, an effort to respond to these concerns. This blog post will discuss and analyze each of these eleven CDIs in turn. (On the SEC website, these appear in the Securities Act Rules and Interpretations Section as Questions 256.23 through 256.33, and will be numbered accordingly here).

Question 256.23

Here, the SEC states explicitly that the use of an unrestricted, publicly accessible website to offer or sell securities would constitute general solicitation or advertising. Therefore, a company relying on the “old” Rule 506(b) to offer securities would be barred from doing so on a publicly accessible website. This is hardly surprising, though it is nice to have it stated so explicitly.

Question 256.24

Here, the SEC addresses what kinds of information a company can widely disseminate without violating the Rule 502 ban on general solicitation. This can be an issue because the SEC takes a very broad view of what constitutes an “offer” to sell securities. Information which is designed or which can have the effect of arousing investor interest in a company, even if no actual mention of any securities being offered or sold is included, may in some instances be considered to be “general solicitation or advertising.” An example might be a press release that includes rosy projections about future potential growth or future earnings. The idea is that, if the company is considering raising capital in the near term, widely distributed communications that have (or appear to have) the intent of ginning up interest may be deemed to be “general solicitation,” which again would preclude the company from relying on the registration exemption under Rule 506(b). As the SEC puts it, information which “condition[s] the public mind or arouse[s] public interest” in a securities offering (even where the offering is not mentioned or alluded to) would result in a violation of the general solicitation ban. Conversely, information that does not condition or arouse the public’s interest would be acceptable. Thus, disseminating purely factual business information about the company would not violate the restriction on general solicitation.

Question 256.25

This brings us directly to the next question, which asks: What is factual business information?

As with many securities-related issues, the SEC’s answer stresses that its determination of what constitutes factual business information is dependent on the specific circumstances in each instance. In general, however, “factual business information” means information about the issuer itself, its general financial condition, the products and/or services it offers, and the advertising of those products and services in the normal course of business. This definition largely tracks the definition of “factual business information” found within Rule 169, although it should be noted here that this Rule does not apply directly to Rule 506 transactions and thus should be viewed strictly as a general guideline. Where a company must be careful is when information it is providing includes what are often called “forward-looking statements,” such as projections or predictions about future performance, and in particular any forecasts or opinions about the future value of the company’s securities.

Companies which are contemplating making use of Rule 506(b) to raise capital in the near-term must be aware that the information they send out may be more closely scrutinized with respect to whether these efforts constitute “general solicitation or advertising” in connection with their intended offering. Although, as the SEC says, each situation is fact and circumstance-specific, one thing to consider is whether the company is acting in a way similar to or different from its own past practices. For example, if a company has not previously been in the habit of releasing quarterly sales results in the past, and then begins to do so shortly before attempting to raise capital in a private placement, this change in behavior may be flagged and scrutinized by the SEC. In general, companies which are considering using Rule 506(b) to raise capital should whenever possible consult with legal counsel to ensure that they do not inadvertently include information extending beyond what the SEC here refers to as “factual business information.”

Question 256.26

This question discusses one way to demonstrate the absence of general solicitation, namely where an offer to purchase securities is made to a person or persons with whom the issuer, or a person acting on its behalf (such as a registered broker-dealer acting as a placement agent) has a “pre-existing, substantive relationship.” For example, if a company is engaging in a later-stage financing round, offering securities to persons who have invested in prior rounds would generally not be considered general solicitation. Similarly, if the issuer is offering the securities through an intermediary such as a registered broker-dealer (BD), the issuer can “piggyback” onto the pre-existing, substantive relationship that the BD has with its clients, and thus the offering of securities to these persons would also not constitute general solicitation.

Question 256.27

This question asks whether there are situations where an issuer or its agent can provide information about a securities offering to persons with whom it does not have a pre-existing, substantive relationship without that information being deemed to constitute general solicitation.

The short answer is yes; the more precise answer is yes, but only in certain instances. In their answer to this question, the SEC acknowledges the “long-standing practice” where issuers or their agents are introduced to prospective investors who constitute an informal, personal network of individuals experienced with investing in private placements. The universe of early-stage investors, particularly those individuals who regularly serve as so-called “angel” investors, tends to be small and somewhat tight-knit (particularly in areas like technology). Angel investors often introduce companies they like to others in their groups. Making offers of securities to these individuals would not, per se, constitute general solicitation or advertising. In a sense, the issuer would be relying on the assumption that all of the investors in this network have the necessary financial experience and sophistication. Thus, an individual investor’s membership in this informal network serves to convey to the issuer (or its agent) the information that the issuer would normally attain by virtue of a pre-existing, substantive relationship with that investor.

Caution should be exercised before relying on this SEC guidance too heavily; as the SEC itself notes, the greater the number of people with whom an issuer does not already have a pre-existing, substantive relationship, the more likely it will be that the SEC will find that there has been general solicitation. There is, of course, no predetermined number; as with everything else, the determination will depend on the specific facts and circumstances of each case.

Question 256.28

This question asks straightforwardly whether someone other than a registered BD is able to form a pre-existing, substantive relationship with a prospective offeree (of securities), thus avoiding the general solicitation trap. According to the SEC, investment advisers who are registered with the SEC may also be able to establish such a relationship because they owe a fiduciary duty to its clients to provide only suitable investment advice (BDs owe similar duties to their clients.) The theory is that, in order to fulfill this fiduciary duty, the investment adviser would need to reasonably determine that its client is financially sophisticated and experienced enough to invest in the issuer’s securities. (Remember that a reasonable determination of an investor’s sophistication is the primary impetus behind the requirement of a pre-existing, substantive relationship in the first place.)

Question 256.29

This question asks for a definition of what “pre-existing” means in the context of a pre-existing, substantive relationship. Here, thankfully, the term is rather self-explanatory. For an issuer itself, this means that the issuer formed its relationship with the prospective offeree before the commencement of its offer to sell securities. If the relationship was formed through an intermediary such as a BD or investment adviser, this means that the relationship was formed before the BD or investment adviser became involved in the offering.

Question 256.30

This question deals with a related follow-up: Is there a minimum waiting period required for an issuer (or its intermediary) to establish a pre-existing, substantive relationship with a potential investor before it can commence an offering of securities? In short, the answer is no; so long as the relationship was established before the offering, offering securities to that potential investor will not constitute general solicitation.  This is a departure from the previously endorsed waiting period of 30 days between the self accreditation of a prospective investor and the ability of an agent to make an offer to such person.  See Lamp Technologies No-Action Letter (May 29, 1997).

In practice, of course, it would be prudent to impose at least some nominal waiting period, but there is no technical requirement for any particular length of time to pass between the establishment of the pre-existing, substantive relationship and the offering of securities.

The SEC also mentions a specific, limited accommodation it will allow for certain private funds that offer investments on a semi-continuous (e.g. quarterly or annual) basis, but as this accommodation is not applicable to most companies raising capital, I will forego further discussion of it here.

Question 256.31

This question asks for a definition of what constitutes a “substantive” relationship for the purposes of demonstrating the absence of general solicitation. Here, the SEC is kind enough to oblige by offering an actual definition: A “substantive” relationship is “one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.” The SEC also specifically cautions here that mere “self-certification” is insufficient, in and of itself, to establish a substantive relationship. (Note that it may be possible, however, for an issuer to rely on an intermediary’s own reasonable belief; e.g. if the investor’s BD tells you the investor is sufficiently sophisticated and informed, that may be enough to establish the issuer’s own reasonable belief.)

Question 256.32

This question asks whether anyone other than BDs and investment advisers can form a pre-existing, substantive relationship with a potential investor in order to demonstrate the absence of general solicitation. The short answer here, again, is yes. What should be kept in mind is that it is the nature of the relationship which broker-dealers and investment advisers have with their clients, rather than the mere fact of the relationship itself, which allows them to demonstrate the existence of such a relationship. Thus, as the SEC puts it, “there may be facts and circumstances in which a third party, other than a registered broker-dealer [or registered investment adviser] could establish a pre-existing, substantive relationship.”

Practically speaking, it’s possible but difficult. Unless the third party (such as the issuer itself) has either a pre-existing business relationship or some kind of recognized legal duty to its offerees, the SEC cautions that it will be more difficult to establish a pre-existing, substantive relationship. For this reason, if the issuer will not be using an intermediary such as a registered BD or investment adviser, it may wish, for pragmatic reasons, to consider offering securities under Rule 506(c), rather than Rule 506(b), thus avoiding the general solicitation issue.

Question 256.33

Finally, Question 256.33 asks whether the holding of a “demo day” or “venture fair” will necessarily constitute general solicitation. The short answer is no; whether such an event constitutes general solicitation depends, as usual, on the specific facts and circumstances. Here, the two primary considerations are 1) what is being presented; and 2) who is the audience.

First, if the presentation does not involve anything that would be considered an “offer” of securities, there is no general solicitation issue. (Keep in mind, of course, the SEC’s broad interpretation of “offer” discussed above with respect to “factual business information.”) Second, if the presentation does involve an “offer” of securities, whether the event constitutes general solicitation will depend on who is invited to the event. If the only people attending are those with whom the issuer (either itself or through its intermediary) already enjoys a pre-existing, substantial relationship (or to whom it is being introduced through the sort of informal, experienced investor networks discussed above in Question 256.27), then the event will not constitute a general solicitation. (Keep in mind, however, that if materials related to the offering are distributed at such an event, and find their way to a wider public audience later, there may be a general solicitation issue.)

Thus, if an issuer is considering holding an event such as a demo day or venture fair, and intends to rely on the “old” Rule 506(b) for its private placement, it must first determine whether its activities will be deemed by the SEC to constitute an “offer” of securities; if so, it must carefully restrict access to this event to those with whom it has a pre-existing, substantive relationship (or, again, to those who may be excepted from this general rule by virtue of their involvement in an informal investing network as discussed above.)

I have previously discussed securities law-related issues about pitches and demo days here.

In a nutshell, if your company is intending to raise capital in a Rule 506(b) private placement, it must be careful about what information it provides and who it provides that information to. As this blog post has hopefully made clear, even following this recent round of CDIs, there are few hard and fast rules or “lines in the sand” when it comes to determining what constitutes general solicitation, and it is always prudent to consult with legal counsel experienced in securities law matters.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate, securities, and intellectual property law.