All You Ever Wanted To Know About Form D: When, Why and How to File

Why File Form D?

When raising money in a private placement, the most common path for companies to take is to make use of one of the Regulation D exemptions from registration, utilizing either Rule 504, 505 or, most commonly, Rule 506. Once the offer for private placement is made, Rule 503 of Regulation D requires the companies engaging in the private placement (let's refer to them as the “issuers”) to file a Form D—Notice of Exempt Offering of Securities—with the Securities and Exchange Commission (the “SEC”).

What Information Do I Need To Have To Be Able To File Form D?

Here is the information you need:

• Company name, principal place of business and contact information (including a phone number)
• Type of entity, state and year of incorporation
• List of related parsons (executive officers, directors, promoters)
• Size (based on revenue or NAV) - this info is optional
• Federal exemption claimed for the offering of securities
• Date of first sale
• Whether the offering will last for longer than a year
• Type of security offered (debt, equity...)
• Whether the offering is made in connection with a business combination
• Minimum investment accepted
• Information related to sales compensation (if any)
• Total offering amount, amount already sold and amount remaining to be sold
• Number of investors (and separately the number of non-accredited investors) 
• Amount of sales commissions and finders' fees
• Use of proceeds and amounts paid to officers, directors and promoters as compensation.

When to File Form D?

Form D must be filed no later than fifteen calendar days following the first sale of securities in the offering. If the fifteenth calendar day falls on a weekend or holiday, the deadline is pushed back to the next following business day (but note that otherwise both weekends and holidays are counted for purposes of the fifteen day total.) The “date of first sale” is the date on which the first investor is contractually obligated to invest (e.g. if an investor signs a binding contract to invest on January 1, requiring payment for the securities on January 10, the date of first sale is January 1.)

Form D is also the correct form to use when the issuer seeks to amend an original Form D filing. Part 7 of the Form allows the issuer to indicate whether the filing is an original filing or an amendment to one previously filed. An issuer may choose to file an amendment at any time (i.e. a permissive filing). However, there are also certain situations, laid out in Rule 503, where the issuer must file an amendment. These are:

• To correct a material factual mistake in the previously filed Form D. The amendment must be filed “as soon as practicable after discovery of the mistake or error.”
• To reflect any change in (i.e. update) the information provided in the previously filed Form D (but only if the offering has not already terminated). Although this second requirement seems very broad, Rule 503 also carves out a number of exceptions where certain changes in information will not require an amended filing, if the only information that has changed includes only:
• The address or relationship to the issuer of a “related person” (i.e. executive officer, director, and/or promoter);
• The issuer’s revenues or aggregate net asset value;
• Any change in the minimum investment amount of 10% or less;
• The address or state of solicitation for anyone receiving sales compensation in connection with the offering;
• Any change in the total offering amount of 10% or less;
• The amount of securities being sold or remaining to be sold;
• The number of non-accredited investors who have invested in the offering (so long as not over 35)
• The total number of investors participating in the offering; or
• Any change in the amount of sales commissions, finders’ fees or use of proceeds for payments to executive officers, directors, or promoters or of 10% or less.

In addition, so long as an offering is ongoing, the issuer must file annually, either on or before the first anniversary of the original filing or the anniversary of the latest filed amendment (whichever is later.)

How to File Form D?

Now that we’ve discussed when to file Form D and what information to include, let’s move on to discussing how to file it. The first thing to know is that the SEC requires that Form D be filed electronically using its Electronic Data Gathering, Analysis, and Retrieval System (more affectionately known as EDGAR). To access the EDGAR filing system (located here), a company must have both a Central Index Key (CIK) and an EDGAR access code.

If the issuer has never previously filed anything with the SEC, electronically or otherwise, it needs to apply to get the CIK and EDGAR access codes by using what is known as Form ID. The SEC website provides a super helpful guide to this process here (see specifically Steps 2 and 3). Remember that the Form ID must be printed, signed and notarized by an authorized person, and then submitted as an attachment to the SEC.  Then, the SEC sends the filer the CIK number by email, typically within a couple of days.  Next, the filer uses the CIK number to obtain the EDGAR access codes.  Once the company has obtained its CIK and EDGAR access code, it can log on to EDGAR here and from there follow the instructions to submit Form D.  I would suggest allocating 2-3 days to get through this process.  

Who Can Sign Form ID and Form D?

The forms can be signed by the issuer's executive officer or director.  An attorney for the company may also sign, but that attorney must be duly authorized by the company or be acting under a power of attorney or other corporate authorization.  So, when the attorney for the company is attaching a notarized Form ID, he or she should also attach the authorization from the company.  

One final thing to note about EDGAR: although it is an online filing system, it is not available 24-7. The system may be accessed between 6 a.m. and 10 p.m. Mondays to Fridays (excluding federal holidays).

This blog article was written and published on June 16, 2015, and the information is accurate (to the best of our knowledge) as of this date.  As you know, with time rules and forms change, and this information may become inaccurate or obsolete.

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.

What Should Start-up Founders Know About Rule 701?

In my opinion, all startup founders should be familiar with and actually understand Rule 701 under the Securities Act because this is precisely how they get to issue equity (restricted stock or options) in their startup to their employees, officers, directors, consultants and advisors in order to provide them with the right kind of incentives. Rule 701 allows startups to do so in a private placement, without registration with the SEC, and with minimum compliance requirements (unless the aggregate offerings exceed $5 million in any 12-month period). One important thing to keep in mind is that the exemption applies only to the registration requirements of the Securities Act; other provisions, most importantly the antifraud provisions, remain fully applicable, which means that any disclosures made by the company may not be materially false or misleading.

Where does Rule 701 fit in?

As you know, all issuances of securities by a company have to be registered with the SEC unless a particular offering falls under an exemption from registration. You are familiar by now with Rule 506 that provides an exemption from registration for securities issued in a private placement. Well, Rule 701 provides an exemption from registration (also on a federal level) for securities that private companies may issue as equity compensation to its employees, directors, officers, consultants and advisors.

Principal requirements and restrictions relating to a Rule 701 offering.

1. Only the issuer (i.e. the company) may use the Rule 701 exemption. This rule is not available for resales.

2. The company has to be a private company (i.e., not be subject to reporting requirements under Section 13 or 15(d) of the Exchange Act). But a company that files Exchange Act reports on a voluntary basis or in accordance with a contractual obligation, is eligible to use Rule 701.

3. The persons to whom offers and sales of securities may be made pursuant to the Rule 701 exemption include employees (including employees of majority-owned subsidiaries), directors, general partners, trustees, where the issuer is a business trust, officers, consultants and advisors. There are many SEC no-action letters regarding who are the eligible recipients of Rule 701 equity (there is some uncertainty about who are the eligible advisors and consultants), so startups should check with their attorney to ensure that they do not issue Rule 701 equity to ineligible persons.

4. Securities offered under Rule 701 are “restricted” securities, and cannot be resold unless they are registered with the SEC or are resold pursuant to another exemption (such as Rule 144).

5. Offering and sale under Rule 701 must still comply with any applicable state “blue sky” laws.

6. Rule 701 equity may be offered and sold only pursuant to a written compensatory benefit plan (or compensation contract). The Rule defines “compensatory benefit plan” as “any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, deferred compensation, pension or similar plan.” This means that the startup should invest into developing an equity compensation plan early on in its existence.

7. The Rule is not applicable to transactions entered into for capital-raising purposes.

8. For equity offered and sold to consultants or advisors, several special rules apply. The Rule is only available to them if they are 1) natural persons; and 2) they provide bona fide services to the company which are not connected to any offering or sale of securities in a capital-raising transaction and which are not intended to promote or maintain a market in the issuer’s securities (whether directly or indirectly).

What else do you need to know about Rule 701?

1. Aggregation Limits

Over the course of any rolling 12-month period, the total aggregate sales price or amount of securities sold may not exceed the greatest of:

1) $1 million;

2) 15% of the issuer’s total assets, as measured on the date of its most recent balance sheet (if no older than its last fiscal year end); or

3) 15% of the outstanding amount of the class of securities being offered and sold in reliance on the Rule (again as measured as of the date of its most recent balance sheet).

There is no (theoretical) limit to the amount of money that can be raised pursuant to Rule 701, provided that whatever amount raised remains within the aforementioned limits. However, there are some enhanced disclosure requirements when the aggregate sales price or amount of securities sold exceeds $5 million in any consecutive 12-month period.

2. Disclosure Requirements

1. For aggregate offerings equal to or less than $5 million, the company must deliver to the recipients only a copy of the compensatory benefit plan or compensation contract.

2. For aggregate offerings exceeding $5 million, the company must, in addition to a copy of the compensation plan/contract, provide in a reasonable amount of time prior to sale:

• A summary of the material terms of the plan (or, if subject to ERISA, a copy of the summary plan description required by that Act);
• Information about risk factors associated with the investment in the offered securities; and
• Financial statements (prepared in accordance with GAAP) required by Part F/S of Form 1-A under Regulation A, including at a minimum the company’s latest balance sheet as well as statements of income, cash flows, and stockholder equity for the preceding two fiscal years (or for the period of the issuer’s existence, if less than such a period). Note that audited financial statements must be provided only if the company has already prepared them; the company need not undergo a financial audit to comply specifically with these disclosure requirements.

Conclusion

Rule 701 can be a very useful and relatively inexpensive tool for start-up companies wishing to provide equity compensation to their employees, directors, and others. There are no SEC reporting requirements, and the disclosure requirements are, in general, not particularly onerous. At the same time, the Rule does impose a number of limitations and exclusions which the company must carefully abide by. The company should always have a knowledgeable attorney to develop or review any proposed Rule 701 compensation plan to ensure compliance with its requirements.

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 business, corporate, securities, and intellectual property law.

Handshake Agreements: Still a Good Idea?

I’ve seen this many times before: entrepreneurs enter into handshake agreements with others, trying to save on legal fees. Often, the counterparties are contractors, employees, investors, or co-founders. These entrepreneurs are not entirely wrong to do so. Oral agreements are still enforceable for the most part. Here is a short summary of when handshake agreements can be enforced in a court of law, when agreements must be in writing, and why it is still a good idea to write it all down.

What You Need to Do To Make an Oral Agreement Enforceable

Most agreements can be oral. The exception is agreements that are required to be in writing by the Statute of Frauds (see below). Like any other contract, oral agreements are enforceable if they have all the requisite terms: an offer, an unconditional acceptance of that offer, and an exchange of consideration. The contracting parties must be capable of contracting (no minors please), and they must be in consensus, i.e, have a “meeting of the minds.” The existence of oral agreements may be difficult to prove: a party’s word might not be enough. So, you need to dig up other evidence that a contract existed, such as receipts, emails, photographs, memos, testimony of third parties, etc.

These Agreements Must Be in Writing

I’d like to introduce a new (for some) legal concept: the Statute of Frauds. The exact requirements vary state by state, but here are the essentials: the Statute of Frauds tells us which contracts MUST be in writing in order to be enforceable. Here is the list:

• Contracts that cannot be performed within a year
• Contracts relating to transfer of interests in real property (including options to purchase and leases)
• Contracts by which a person agrees to pay or guarantee another person’s debt
• Prenuptial agreements
• Contracts for the sale of goods for $500 or more.

Even if a contract does not specify its duration, courts can infer it from the intention of the parties. For example, this can happen to oral employment agreements if the court determines that the intended duration of the employment relationship was for over a year.

Why It is Still Better To Write Things Down

We are all optimistic about the future of our relationships. We firmly believe that nothing bad will happen to our venture because we trust one another. Unfortunately, a few things can happen. First, without even realizing it, we may fail to agree on ALL aspects of our business deal. Yes, we discussed the essentials, but perhaps failed to think through all of the steps. Second, memory fades. If we base our agreement only on a handshake, we may find it difficult to recall some of the terms down the road. Third, we may have misunderstood one another, and won’t realize it until it is too late.

Writing things down allows parties to negotiate all of the aspects of the proposed transaction. Let’s take a software consulting agreement as an example. Defining the scope of services, the time frame for the delivery of services, the acceptance process, the payment amount and timetable, ownership of IP (both created and pre-existing), the term of the agreement, who can terminate the agreement and with what consequences, etc. takes time and effort. Often I find that parties haven’t even thought about some of the specific terms that they need to agree on in order for their project to work. A contract can be viewed as an ultimate expression of the parties' intentions. It should overrule everything that’s been said during the negotiations. Only what is in writing matters. That’s why a well-written contract should address all scenarios that can happen in a project. A party failed to deliver services on time? No problem, check Section 3(a) for the remedies available to you. You are not satisfied with the quality of the service? Check Section 4. You still haven’t received payment? Go to Section 5… and so on.

Conclusion

It is not always necessary to hire lawyers to draft contracts. A quick summary of all essential terms, signed by both parties, even if it is in an email or on the back of a napkin, will suffice. But if you can afford it, hire a professional to help you draft a full-blown agreement. It is like having insurance, - it might protect you down the road.

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 business, corporate, securities, and intellectual property law.