PPM

PPM

Private Placement Definition & Introduction to Private Placement Process

At the ISIN Network, the term “private placement” is used in reference to raising capital and creating a private placement memorandum in order to procure financing. ‘Private placement’ thus refers to the offer and sale of any security by a brokerage firm (or by the company seeking capital). A private placement offering stands out precisely because it does not involve a public offering, hence it’s a ‘private offering,’ or a private placement offering (PPO). Private placements are unique in that the private placement offering is not subject to a registration statement filed with the SEC under the 1933 Securities Act.

Private placements – usually conducted via a private placement memorandum – are conducted in reliance upon Sections 3(b) or 4(2) of the 1933 Act as construed, under Regulation D as promulgated by the SEC, or both. Regulation D sets forth various guidelines for compliance with the Private Offering Exemption. Any registered representative who is involved in the private placement offering process is expected to have a working familiarity with Regulation D or other Regulations like 144A. Regulation D acts as the backbone of the entrepreneurial world in the American regulatory landscape. Both start-ups and later-stage growth companies seeking investment capital and funding for their businesses typically make use of Regulation D.

For companies conducting a private offering to qualify for a private placement, the issuer (the one selling the securities) must meet either the requirement of Sections 3(b) or 4(2) of the 1933 Act as developed through SEC interpretation and court decisions. Otherwise, the issuer must follow the conditions set out under Regulation D of the 1933 Act. Persons claiming the exemption from the 1933 Act carry the burden of proving that its activities came within that exemption. Often, this exemption is spelled out in the offering documents, commonly known as the private placement memorandum (PPM).

Regulation D

Reg D Overview

Regulation D (or “Reg D”) is a series of six rules, Rules 501-506, and 506b and 506c, that establish three transactional exemptions from the registration requirements of the 1933 Act. When reading the information below, keep in mind our statement from above: that Regulation D is the backbone of American entrepreneurial world. This will help shed light upon the rules and their details below. These rules can be read in full at the SEC’s website, www.sec.gov.

Regulation D Rules 501-503 set forth definitions, terms, and conditions that apply generally throughout Regulation D. Specific exemptions are set out in Reg D Rules 504-506.

Rule 504 of Regulation D (Reg D)

Regulation D Rule 504 applies to transactions in which no more than $1,000,000 of securities (such as stocks, bonds, debentures, notes, etc.) are sold in any consecutive 12-month period. Rule 504 imposes no ceiling on the number of investors (in theory you can have as many investors as you want), permits the payment of commissions, and imposes no restrictions on the manner of offering or resale of securities. Further, Rule 504 does not prescribe specific disclosure requirements, unlike Rule 505 and Rule 506, below. Generally, the intent of Reg D Rule 504 is to shift the obligation of regulating very small offerings to state “Blue Sky” administrators, though the offerings continue to be subject to federal anti-fraud provisions and civil liability provisions of the Exchange Act. Blue Sky rules typically refer to each individual state or jurisdictional rules for private placement offerings.

Rule 505 of Regulation D (Reg D)

Regulation D Rule 505 applies to transactions in which not more than $5,000,000 of securities is sold in any consecutive 12-month period. Sales to 35 (thirty-five) “non-accredited investors” (see below for a definition, and visit the SEC’s website for a full definition) and to an unlimited number of accredited investors are allowed under Rule 505 of Reg D. An issuer under Rule 505 may not use any general solicitation or general advertising to sell its securities, meaning no public advertisements, e.g. television, radio, etc. Rule 505 of Regulation D is a popular avenue for raising capital, although Regulation D Rule 506, outlined below, surpasses Rule 505 in popularity.

Rule 506 of Regulation D

In Regulation D Rule 506 there is no limit to the dollar amount that can be raised in this private offering, i.e., an unlimited amount of capital can be procured. Rule 506 of Reg D is available to all issuers for offerings sold up to, but not beyond 35 (thirty-five) non-accredited investors or purchasers and an unlimited number of accredited investors. Reg D Rule 506, however, unlike Reg D Rule 504 and Reg D Rule 505, does require the issuer of the securities to ensure that a subjective determination – which happens at the time of acquisition of the investment – that each non-accredited investor or purchaser meets a certain “sophistication” standard. These sophistication standards, individually or in conjunction with a “Purchaser Representative,” must be made. Like Rule 505, Rule 506 prohibits any general solicitation or general advertising, such as on television or the radio, etc.

Accredited Investor

“Accredited Investor,” defined fully at the SEC’s website, www.sec.gov, is defined in Rule 501(a). The principal categories of accredited investors are as follows:

1) Directors, executive officers, and general partners of the issuer, including general partners of general partners in two-tier syndicating. (The term “executive officers” is more fully defined in the Regulation.)

(2) Purchasers whose net worth either individually or jointly with their spouse equals or exceeds $1 million. It is important to note that while there is no definition of “net worth” in Regulation D, there similarly is no requirement of liquidity in the calculation of net worth for this accreditation standard. Thus, a purchaser’s home, furnishings, etc. are includable in the determination of net worth.

(3) Natural person purchasers who have “income” in excess of $200,000 in each of the two most recent years and who reasonably expect an income in excess of $200,000 in current year (or $300,000, jointly with their spouse). In addition, rules change frequently (check with the SEC).

(4) A business entity will be treated as a single accredited investor unless it was organized for the specific purpose of acquiring the securities offered, in which case each beneficial owner of the security is counted separately. Its important to only include the proper investors in your private placement

(5) There are more requirements to be considered an Accredited Investor. Contact ISIN.net for more information.

Additional Compliance Considerations Under Regulation D

The SEC has pointed out the following regarding Regulation D:

1. Regulation D does not exempt offerings from the anti-fraud and civil liability provisions of the various federal securities laws.
2. Further,Regulation Din no way relieves issuers of their obligation to furnish to investors whatever material information may be needed to make any required disclosures not misleading.
3. Similarly, notwithstanding exemption from registration at the federal level,Regulation Din no way obviates an issuer’s obligation to comply with applicable state law.
4. Regulation Dis interpreted as providing “transactional” exemptions to issuers only. An investor whose purchase was exempt from registration cannot resell his or her interest without establishing an independent basis of exemption.
5. The three exemptions are not intended to be mutually exclusive, that a reliance on one exemption is not deemed to be an election to the exclusion of any other applicable exemption.
6. Finally, the exemptions of Regulation D may not be claimed with respect to any plan or scheme to evade the registration provisions of the act.

Existing state securities regulations at times impose substantially more onerous limitations on issuers than Regulation D. Issuer’s counsel or consultants must be consulted regarding the requirements of the securities rules of each state in which an offering is going to be sold. This basically translates to the fact that each individual state, and depending on one’s location and where capital is being sought (one’s country as well), must comply with local rules and regulations.

Form D

Form D has two components, federal and state. The Federal Form D notices are due within fifteen days after the first sale of securities in an offering under Regulation D. The Federal Form D for Regulation D is a free application.  Additionally, each state has their own criteria for the filing of the state Form D, and each state has a fee of some sorts for this filling. The federal and state Form D can be prepared by Issuer’s consultants or counsel, or by oneself. The ISIN Network’s staff can help your company prepare and submit the Form D.

Private Placement of Restricted Securities Outside Regulation D

The specific requirements that need to met or satisfied in order to establish an exemption under Section 4(2) for a private placement are not stated in that section of the Securities Act of 1933. After reviewing SEC interpretations and court decisions dealing with Section 4(2), the basic requirements which a private placement offering must achieve can be determined. Although not extensive and not exhaustive, they are summarized below:

1. All the offerees and purchasers must have access to the same kind of information concerning the issuer which would appear in an SEC registration statement, and these persons must be able to comprehend and evaluate such information (all prospects must be given the same information and offering). It should be noted by each issuer that any offer to an offeree who would not qualify, as well as a sale to a purchaser who would not qualify (those, for example, that are not accredited investors) ,may destroy the private placement exemption and result in a violation of Section 5 of the 1933 Act. It is of paramount importance that all prospects are in fact legitimate prospects, otherwise an offering can become null and void.
2. The issuer and any parties acting for the issuer, including the broker-dealer, must take all reasonable steps to insure that the information given to the offerees and purchasers is complete and accurate. This is “due diligence.” Everything in offering literature (the private placement memorandum, for instance) must be accurate. All information passed on in the course of the private placement, either orally or by memorandum (or offering circular), is subject to the anti-fraud provisions of the federal securities laws and therefore must be taken seriously and be made accurate. The fact that the private placement offering memorandum is not reviewed by the SEC does not lower the standards for accuracy which would be applicable to any registered offering.
3. All of the offerees must have access to meaningful current information concerning the issuer. The fact than an offeree has considerable financial resources or is a lawyer, accountant, or businessperson, and thus may be considered “sophisticated,” does not eliminate the need for appropriate information to be made available. Again, all parties should receive the same information and have access to the issuers if questions are needed to be answered.
4. While there is no specific limitation on the number of offerees, the greater the number of offerees, the greater the likelihood that the offering will not qualify for the exemption. In this connection, a private placement cannot be the subject of advertising, general promotional seminars, or public meetings in connection with the offering. Again, television and radio are just two avenues highlighted here, but many more forums are prohibited. This limitation does not preclude meeting with offerees to discuss the terms of the offer or to present information concerning the issuer or the offering. After the private placement offering has been completed, a general announcement (such as a tombstone ad) concerning it may be made if this is desired, but must be done in full compliance of the rules. We do not advocate tombstones whatsoever. Contact us for information on tombstone ads.
5. Purchasers in a private placement must acquire the securities for investment and not for the purpose of further distribution. Meaning, purchasing stock in a company should be undertaken to hold the stock for investment purposes, not to resell right away. If the purchaser acts in such a manner so as to participate in distribution of the securities to the public, either directly or indirectly as a link between the issuer and the public, he or she will be deemed to be an underwriter and the selling broker-dealer and other participants in the distribution, including the issuer, will be in violation of Section 5 of the 1933 Act. Those selling the securities must be licensed and conform to other regulatory standards, i.e. FINRA (ISIN Network) does not sell securities of any kind and is not a broker dealer). Each of the purchasers must intend to acquire for investment at the time the securities are purchased. Whether or not investment intent was present will be determined from all the circumstances surrounding the acquisition. Such circumstances would include the financial capability of the purchaser to hold the securities for the long term and whether the purchaser signed a letter of investment intent. The amount of time the securities have been held (the “holding period”) is one of the factors in a hindsight determination that an investment intent existed at the time of purchase. A two-year holding period is deemed to be the bare minimum, but consultation with professional should be sought in order to determine if this time frame can be shortened, or if it needs to be lengthened. ISIN Network can help consult on this matter.

What is apparent from the aforementioned discussion is that up-to-date and accurate information about the offerees in a private placement transaction is absolutely essential. This is essential for the making of judgments as to  the suitability of the investor at hand, and his or her ability to evaluate an offering, and investment intent.