By Bill Daly / Guest Editorial

Iowa’s Creative Corridor has established a start-up community that is strong, vibrant and continuing to grow. As these start-ups develop and expand, especially high-growth start-ups that are looking to scale, the founders and owners will often pursue equity financing through private offerings.

Below is a general primer start-up founders and owners should be aware of as they raise capital.

Private offerings

A private offering is a sale of securities by a company in which the company does not register the sale with the U.S. Securities and Exchange Commission (SEC) or any state but instead claims a registration exemption from both the SEC and each applicable state where the securities are sold. As part of a “private offering,” the company is often regulated on how it can contact or market to potential investors, the amount of capital it may raise, the number and types of investors from which it may obtain funds, and the information it must provide its investors.

The SEC and each state where the company sells securities regulate the private offering of securities. So, for example, if an Iowa company raises capital from investors in Iowa, Illinois and Wisconsin, the company must comply with the federal securities laws and the securities laws of Iowa, Wisconsin and Illinois. Most start-up companies structure their offering to qualify for exemptions from federal and state registration requirements.

If a company fails to properly comply with the federal and state securities laws, that company may have to return the funds to the investors, face potential fines or not be allowed to raise additional capital for a certain period of time. In addition, management of the company (which often includes the founders) may have personal exposure because of the company’s failure to comply with the securities laws.

General solicitation

The SEC recently amended its rules (effective as of Sept. 23) to allow for general solicitation and advertisement in certain private offerings that comply with the new SEC rules. However, if a company utilizes general solicitation, the company can only sell to “accredited investors,” and also the company must take certain additional actions, including enhanced verification of the investor’s status.

If a start-up company does not wish to solicit its offering to a general audience or meet the enhanced investor status verification requirements, the company issuing the security will be prohibited in most cases from advertising or making a general solicitation of the securities. In general, to avoid a general solicitation, companies should ensure there is a substantive pre-existing relationship between the company (or its management or agents) and any potential investor. As part of this prohibition, companies also should be mindful of the language they use when giving public pitches regarding their company and should, in most cases, include proper disclaimer language in such presentations.

Investors

The securities laws are designed to protect investors in private and public offerings. Broadly speaking, the SEC views investors in private offerings as either “accredited” or not “accredited.” Accredited investors are those individuals or entities that meet certain requirements set forth by the SEC, which requirements relate to wealth, income or financial strength. Generally speaking, companies obtain a regulatory advantage (but not a “free” pass) by selling securities to only accredited investors and, in the case of the new Rule 506(c) offerings (allowing general solicitation), only accredited investors can participate.

Investment amounts

Securities laws allow for multiple private offerings to be integrated together, therefore, the amount of capital that a company has raised in the previous 6-12 months, as well as the amount the company intends to raise in the next 6-12 months will often be a significant determinant in the amount requested and structure of the current investment round. The SEC, under Regulation D, has imposed varying private placement requirements for offerings depending on the size of the offering and the status of the investors. Therefore, during the initial planning stages of any capital raising period, companies should address how much capital they intend to raise now and in the coming year and the “status” of their likely investors.

Anti-fraud and disclosure requirements

Even if a company structures its private offering so that the offering is exempt from the federal and state registration requirements, the federal and state securities laws still have anti-fraud concepts and rules that will affect the company’s offering. These requirements may be applicable to both verbal statements and written documents that companies provide to potential investors. The scope of any required disclosure and its accuracy is an important topic that a company needs to consider in its planning.

 

 

Bill Daly is an attorney at Shuttleworth & Ingersoll, P.L.C. and a member of its securities and equity finance and startup and innovators practice groups.