Private Company Director

Securities Laws Can Impact Private Companies, Too

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Boards should be aware of legal issues that apply to raising capital, M&A and more. 

Boards of private companies typically focus on strategic matters such as market forces, competitive dynamics, business continuity and succession. But from time to time all private companies find that they need an infusion of capital to fuel growth, enhance business processes, execute continuity strategies or achieve operational and strategic goals. As a result, directors of private companies should be familiar with the processes used to raise capital, in compliance with securities regulations, in order to assist the company’s management in executing financial strategies, including raising capital and conducting mergers and acquisitions. These activities should be guided through a lens of risk management and compliance in the ever-expanding securities regulatory framework that exists in our country today.

Securities laws have a significant impact on private companies in the United States. These laws are designed to protect investors and maintain the integrity of the financial markets. While some securities laws primarily apply to public companies, there are regulations that private companies must also comply with, especially if they plan to raise capital or engage in certain financing activities. Consider this excerpt from the SEC’s fact sheet What Does the SEC Have to Do With My Private Company?:

“Private companies can raise capital in several different ways, including by selling investment instruments called securities. The U.S. Securities and Exchange Commission, or SEC, regulates the offer and sale of all securities, including those offered and sold by private companies. Under the federal securities laws, every offer and sale of securities, even if to just one person, must be either registered with the SEC or conducted under an exemption from registration. This is true for companies of all sizes, private and public alike, and includes sales made to anyone, including friends, family, angel investors and venture capital funds.”

Here are several examples of regulatory matters governing capital raises that you may want to consider in your role as a director for private, middle-market companies.

Raising Capital

SEC safe harbor. If your company raises capital frequently, you may encounter the SEC’s Rule 3a4-1, which provides a safe harbor for issuers to raise capital “not more than once per year” without involving a broker-dealer. Very simply, a broker-dealer sells your securities to raise funds for your company. 

If your company is raising capital more than once per year, you may need to include a broker-dealer in the raise to assure that you comply with U.S. securities laws. Only 20% of private securities offerings in this country are executed through a broker-dealer, but you may need to consider engaging such a securities professional to avoid falling afoul of securities laws. 

A union of states. Not only do you need to be cognizant of federal securities law, but you must also consider the securities laws of each of the 50 states (and any territories) in which you intend to raise capital. These laws are called Blue Sky Laws and vary from state to state. Engaging an investment banker and a securities attorney helps you navigate these laws with compliance and confidence — a strong position to be in when raising funds.

General solicitation. In 2013, the universal solicitation of prospective investors became legal for the first time since the 1930s. Private companies may now more broadly solicit prospective investors and can even publicly advertise their offerings, provided those companies meet certain guidelines regarding “accredited” investors.  

Currently, the primary requirements to qualify as an “accredited” investor are a net worth above $1 million, excluding the primary residence, or income of $200,000 or more over the course of several years. Beyond these, individuals must also display sufficient financial sophistication and resources to sustain the risk of loss. 

A new bill now under consideration in Congress, the Accredited Investor Review Act (H.B. 1579), seeks to reduce asset and income requirements so that investors with lesser financial resources can participate in private investments. If passed, this bill will allow an entirely new set of investors to capitalize on higher returns yet also be exposed to losses, as is the case with all uninsured private placements.

In a general solicitation offering, each investor’s accreditation status must be verified by an independent third party. You may want to search “investor verification” to better understand the degree of verification required by the SEC.

Crowdfunding. The JOBS Act passed by Congress in 2012 gave private companies greater access to crowdfunding, especially through portals and broker-dealer intermediaries. But SEC regulation imposes specific requirements on the amount that can be raised, investor limits and disclosure obligations. Crowdfunding portals are rampant and don’t always comply with securities law, so make sure your company’s management thoroughly vets any given portal before engaging with it.

Anti-fraud provisions. Private companies, even if exempt from certain registration requirements, are still subject to anti-fraud provisions under federal securities laws. This means they must not make false or misleading statements, omit material information or engage in fraudulent practices when offering or selling private securities. The SEC actively enforces these provisions and can take legal action against companies found to be in violation. Penalties for securities fraud can lead to substantial fines, securities issuance prohibitions and, in severe cases, criminal charges. While charges for issuer securities fraud are not common (unlike broker-dealer securities fraud charges, which are quite common in this country), they do occur. And when they do, they lead to lengthy time in court along with extensive legal fees.

Board members can hire an independent third party to conduct due diligence on the offering documents. This provides “another set of eyes” and an extra level of professionalism to verify that documents are factual and do not contain false or misleading information. That professional can be an investment banker, an attorney specializing in securities or a third-party due diligence company. 


Mergers and Acquisitions

While the U.S. Congress recently passed new regulations as part of an omnibus bill in March of this year (H.R. 2617), loosening regulations governing mergers and acquisitions, private company boards still need to be fully informed of how U.S. securities laws may impact their acquisitions and divestitures. Acquiring another company by purchasing its stock is a securities transaction and requires compliance with SEC rules.


Exemptions and Thresholds

Private companies may be exempt from certain registration and reporting requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934. For example, private offerings that meet the criteria for exemptions, such as Regulation “D” or Regulation “Crowdfunding,” can be conducted without registering the securities with the SEC. These exemptions have specific limitations and conditions that companies must adhere to. For example, under Regulation Crowdfunding, private companies can raise funds from the general public of up to $5 million in a 12-month period, subject to various disclosure requirements and limitations on individual investor contributions. Rule 506 is the most used exemption under Regulation D. It allows issuers to raise an unlimited amount of capital but limits the number of unaccredited investors allowed to purchase the offering.

Justine Tobin is an advisory board member of First Citizens Bank Charlotte Metro and Mobilads, and the founder and CEO of Tobin & Company Investment Banking Group and Tobin & Company Securities, a licensed broker-dealer.

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