Structuring The Private Placement Or Venture Investment- Pre-Deal Considerations
I recently blogged about how to determine valuation in a start-up or development stage entity for purposes of structuring a prepackaged private placement, or for negotiating the venture capital transaction. I followed that blog with one explaining the various types of financial instruments that can be used for an investment.
Before a company can package a private placement offering or effectively negotiate with a venture or angel investor, it has to have its proverbial house in order. This blog circles back to the beginning discussing pre-deal considerations.
General
In order to successfully attract quality investors, a company must have its financial and legal house in order. I always advise my clients to act as if they are public, even if they never intend to go public. What is meant by that is to maintain proper corporate books and records. Draft and sign minutes of meetings of the board of directors, officers or committees. Keep systems in place to make
Structuring The Private Placement Investment- The Form Of The Investment
I recently blogged about how to determine valuation in a start-up or development stage entity for purposes of structuring a prepackaged private placement, or for negotiating the venture capital transaction. Determining a valuation is instrumental to answering the overriding questions of what percentage of a company is being sold and at what price. However, once you determine the value, you must determine what financial instrument is being sold, or put another way, what will be the form of the investment.
The world of financial instruments can appear daunting and complicated, and no entity should attempt to structure a private offering or enter into an investment agreement without the advice of competent counsel. However, an understanding of the basic components of financial instruments will increase the efficiency of counsel and greatly add to the comfort level of all parties involved. This blog is limited to a discussion of the basic components of financial instruments that would be used to finance
Structuring The Private Placement Investment- Development Stage Or Start Up Company Valuation
The question:
As the economy has been gaining strength, so have the number of entrepreneurs seeking private equity investments through pre-packaged structured private placement offerings, and negotiated venture and angel capital sources. A question that arises almost daily in my practice is how to determine a valuation for a development stage or start-up venture. Determining a valuation is instrumental to answering the overriding questions of what percentage of a company is being sold and at what price.
The Answer:
For business entities with operating history, revenue, profit margins and the like, valuation is determined by mathematical calculations and established mathematically based matrixes. For a development stage or start-up venture, the necessary elements to complete a mathematical analysis simply do not exist.
In the case of a pre-packaged private placement offering for a development stage or start up venture, valuation is an arbitrary guess, a best estimate. In the case of a negotiated investment with a venture capital or angel
Crowdfunding 101
As I recently blogged, the President has signed the Jobs Act including the much anticipated Crowdfunding bill. Crowdfunding is a process whereby companies will be able to raise small amounts of money either directly off their own website or using intermediaries set up for the purpose. The Securities Act of 1933, as amended, (Securities Act) prohibits the sale or delivery of any security unless such security is either registered or exempt from registration. Crowdfunding will be an exemption from registration. The exemption will likely be codified as a new and separate exemption likely under Regulation D and will include an overhaul of the current general provisions of Regulation D found in Rules 501-503.
Crowdfunding Exemption Possibilities
The exemption will likely be limited to $1 million in any twelve (12) month period, or up to $2 million if the company provides certain financial disclosure such as audited financial statements. As proposed, each investor will be limited $10,000 or 10%
Basic Refresher On The Private Placement Exemption
Section 4(2) of the Securities Act of 1933, as Amended (“Securities Act”) provides the statutory basis for private placement offerings. In particular, Section 4(2) exempts “transactions by an issuer not involving any public offering.” The key components of this statutory exemption are that the offering must be by the Issuer, not an affiliate, agent or third party, and that the transactions must not involve a public offering. In order to determine if there is a public offering, practitioners must consider Section 2(11) of the Securities Act which defines an underwriter. The Securities and Exchange Commission (“SEC”) and courts limit the scope of Section 4(2) by preventing indirect public offerings by issuers and control persons through third parties. Accordingly, if an investor acts as a link in the chain of transactions resulting in securities being distributed to the public, they are an underwriter, and the exemption under Section 4(2) is not available.
The Ralston Purina Standard
The leading case interpreting Section
Section 4(6) Registration Exemption for Accredited Investors
Section 4(6) provides a registration exemption for offerings to accredited investors, if the aggregate offering amounts up to the dollar limit of Section 3(b) (currently $5,000,000), if there is no advertising or public solicitation in connection with the transaction by the Issuer or anyone acting on the Issuer’s behalf.
The term accredited investor is defined in section 2(a)(15) and generally includes:
- Banks, insurance companies and pension plans;
- Corporations, partnerships and business entities with over $5 million in assets;
- Directors, executive officers and general partners of the issuer;
- Natural persons with over $1 million net worth or over $200,000 in annual income for two years; and
- Entities, all of whose equity owners are accredited.
In addition, the SEC has the power to define as an accredited investor any person, who, on the basis of such factors as financial sophistication, net worth, knowledge, and experience in financial matters, or amount of assets under management qualifies as an accredited investor.
Section 4(6) and
An In-Depth Review of Private Placements Under Section 4(2)
Section 4(2) of the Securities Act of 1933 provides that the registration requirements of Section 5 do not apply to “transactions by an issuer not involving any public offering.” The definition of an “issuer” is pretty straightforward as found in Section 2(a)(4) and includes, “the person who issues or proposes to issue” a security and is understood to mean the entity that originally sells the securities. However, not so straightforward is what constitutes a “public offering,” which term is not defined in the Securities Act. In reliance on Section 4(2) the SEC enacted Rule 506 as part of Regulation D.
Rule 506 as a Safe Harbor Provision
Rule 506 is a Safe Harbor. In other words, if all the conditions of Rule 506 are met, you can rest assured that the conditions of Section 4(2) have been satisfied. However, Section 4(2) can be satisfied as a standalone exemption separate from Rule 506. The importance of the distinction between Section 4(2)
When Can Separate Issuer Offerings That Occur Within a Short Time Be Integrated?
The integration doctrine prevents issuers from circumventing the registration requirements of the Securities Act of 1934 by determining whether two or more securities offerings are really one offering that does not qualify as an exempt offering, or an exempt offering is really part of a registered public offering.
Securities Act Release No. 33-4552 (November 6, 1962) sets forth a five factor test that is used as a guideline in determining whether the separate offerings of an issuer that occur within a short time of one another will be integrated. These same factors are set forth in the Note to Rule 502(a) of Regulation D, which factors address whether the offerings:
- are part of a single plan of financing;
- involve the issuance of the same class of securities (convertible securities, warrants, and other
- derivative instruments generally are deemed to be the same class as the underlying security unless the terms of the primary security prohibit exercises until at least the one
