Rule 506 Private Placement Offerings

There are a number of advantages to private placement offerings that are made under Rule 506.

  1. States Cannot Block.

    With a Rule 506 offering, no state can require a review of the merits of the offering (and possibly stop the offering). The most a state can do is require that a short "notice" filing be made and charge some relatively minor fees.

  2. No Specific Disclosures.

    If all of the potential investors are accredited (as opposed to merely "sophisticated"), then there no specific disclosures are required. This is useful because otherwise offering materials must be provided that comply with the disclosure requirements of Rule 502(b). (Still, the company making the offering must disclose all information that a reasonable potential purchaser would want to know.)

    1. A "quick and dirty" definition of "accredited investor" is:

      1. Any organization not formed for the specific purpose of acquiring the securities offered with total assets in excess of $5,000,000;

      2. Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;

      3. Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his purchase exceeds $1,000,000;

      4. Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

    2. Note that it is safer to restrict Rule 506 offerings to accredited investors anyway, since there can always be arguments over whether a particular investor is "sophisticated".

  3. Unlimited Offering.

    An unlimited amount of money can be raised with a Rule 506 offering.

  4. Prequalified Investors.

    Still, the usual private-placement limitation against general solicitation or advertising applies.

    1. Assuming that only accredited investors will be allowed to invest, this means that the company may only solicit pre-qualified accredited investors. (It is NOT permitted to solicit both accredited and non-accredited investors or to solicit investors where it is not known whether or not they are accredited – even if only accredited investors are actually allowed to invest.)

    2. According to the SEC, a broker or dealer registered with the SEC may determine whether an investor is accredited. The SEC has left the door open for officers or directors of an issuer who are not licensed as brokers or dealers but who have the requisite ability to make the determination that an investor is accredited; still, if one wants to be absolutely safe, a broker or dealer should make the determination.  Whoever does it cannot just rely on a statement by the investor that he/she/it is accredited, even if that statement is given in writing.  Instead, a questionnaire must be used that provides sufficient information to support a reasonable belief for the reviewer that the investor is accredited.

    3. "Pre-qualified" means that the determination that the investor is accredited must be made before any offer is made. The determination also has to be made separate and apart from the investor’s interest in a particular offering.

    4. The offering company may contact accredited investors only in a few limited ways:

      1. Many broker-dealers keep lists of their clients who are accredited. Assuming that they have used a "reasonable belief" questionnaire to determine that the investors are accredited, the company may send solicitations to that list. (Of course, the brokers are going to want to charge for this.)

      2. Some websites have been established where a potential investor can complete a "reasonable belief" questionnaire that is then reviewed by a broker-dealer to determine if the investor is accredited. The offering company can then solicit the accredited investors through the website company.

        1. Some examples (these are NOT endorsements) are:

          http://www.californiainvestmentnetwork.com/entrepreneur

          http://www.mcomm.com/prequalinvestorslists.html

      3. If the offering company has a list of potential investors (such as an affinity group), it can hire a broker-dealer to send a "reasonable belief" questionnaire to the potential investors to determine which ones are qualified.  The offering company alternatively could have one of its officers or directors who is qualified make this determination, but there is  no certainty that this is acceptable to the SEC.  No mention of the company’s offering can be made in this process though. The company can then send a solicitation to only those pre-determined to be accredited.

      4. .  A company may place an accredited investor questionnaire on its web site. Once a determination has been made  that a potential investor is accredited, that potential investor may be given a password that provides access to a page in the web site that gives information on the offering.

  5. Legal Work.

    If only accredited investors are solicited, the legal work includes the following:

    1. Review of the offering circular/private placement memorandum/prospectus (and any other documents given to prospective investors).

      1. As noted before, even if the offering is being made to accredited investors only, all information that a reasonable investor would want to know about must be included. We can provide a checklist for this.

      2. Note that the risk section is crucial. All significant risks should be discussed, although the company may also explain how it plans to minimize or counter these risks.

    2. Preparation of an investor/subscription agreement (including the proper representations for securities exemption purposes).

    3. If needed, preparation of a consent to electronic delivery of documents.

    4. Preparation and filing of Form D with the SEC.

    5. Preparation and filing of notices for those states having potential investors to whom a solicitation is made.

      1. Because the California rules are uncertain on this point, we file both a 25102(f) form and a copy of Form D (along with the proper consent to service form and specified transmittal letter) with California to be safe.

    6. The cost for these items is approximately $2,500 to $5,000, plus approximately $1,000 for each state where the securities are offered. Filing fees are extra. Please note that these estimates are highly dependent on how solid the investor documents are when we begin to review them. Also, the fees will be higher for any work not on this list. If non-accredited investors are going to be solicited, the costs will be substantially higher.

March 2005