From brand new start-ups to eighty-year old Fortune 500 companies, most companies, even publicly traded ones, raise equity capital through private placements of securities.
A private placement, sometimes referred to as a private offering, is a sale of restricted securities by an issuer pursuant to an exemption from the registration requirements of the Securities Act of 1933. Frequently, the exemption falls under the safe harbor provisions of Regulation D (or Reg D, for short).
Generally speaking, restricted securities are ineligible for resale into the public market until certain conditions have been met. To sell restricted securities, either a resale registration statement must be filed with the Securities and Exchange Commission and declared effective, or resale must be permitted pursuant to an exemption or under an applicable rule, such as Rule 144.
As most experienced entrepreneurs know, raising significant amounts of equity capital for an early-stage company is rarely easy. The uninitiated often believe that all they need is an introduction to a couple of wealthy investors, an hour or two in a room with them to show them the wonders of their great idea or product, and out will come the checkbooks.
This rarely (if ever) happens. Selling equity securities is a deliberate process. While every private offering or sale by a company of its securities is somewhat different, the ramifications for a misstep sometimes leads not only to an unsuccessful offering but can lead to personal liability of the promoters of the offering.
Personal liability is imposed not only for malicious fraudulent conduct, but could apply, for example, when the company issuing securities cannot comply with an order to rescind a sale to an investor because the company failed to comply with the private-offering legal requirements or omitted to state a material fact to the investors concerning the company. Again, it does not require intentional misconduct or deceipt. This is why it is important to do the process right. Not only will doing the process right limit personal liability exposure, but your offering will likely be more professional and attractive to investors.
Below is the general sequence of events in a private offering of securities:
- Prepare business plan, including an executive summary and a long term capitalization plan
- Conduct organizational “clean up” and “due diligence”
- Obtain necessary company authorizations
- Decide whether to use a placement agent and if so, identify, contact, interview, and select placement agent(s)
- Negotiate agreement with placement agent(s), if applicable
- Define parameters, procedures, contingencies, timing, and geographic scope of offering
- Conduct initial blue sky (or state securities law) research
- Identify investor qualification standards (e.g., accredited, sophisticated, state residency requirements)
- Prepare offering terms or term sheet
- Prepare offering agreements and documents (e.g., subscription or purchase agreement, investor questionnaire, shareholder agreement, charter amendment)
- Prepare the private placement memorandum (PPM)
- Identify prospective investors
- Select desired offering exemption
- Set up monitoring mechanism for PPMs
- Identify printer and forward PPM for copying
- Obtain applicable investor introductions and conduct initial investor presentations
- Circulate the PPM to interested prospective investors
- Close the transaction
- Make necessary federal and state filings
- Issue stock certificates
The list above describes how the process typically works, but sometimes tasks are eliminated or abbreviated, the order changes, or other tasks are added, such as obtaining a legal opinion, amending articles or bylaws, preparing an investor rights agreement, qualifying for the state angel investor tax credit program, etc. In coming weeks, we’ll cover a number of these steps in more detail.