Tim Gillis, Attorney at Law of Jacksonville law firm GILLIS WAY & CAMPBELL was recently interviewed for his knowledge and experience on private placement of securities. In this interview, get important information and tips on offering private placement of securities from a legal standpoint.
Private Placement of Securities
Q: What does private placement of securities involve?
Gillis: It is called a private placement as opposed to a public offering. You probably have an idea on what a public offering is, like an IPO. What many people probably do not realize is that a security is an ownership interest in a company. If you have a small S Corporation, own stock, have an LLC that you own or have a membership interest, that is a security.
A partnership interest is a security. It is an ownership interest in a business. The general rule is unless there is an exemption from registration, any offer and any sale for securities must be registered. Fortunately, there are a lot of general exemptions from registration and typically those are what we call private placements.
Private placements mean you are not making a general public offering. For example, you are not running an ad in the Wall Street Journal offering to sell stock to anyone.
You are just targeting the offer to certain buyers. Those buyers are going to be people to whom you have been introduced by folks that you know. Sometimes they will be introduced to you through broker-dealers (people who are actually licensed to go out and find buyers for you). Again, it is not a general solicitation. It is a small offering to a select group of people.
Q: What is involved in preparing a private placement?
Gillis: Preparing a private placement depends on whether you have a very simple one or a more complicated one. A simple one is where you already have an identified group of potential accredited investors you are going to approach who know your business and that are going to buy into your business.
These are usually sophisticated individuals who would do their own due diligence of the company and it will usually be extensive. They will take a hard look into the financials, talk extensively with the management, and look into the industry.
If you are actually going to propose the sale of your company to people you do not know, who you have been introduced to or are accredited investors, then usually we put together what is called a Private Placement Memorandum (PPM). A PPM makes all the disclosures that you need to make to comply with the law. In other words, it is a sales tool, but it cannot be misleading. It cannot fail to omit material information. It can be misleading if you do not mention something that is unfavorable.
Typically you will find all the state law disclosures in the front of the PPM. It provides the information that is applicable to you. Additionally, there will be the federal disclosure which, for example, tells you that this has not been registered with the Securities and Exchange Commission (SEC) and has not been approved by the SEC.
There are a lot of generic risk factors out there which are frowned upon. One that we see often is, If you invest money in this business, you will see it all. There are variations of this but this is what they are essentially telling people. These statements are similar to that clause you see on prescription drugs – “they may cause death.”
There is usually a management discussion included with the PPM where the management tells you the background of the company, the industry, their prospects for the company, and how they feel about the company. It gives you the biographical information of the people who run the company, the officers, directors, and key employees. Information regarding the company’s intellectual property is also included. Most key information that an investor needs to consider is provided with the PPM.
Financials are usually included with the PPM. All of this information needs to be accurate.
A form subscription agreement will also be included with the PPM which basically says, Here is all the information we would want you to sign and here are the legal documents we would want you to sign in the event that you agree to invest in the company on our terms.
If the investor is a large investor or a sophisticated investor, they may try to negotiate those documents. If the investor is not so sophisticated or if they like the investment opportunity, they will sign on the terms the company proposes, although they usually negotiate a little bit.
Basically, a PPM tends to include the information mentioned above. It can be a thick packet of paper and you want to control who gets a copy of it. You may consider numbering the PPMs and keeping a record of whom you give them to because you do not want them distributed to just anyone. You would not want your competitors to obtain a copy so there should be a confidentiality agreement that accompanies the PPM.
Q: Who can private placement be sold to?
Gillis: The traditional way of thinking about private placements is that they are sold to accredited investors. These are the “rich people.” The threshold is if you: make $200,000 or more as an individual; $300,000 or more as a married couple; or have $1 million or more net worth, excluding the value of your primary residence. Typically, that is the definition of individuals as accredited investors.
At one time when real estate spiked, some investors included their primary residences as part of their net worth which categorized them as accredited investors. When the real estate market took a dive, it did not end well for these investors.
Private placements can now be sold to unaccredited investors or normal mom-and-pop business owners. However, there are strict rules about that and you need to be careful. Typically there are limits in a placement to unaccredited investors. The information that you have to give them is significantly more than if you were limiting it to accredited investors only. If you let an unaccredited investor into your offering, your potential for liability goes up significantly. If you are a business raising money, you have to comply and you have to be careful.
Q: What is Regulation D?
Gillis: The general rule is that if you are making an offering of a security with a very broad definition, meaning you do not own any stock ownership or any LLC membership, then it must be registered with the SEC and/or the state securities agency in order to offer it. There is a statutory exemption for non-public offerings. Regulation D contains the regulations that have been issued to implement that (rules under which you do not have to register your offering with the SEC prior to bringing in investors). Those are what we call the safe harbor regulations. If you comply with one of the exemptions in Regulation D, then you do not have to register federally and typically the states do not require registration. In the federal system you have federal and state regulation. Usually if you are exempt at the federal level, you are exempt at the state level as well. You may be required to file a notice with the state and pay a fee. You will have to file a form with the SEC once you do a private placement but it is not a registration.