To avoid having your private equity offering invalidaited because you didn't sell your securities to the right investor
(accredited investors who can't complain they didn't understand the materials),there are several representation that
you would be well served to require:
Rich: The investor has the ability to bear the risk of the investment. This is the so called
rich test, spelled out in Regulation D in specific income and net worth tests, but running through the entire concept of the
private -offering exemtion. Some peaple beleive it is incumbant on the issuer, in close cases , to obtain backup information
that is,investor's personal financial statements. If your smart you will too.
Smart :The investor has the requisite knowlege and experiance to evaluate the merits and risks
of an investment. This is the smart or sophisticated test . Insisiting on backups is open to cautious issueers. They may seek
recitations of an investor's experiance with venture investments and/or general business experiance. The smart test must be
passed by nonaccredited investors in rule 56 offerings under Regulation D. Qualifying investors as smart and rich protects
broker/dealers, who are subject to the rules laid down by their respecting governing bodies, the National Association of Securities
Dealers (NASD) and various state authorities.
Diligent: The investor has read (and claims to understand) all the offering material including,
in particular, the risk factors.
This representation is designed to bind the investor to the exculpatory statements in the PPM(private placement memorandium)
that indicate that the investment involves a high degree of risk.
This is called : Must-have investor representation.
The Securities Act of 1933 dictates that sales of all securities in the United States have to
be registered with the Securities and Exchange Commision (SEC), except for those specifically exempted from regulation requirements.The
so-called Section 4(2)-- or private placement-- provides the basis by which most emerging business enterprises make
private offerings of securities in the United States, and thus, most don't have to register with the SEC.
A couple of decades ago, however , Regulation D was enacted to provide a safe harbor for private-equity
offerings --in other words, if you comply with Regulation D fully. your offering will be veiwed by the SEC as a good private
placement. Before Regulation D, offerings were limited to some (not well defined) number of offerees who were define as smart
and rich in the jargon of the trade. Regulation D has helped many companies raise a great deal of money. It also has helped
company lawyers and cheif financial officers sleep better at night by providing an easy to follow exemption.
One note to keep in mind at the outset of this discussion:Issuances of stock to employees, directors,and
consultants pursuant to a written compensation plan and not for the purposes of raising capital have been exempt for the past
10 years or so under a differant law ---Rule 701 of the Securities ACT of 1933.
Keep in mind,too that regulation D exempts private offerings only at the Federal level and that you
must adhere, unless exempt, to state laws that govern securities transactions ( the so-called blue sky laws, preempted for
most Regulation D offerings), reguarless of your federal status.
( Tinkerbell thought that he would move up into the reading of this chapter of this book
to tell you something important that he had read further on).
Complying with the ban on "general solicitation".
Everything sounds pretty good so far,right? It is,but now is the time for a word of caution.
Reguardless of the number of purchasers (maybe even none) or offerees that you approch to buy
your private equity offering,if the placement is made on the basis of either a general solicitation or general advertising
the exemption is lost, and you've officially screwed up in a big way!
Unfortunately, making this simple mistake is all too easy. The problem is that getting a deal
in front of even a limited number of potential purchasers without participating in some kind of activity that is reasonably
viewed as solicitation is difficult. The problem facing a business founder approching Regulation D is how to keep from running
afoul of the ban on general solicitation, and yet getting an offering memorandum out to a wide enouph audiance to have a chance
at raising the money.
Record keeping ----- the first rule of record keeping almost goes without saying ---- but it
bears constant repetition --- keep careful records--- Here will say it again keep careful records.
Why? an analysis of cases in which issueers went too far in soliciting or advertising their
securities shows one consistant theme: The issuer and its agents didn't keep careful records and therefore couldn't state
with certainty, exactly when challenged in court, exactly how many and what type of peaple were offered the opportunity. And,
if you can't prove with a high degree of certainty who has seen your opportunity, how can you prove your offer hasn't been
widely distributed?
The answer is simple; You can't.
No Advertising!
Don't be lulled into a false sense of security, thinking that because the ban on advertising
is stated in terms of a ban on general advertising, anything short of advertising in a newspaper or on radio or television
is okay: It isn't. In fact the ban on general advertising actually means no advertising whatsoever.
Because conjuring up a practical scenerio involving "nongeneral" advertising is difficult, any
sort of adverising for a private equity offering is strictly off limits. Thus announcements of the offered opportunity in
the newspapers on the radio,on television, and so forth,are not in order.
You may think this constraint is clear enouph--- either you loudly announce the investment opportunity
in the media or you don't---- but nothing in life is simple when securities laws are involved.
Even if you keep careful records, you still may be accused of a forbidden solicitation because
the word "general" isn't a precisely measurable term.
For example: a founder may want to mail her business plan to a list of , say, all venture capital funds named in
Pratt's guide to Venture Capital Sources, the most common referance book in the field. So, a mailing goes out to 1,000 names,
is that general solicitation?
The SEC helped illuminate this issue through a series of no-action letters (so named because
the SEC indicates in the letter, it is hoped, that it won't take enforcement action against the issuer for engaging in a specified
course of conduct). Taken together, these letters indicate a staff veiw that general solicitation does not occur when the
solicitor and his targets have a substantial preexisting relationship.
TIP: Some placement agents have devised a way around this restriction, however. To establish meaningful
pre-exsisting business relationships between the agents and prospects, agents send out cold mailings well in advance of deals-
questionnaires asking indiviguals to fill in certain financial information thereby establishing a record of their sophistication
in such transactions.
Remember: But don't forget, keeping careful records is absolutly critical in helping to identify
all offerees, even though the names don't appear on a master mailing list. And if an intermediary party-- a lawyer, an accountant,
a broker, an agent,whoever---- is asked to help, keeping detailed records of that intermediary's activities also is important.