SEC Changes Rules to Improve Deal Flow for Private Companies and Investors

Client Alert
December 9, 2020

In a 3-2 vote held in November 2020, the SEC approved new rules and amendments to existing rules that are intended to harmonize, simplify and improve the private placement regime that start-ups and other issuers, small and large, rely on to raise private capital. The SEC recognized that the current system of private placement exemptions, which was built over many decades, was filled with gaps and uncertainties. The adopting release covered a wide range of topics to address these matters, including:

Rather than discuss each of the changes recently approved by the SEC, this Client Alert will focus on certain key takeaways that we expect will have significant potential benefits to private companies and investors. 

Offering Limits: Regulation Crowdfunding and Regulation A

Regulation A and Regulation Crowdfunding contain a variety of requirements and investor protections, including limits on the amount of securities that may be offered and sold and limits on how much an individual may invest. The SEC has estimated that approximately $2.7 trillion of new capital was raised through exempt offering channels in 2019, of which approximately $1.1 billion was raised under Regulation A and Regulation Crowdfunding combined.

Regulation Crowdfunding

Crowdfunding refers to a financing method in which capital is raised through soliciting investments from a large number of people. In October 2015, the SEC adopted Regulation Crowdfunding, which was intended to help provide capital to start-ups and small businesses by making relatively low dollar offerings of securities less costly. However, Regulation Crowdfunding did not have the impact on capital formation that the SEC had hoped.

The number of offerings and the total amount of funding under Regulation Crowdfunding have been anemic, with issuers raising $108 million from May 2016 through December 2018. Further, the typical crowdfunding offering was relatively small and raised only a modest amount of capital. In an effort to increase the use cases for Regulation Crowdfunding, the SEC adopted amendments to Regulation Crowdfunding as summarized below. The amendments will:

Regulation A

Regulation A is an exemption from registration that establishes two tiers of offerings for a 12-month period:

The SEC is required to review the $50 million Tier 2 offering limit every two years. The SEC’s recently adopted amendments to Tier 2 of Regulation A will:

We think the changes to Regulation Crowdfunding and Regulation A are likely to increase the number and size of offerings by issuers under these rules and will result in a wider range of investment opportunities for investors.

Special Purpose Vehicles

Previously, Regulation Crowdfunding required investors purchasing securities in an offering to hold the securities in their own name, creating administrative complexities. We also believe this contributed to limiting the attractiveness of Regulation Crowdfunding because any offering resulted in an excessively large number of investors on an issuer's capitalization table.

In order to reduce the administrative complexities associated with a large and diffuse shareholder base, the SEC adopted certain amendments to allow investors who are natural persons to invest through a crowdfunding vehicle, which would constitute a single record holder in the company’s capitalization table. Further, among other things, the crowdfunding vehicle must:

This approach is intended to benefit both investors and issuers alike by allowing investors to achieve the same economic exposure and voting power as if they had invested directly in the underlying issuer, while allowing the crowdfunding issuer to maintain a simplified capitalization table and reducing the administrative complexities associated with a large shareholder base.

Demo Days

For years there has been a question as to whether a start-up company’s demo day presentation may disqualify it from relying on certain private placement exemptions available for the sale of stock or other securities. Demo day events feature groups of start-up companies making presentations to prospective investors and other attendees. Although each presentation typically focuses on the start-up company’s business, they often conclude with the company’s capital raising plans. In the past, when a founder had informed the audience that his company was currently raising funds, these statements could have potentially fallen within the broad definition of a "securities offering" as interpreted by the SEC.

In 2015, the SEC issued guidance that suggested that the offering of securities at a demo day may constitute a general solicitation unless the attendees are limited to an audience exclusively made up of persons (i) with whom the issuer or the organizer of the event has a pre-existing, substantive relationship or (ii) who have been contacted through a personal network of experienced investors with sufficient financial experience and sophistication.

Whether there has been a general solicitation is a fact-specific determination. In general, the greater the number of persons without financial experience, sophistication or any prior personal or business relationship with the issuer that are contacted by an issuer or persons acting on its behalf through impersonal, non-selective means of communication, the more likely the communications could be part of a general solicitation.

New Rule 148 will make it easier for companies participating in a demo day to remain in compliance with the SEC’s private placement exemptions. Listed below are specific requirements under the Rule:

Under the new Rule, companies would be allowed to discuss their securities offerings, provided they only cover the following information:

The Rule also includes additional restrictions for events that allow attendees to participate virtually by requiring that online participants fall within at least one of the following categories: (i) they must be members of, or otherwise associated with, the event sponsor’s organization, (ii) the sponsor must reasonably believe such attendees are accredited investors or (iii) the attendees must be invited to the event by the sponsor based on industry or investment-related experience reasonably selected by the sponsor in good faith and disclosed in the public communications of the event. These restrictions do not apply to individuals that attend the event in person.

The SEC also noted that if the organizer of the event limits the event attendees to individuals or groups of individuals with whom the issuer or the organizer has a pre-existing substantive relationship or that have been contacted through an informal, personal network of experienced, financially sophisticated individuals, then the issuers could avoid the limitations of new Rule 148 because the communications at the event would not likely be considered general solicitations or general advertising.

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The amendments and new rules discussed above are expected to become effective in late February or early March. The recent changes adopted by the SEC to the exempt offering framework are significant and detailed. This Client Alert provides a brief overview of only certain noted provisions. If you would like further information, please contact the lawyer at Sullivan & Worcester LLP with whom you regularly consult, or the lawyers listed above.

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