Capital Raising

The SEC Releases the Division of RSFI’s Report on Regulation D Offerings

by Vanessa Schoenthaler on April 11, 2012

Yesterday the Securities and Exchange Commission’s Division of Risk, Strategy and Financial Innovation released a report analyzing information extracted from all Form D filings made with the Commission between January 2009 and March 2011. The report, entitled Capital Raising in the US: The Significance of Unregistered Offerings Using the Regulation D Exemption, coincides with a slide presentation given before the Advisory Committee on Small and Emerging Companies in October 2011. The report looks at the amount of capital raised using the Regulation D exemptions (Rules 504, 505 and 506) as compared to the amount of capital raised using other methods, public and private, and gives us a bit of insight into common Regulation D offering characteristics and the companies that most frequently avail themselves of the Regulation D exemptions.

Common Regulation D Offering Characteristics

Using information reported in response Item 13 of Form D, the report begins by estimating the total amount of capital raised in Regulation D offerings for the 2009 and 2010 calendar years (take a look at the report’s appendix for some of its methodologies and assumptions, including the treatment of Form D amendments). Item 13 of Form D requires that a company specify:

  • the total amount of securities to be offered (Item 13(a)), expressed as a dollar value or as an “Indefinite” amount (indicating that the total offering amount is undetermined or cannot be determined at the time of the Form D filing);
  • the total amount of securities that have been sold as of the time of the Form D filing (Item 13(b)); and
  • the total amount of securities that remain to be sold (Item 13(c)).

Based on a review of these figures the report estimates that, for the 2009 and 2010 calendar years, capital raised through Regulation D offerings ranged from a minimum (calculated using Item 13(b)) of approximately $587 and $905 billion, respectively, to a maximum (calculated using Item 13(a)) of approximately $1.5 and $1.2 trillion, respectively. With the average offering size being approximately $30 million, but the median offering size only being approximately $1 million, suggesting that a large number of smaller offerings took place.

Among the available Regulation D exemptions, Rule 506 was by far the most popular one to be claimed during the period examined. Rule 506 allows you to raise an unlimited amount of capital from an unlimited number of accredited investors, and up to 35 non-accredited investors, provided certain information and other requirements are met.

The data also reveals that during the 2009 and 2010 calendar years the total amount of capital raised in Regulation D offerings was more than twice the total amount of capital raised in public equity offerings. There are, however, other factors that might be influencing these findings, not the least of which being the state of the capital markets during the period in question. It’ll be interesting to see if this trend continues as the environment for public equity improves.

Another interesting bit of information revealed by the data is the number and type of investors that typically participate in a Regulation D offering. Only approximately 10% of investors that participated in offerings during the period examined were non-accredited investors. With approximately 90% of offerings being made up of entirely accredited investors. In addition almost 90% of offerings involved approximately 30 investors or less.

Common Company Characteristics

The report also gives us some insight into the type of companies that most frequently avail themselves of the Regulation D offering exemptions. For example, Item 4 of Form D requires that a company identify its industry group and Item 5 asks that it disclose its revenue range (though companies have the option to “Decline to Disclose”).

Based on a review of the responses to Item 4, nearly one-third, or 29%, of the Form D filers in 2009 and 2010 identified themselves as pooled investments funds (of which approximately half, or 55%, further identified themselves as hedge funds). Of the remaining companies, approximately 15% identified themselves as being in the technology industry, approximately 10% in the health care industry and approximately 8% in the real estate industry.

While approximately half of all companies declined to disclose their revenues, of the companies that did make the disclosure nearly 20% had no revenues at all and another approximately 20% had revenues of $25 million dollars or less (the chart below accounts for a $1.00 – $5 million revenue range and a $1 million – $5 million revenue range, but Form D calls for disclosure in the $1.00 – $1 million and $1 million – $5 million revenue ranges, so it’s unclear to me as to whether there’s overlap in the chart or a typo, though I assume the latter). Finally, less than 4% of all companies raising capital in a Regulation D offering reported revenues in excess of $25 million.

Additionally, during the period examined approximately 25% of all companies that raised capital in a Regulation D offering were foreign companies.

And, of the universe of public companies, approximately 10% raised capital in a Regulation D offering, with those relying on Regulation D tending to be smaller and less profitable then their peers.

A complete copy of the report is embedded below, it’s brief and there are plenty of additional charts to flip through:

(Download File)

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The Commission’s New Advisory Committee on Small and Emerging Companies

by Vanessa Schoenthaler on September 13, 2011

Today the Securities and Exchange Commission announced the formation of a new Advisory Committee on Small and Emerging Companies.

The Committee, made up of nineteen voting members and two observer members, will provide advice and recommendations to the Commission on issues related to emerging privately held small businesses and publicly traded companies with market caps of less than $250 million.

Some of the issues the Committee will address include:

  • capital raising through private and limited offerings and initial and other public offerings;
  • trading in securities of emerging privately held small businesses and small publicly traded companies; and
  • public reporting and corporate governance requirements.

The Committee will formally be established with the filing of its charter, fifteen days after publication of the Commission’s notice in the Federal Registrar, and will operate for a period of two years unless earlier terminated or renewed.

A final copy of the charter will be available on the Commission’s website, but below is the undated copy on file in the Federal Advisory Committees Database.

The Committee currently anticipates meeting at least three times each year.

(Download File)

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The SEC Releases its 29th Annual Forum on Small Business Capital Formation Report

by Vanessa Schoenthaler on June 14, 2011

Earlier today the Securities and Exchange Commission released its Final Report from the 29th Annual Forum on Small Business Capital Formation held in November 2010.

This year’s forum yielded 36 recommendations from three working groups and a number of written recommendations submitted by organizations concerned with small business capital formation.

Participation was down slightly, with a total of 60 participants in the three working groups, as compared to 72 last year, and with 37% voting to rank each of the final recommendations, as compared to 44% last year.

There are a few proposals that show up each year, but many of this year’s recommendations focus on Regulation A, the requirements of Exchange Act Section 12(g) and scaled reporting/eligibility requirements for smaller issuers.  The top 5 recommendations include proposals that the Commission:

  • specifically consider the impact of Dodd-Frank Act rulemaking on small business investing;
  • adopt a private offering exemption that does not prohibit the general solicitation of, or advertising to, purchasers that do not need the protections afforded by Securities Act registration;
  • provide better scaling of reporting requirements for smaller companies;
  • exempt companies with a market capitalizations of less $250 million from Section 404(b) of the Sarbanes-Oxley Act (we already know that this one was rejected in April); and
  • increase the permissible offering amount under Regulation A and the number of shareholders that trigger registration under Section 12(g) of the Exchange Act (As an aside: both Fortune and PeHUB are reporting today that there’s a bill in the works that may actually take care of the latter portion of this proposal, by increasing Section 12(g)’s shareholder trigger requirement from its current level of 500 holders of record to 1,000 holders of record exclusive of accredited investors and employees holding stock options.).

(Download File)

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The SEC Proposes Rules for Disqualification of Felons and Other Bad Actors from Rule 506 Offerings

by Vanessa Schoenthaler on May 26, 2011

In addition to final rules and forms implementing the whistleblower program, yesterday the Securities and Exchange Commission also voted, by a margin of 3-2, to propose a series of rule amendments designed to implement Section 926 of the Dodd-Frank Act.

Section 926 requires the adoption of rules disqualifying an offering from reliance on Rule 506 of Regulation D when certain felons or other “bad actors” are involved in the offering. Rule 506 is by far the most widely claimed exemption under Regulation D. For the 12 month period ended September 30, 2010 the Commission received 17,292 initial filings for offerings under Regulation D, of those 16,027 claimed a Rule 506 exemption.

The Actors

As proposed the rule amendments would add a new subsection (c) to Rule 506 entitled “Bad Actor Disqualification”, and would apply to bad acts committed by:

  • the company or any predecessor or affiliated company;
  • the company’s officers, directors, general partners or managing members;
  • beneficial owners of 10% or more of a company’s equity securities;
  • any promoter connected to the company in any capacity at the time of sale;
  • any person that has been or will be paid, directly or indirectly, for the solicitation of purchasers in connection with an offering; and
  • any officers, directors, general partners or managing members of a compensated solicitor.

The Bad Acts

The bad acts triggering disqualification would include:

  • criminal convictions in connection with: the purchase or sale of securities; the making of false filings with the Commission; or the business of an underwriter, broker-dealer, municipal securities advisor or paid solicitor of securities, that have occurred within 10 years of the offering (or 5 years in the case of the company, or a predecessor or affiliated company);
  • being subject to a court injunction or restraining order within 5 years of the offering that, at the time of the offering, prohibits a person from engaging in: conduct in connection with the purchase or sale of securities; the making of false filings with the Commission; or the business of an underwriter, broker-dealer, municipal securities advisor or paid solicitor of securities;
  • being subject to a final order by certain state or federal regulators that, at the time of the offering, bars a person from: association with an entity regulated by the Commission; engaging in the business of securities, insurance or banking; engaging in savings association or credit union activities; or is based on a violation of law or regulation that prohibits fraudulent, manipulative or deceptive conduct entered within 10 years of the offering;
  • certain Commission disciplinary orders related to broker-dealers, municipal securities dealers, investment advisers and investment companies and their associated persons;
  • suspension or expulsion from membership in, or suspension or bar from associating with, a member of a securities self-regulatory organization;
  • being subject to a refusal order, stop order or order suspending a Regulation A exemption within 5 years of the offering; and
  • being subject to a U.S. Postal Service false representation order within 5 years of the offering.

One Exception

The proposed rule amendments contain a reasonable care exception which provides that a company would not lose the benefit of the Rule 506 exemption, regardless of the existence of a disqualifying bad act, if the company can show that it did not know and, in the exercise of reasonable care, could not have know of the disqualification. Establishing reasonable care requires doing your diligence, i.e., conducting a factual inquiry into whether any disqualification exists; the nature and scope of the inquiry will depend on the facts and circumstances of the offering.

The Controversial Provision

At the Commission’s open meeting, one of the more controversial aspects of the proposed rule amendments was the inclusion of disqualifying events that pre-date enactment of the Dodd-Frank Act in the look-back period for bad acts under the rule.

In other words, as currently proposed, if an actor covered by the new rule amendments entered into a negotiated settlement agreement with a federal or state regulator prior to enactment of the Dodd-Frank Act that settlement agreement will still disqualify the actor from participating in Rule 506 offerings, even if they might not have settled had they known at the time that it would have resulted in disqualification.  For a complete discussion of the issue take a look at pages 44-49 of the Commission’s proposing release.

Both Commissioners Casey and Paredes took issue with this provision and ultimately voted against the proposed rules and amendments.

The Commission is soliciting public comments on the proposed rules and amendments, which are due on or before July 14, 2011.

 

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PIPE Issuers: Are Your Investors Strategic or Financial?

by Vanessa Schoenthaler on November 18, 2010

PIPE Issuers: Are Your Investors Strategic or Financial?A recently released academic study, from the University of Kansas and SUNY Albany, analyzed 3,230 private investments in public equity that closed between 1999 and 2007 and found that the stock of PIPE issuers associated with strategic investors significantly outperformed the stock of PIPE issuers associated with financial investors.

Strategic investors are defined as those seeking abnormal returns by adding value to the issuer (e.g., venture capital funds, private equity funds, corporations and other institutional investors), and financial investors as those seeking short-term cash profits (e.g., hedge funds, mutual funds and insurance companies).  The study found that whether an investor had strategic or financial objectives materially influenced deal terms and, in turn, that deal terms had a significant effect on short and long-term stock performance.

Common PIPE deal terms were grouped into three main categories: cash flow rights, control rights and contractual protections.  They were then further examined in terms of investor identity.  The results look like this (note not all terms were present in all deals):

  • Cash Flow Rights. The average share price discount was significantly lower in deals associated with strategic investors, but when interest or dividends were paid strategic investors often received higher rates. Warrant coverage was also less prevalent and the cumulative of all cash flow discounts was significantly lower in deals associated with strategic investors as compared to financial investors.
  • Control Rights. In reviewing control rights, the study used percentage of stock ownership as a proxy for voting rights and found that following a PIPE strategic investors owned a greater percentage of company stock as compared to financial investors, and thus, by proxy, had greater voting rights. Less than 10% of the deals analyzed included board participation rights, but those that did were primarily associated with strategic investors.
  • Contractual Protections. The prevalence of registration rights, anti-dilution protection and redemption rights were significantly greater in deals associated with financial investors as compared to strategic investors. The prevalence of rights of first refusal/investor call options were also greater in deals associated with financial investors as compared to strategic investors.  Only approximately 10% of the deals analyzed included company forced conversion rights, but those that did were primarily associated with financial investors.

Another interesting bit of information from the study: deal terms were more investor-friendly when a placement agent was involved.

So, overall, strategic investors typically seek more control rights, less cash flow rights and less downside protection as compared to financial investors, and PIPEs associated with strategic investors outperform those associated with financial investors over the short and long-term.

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