It may be virtually impossible for startups to avoid general solicitation when selling preferred stock, convertible notes or common stock. Many activities that companies are already doing constitute general solicitation.
Demo Day Events are Often a General Solicitation.
Companies pitch all the time at “pitch” and “demo” day events. Rule 502(c)(2) says that a pitch at “any seminar or meeting whose attendees have been invited by any general solicitation or general advertising” is a general solicitation. The SEC has further confirmed that unrestricted websites also constitute general solicitation. What “pitch day” or “demo day” event is not announced on an unrestricted website? Connecting the dots here, one can presume that companies pitching in these forums that are open to the public and announced on websites are making general solicitations.
Soliciting Investors Through a Database of Pre-Screened Accredited Investors May Be a General Solicitation.
Perhaps the most disturbing language in the final SEC Regulations adopting Rule 506(c) seems to indicate that submitting offering materials to a “database of pre-screened accredited investors created and maintained by a reasonably reliable third party” is a general solicitation. The issuer is required to take reasonable steps to verify accredited investor status. Does this mean that any company seeking angels on AngelList, Gust, EquityNet and other similar services are all making general solicitations? I’ve spoken to many lawyers about this and all say that the rule is not clear.
Integration Can Mean a Prior Private Placement Becomes a General Solicitation.
A final wrinkle that has not received much attention is that the rules of integrating offerings in Rule 502(a) apply to 506(c) transactions. Integration means treating separate offerings of securities as one offering if they take place within 6 months of each other. Numerous factors are analyzed to determine if offerings should be integrated. If a perfectly good “private placement” under 506(b) without general solicitation is integrated with a prior or subsequent offering under Rule 506(c) that has general solicitation, the whole transaction is a 506(c) transaction. The issuer has probably blown it on the part it thought was a 506(b) transaction.
There Are No Hybrid Deals; any General Solicitation Makes the Whole Offering a General Solicitation.
Let me hammer this last point home, the SEC has made it clear that any general solicitation at all makes the whole offering a general solicitation subject to Rule 506(c), even if the purchasers did not make their investment decision based on the general solicitation. For example, a company could close a financing round with investors with whom the CEO has a prior relationship without making a general solicitation. Later, during the subsequent closing period, the company pitches at a “pitch day” competition to finish out the round. Even if the “pitch day” event leads to nothing, because the pitch at the “pitch day” competition is a general solicitation. The whole transaction involves a general solicitation and is subject to 506(c). If the company sold securities in the first closing to any non-accredited investors or did not take reasonable steps to verify that all investors in the first closing were accredited investors, then the company will be in violation of Rule 506(c).
Given the specter of integration, and not knowing if it will make a general solicitation in the future when there are potentially multiple closings in a subsequent closing period, shouldn’t every issuer assume that every offering will involve general solicitation? What companies selling securities do in the future may invalidate what they have already done. Who wants to take that chance?
Get a term sheet for a preferred stock, convertible note, or common stock financing and the full set of closing documents for a preferred stock, convertible note, or common stock financing at VentureDocs. Beginning September 23, 2013 (the effective date of Rule 506(c) allowing general solicitation), our term sheets and purchase agreements for the purchase of securities in reliance on Rule 506(c) will contain appropriate legends and representations and warranties for Rule 506(c) securities law compliance.
Image Credit: CC by Evgeny Tchebotarev