As a business owner, you’re no doubt aware of the importance of financing. Fundamentally, financing provides to spend on business needs. Whether your business is a small mom and pop shop, or the next McDonalds, your business needs financing. Initially, a business owner is likely to rely primarily on self-financing and investment by family and friends. If a business wants to grow, however, it will generally have to obtain funding through venture capital or the sale of securities (“going public”).
How are Securities Regulated?
Enacted in 1933 and 1934, respectively, the Securities Act and the Securities Exchange Act create the framework for regulation of securities in the United States. Among other things, these acts regulate the issuance, registration and public sale of securities, and govern the reporting obligations of public companies. One of the primary ways in which they regulate is by requiring companies wishing to sell securities on the public market to register with the Securities Exchange Commission (“SEC”) and subject themselves to periodic reporting requirements.
The Securities Act regulates the issuance and sale of securities, seeking to ensure public companies provide investors accurate and complete information regarding the issuer, its securities, and the offering so that investors can evaluate the merits of a securities offering and are not deceived. The Securities Exchange Act is intended to complement the Securities Act, serving as the principal source of reporting obligations for public companies and providing regulations establishing a framework to regulate the issuance, sale, and trade of securities. In effect, the Securities Act regulates the issuance of securities and their sale on the primary market, whereas the Exchange Act regulates their sale on the secondary market. Accordingly, it is the Exchange Act that created the Securities Exchange Commission, delegating to it the power to oversee the registration, issuance, and reporting requirements set forth by the securities laws.
What is a Private Placement?
A private placement (also known as an unregistered offering) is a securities offering exempt from registration with the Securities Exchange Commission. Thus, a private placement is used to raise capital without undergoing the costly reporting and regulatory requirements of a public company. Thus, private placements are attractive to small startups that need financing but don’t yet have the means to hire a team of lawyer and accountants to take the company public.
What is an Accredited Investor?
One common private placement is the sale of securities to an accredited investor. An accredited investor is a person or entity who is allowed to deal in securities that are not registered with the Securities Exchange Commission. In effect, by selling securities only to accredited investors, a business may avoid the securities laws’ onerous (and costly) reporting and disclosure requirements.
What Qualifies you as an Accredited Investor?
The securities laws define an accredited investor in Rule 501 of Regulation D.
- Individuals. To be an accredited investor, a person must have annual income exceeding $200,000 (or $300,000 for joint income) for the last two years with a reasonable expectation of earning the same or higher income in the current year. A person is also considered an accredited investor if his net worth exceeds $1 million, either individually or jointly with his spouse.
- Entities. To be an accredited investor, an entity must be a private business development company or an organization with assets exceeding $5 million. Alternatively, an entity consisting of equity investors who are accredited investors also is deemed to be accredited.
What is a Private Placement Memorandum?
Even companies engaging in private placements frequently have to meet certain disclosure requirements. Such requirements are met through the creation of a Private Placement Memorandum (PPM). A PPM is a legal document provided to prospective investors in “private” transactions (such as a transaction with accredited investors) in which the securities are not registered under federal or state law. Like the securities laws, the PPM is intended to protect investors; basically, it is intended to provided certain minimal disclosures to ensure accredited (“sophisticated”) investors are not misled or otherwise deceived. The PPM describes the company selling the securities, the terms of the offering, and the risks of the investment, as well as providing certain items like the company’s financial statements and management information.