23 Mar The mechanics of raising capital for your business
From the earliest “idea-stage” start-ups to some of the largest of the Fortune 500, most companies, even publicly traded ones, raise equity capital through private placements.
A private placement, sometimes referred to as a private offering, is a sale of “restricted securities” by an issuing company that is being made pursuant to an exemption from the registration requirements of the Securities Act of 1933. These include Regulation D, which covers sales to angel investors and venture capital funds, among other things.
The restricted securities are ineligible for resale into the public market until some conditions have been met. Either a resale registration statement must be filed with the Securities and Exchange Commission and declared effective, or resale must be permitted under an applicable rule such as Rule 144, which applies when the issuer of securities is a public company.
As most experienced entrepreneurs know, raising significant amounts of equity capital for an early-stage company is rarely easy. The uninitiated often believe that all they need is an introduction to a couple of well-to-do investors, an hour or two in a room with them to show them the wonders of their great idea or product, and out will come the checkbooks.
This rarely (if ever) happens. Selling equity securities is a deliberate process. While every private offering or sale by a company of its securities is somewhat different, the ramifications for a misstep sometimes leads not only to an unsuccessful offering but can lead to personal liability of the promoters of the offering or, worse yet, jail time.
Personal liability is imposed not only for malicious fraudulent conduct, but could apply, for example, when the company issuing securities cannot comply with an order to rescind a sale to an investor because the company failed to comply with the private-offering legal requirements or omitted to state a material fact to the investors concerning the company. This is why it’s important to do the process right. Not only will it limit personal liability exposure, but your offering will be more professional and attractive to investors.
Below is the general sequence of events in a private offering of securities:
• Prepare business plan
• Corporate “clean up” and “due diligence”
• Obtain necessary company authorizations
• Decide whether to use intermediaries and if so, identify them
• Negotiate agreement with intermediaries
• Select desired offering exemption
• Define parameters, procedures, contingencies, timing, and geographic scope of offering
• Identify investor qualification standards (e.g., accredited, sophisticated, state residency requirements)
• Identify prospective investors
• Conduct initial blue sky (or state securities law) research
• Prepare offering terms
• Prepare the private placement memorandum (PPM)
• Prepare offering agreements (e.g., subscription agreement, investor questionnaire, shareholder agreement)
• Set up monitoring mechanism for PPMs
• Identify printer and forward PPM for copying
• Circulate the PPM to prospective investors
• Close the transaction
• Make necessary federal and state filings
• Issue stock certificates
The list above is typically how the process works, but sometimes tasks are eliminated or abbreviated, the order changes, or other tasks are added (such as obtaining a legal opinion, amending articles or bylaws, preparing a registration rights agreement, qualifying for the state angel investor tax credit program, etc.)
In future installments, I’ll go through in more detail some of the items on the checklist above to give you more specific information concerning the private offering process.