By Laura Anthony, Esq
The Regulation D market
The Regulation D market is comprised of Rules 504 and 505 promulgated under Section 3(b) of the Securities Act and Rules 506(b) and 506(c), both of which are safe harbors under Section 4(a)(2) of the Securities Act. Again, the SEC Report is only based on Form D filings and, accordingly, is subject to deviation for offerings that did not file and/or inaccurate or incomplete information reported by issuers.
Both the number and dollar value of Regulation D offerings has been increasing from 2009 through 2014. For instance, there were 13,764 reported Regulation D offerings in 2009 and 22,004 in 2014. The total amount sold in 2009 was $595 billion, and in 2014 was $1,332 billion. Interestingly, the average offering size was larger in 2009 at $36 million than in 2014 at $24 million.
The SEC Report discussed the cyclicality of offerings as well. Although it is well documented that public markets are cyclical and depend on such factors as business cycle, investor sentiment and time varying information asymmetry, comparable information is not available for the private offering markets. Just based on Form D filings, the SEC Report considers whether there is support for the theory that companies rely on private markets when public markets are in distress, such as during a recession. There is not. In fact, rather it appears that the private offering market increases during strong public markets and decreases during weak public markets. The health of the private offering market correlates with the health of the public market.
As noted in the Report, “there is a strong, positive correlation of the incidence of new Regulation D offerings with the economic condition of the public markets. In particular the level of Regulation D offering activity closely follows the level of the S&P 500 index.” From 2009-2014 there has been an increase in Regulation D offering activity consistent with the steady increase in the S&P 500.
The Regulation D marketplace for non-financial issuers generally comprises equity offerings as opposed to debt offerings, which are more common in the public market. Moreover, equity is usually indicative of new money and capital whereas debt is often used as a refinancing tool for existing debt. Financial issuers generally use Rule 144A and such offerings are generally debt. In other words, small businesses looking to grow with new capital rely on Regulation D equity offerings.
Rule 506 of Regulation D continues to be the most common exemption. Since 2009, 95% of private offerings are completed under Rule 506. It is clear to me, and the SEC, that the reason for this is that Rule 506 pre-empts state law, avoiding state registration and other arduous blue sky process. The SEC points out that depending on state law, Rule 504 and 505 offerings can be sold to non-accredited investors and, under Rule 504, can be freely tradeable. Despite this benefit, issuers clearly find the state law pre-emption as a more important deciding factor and are willing to accept the restrictions under Rule 506 as a trade-off (i.e., either accredited only or a limit of 35 unaccredited, restricted securities, no general solicitation or advertising under 506(b) and added accredited verification under 506(c), etc.).
From 23 September 2013, the date of enactment, through 31 December 2014, a total of 2,117 Rule 506(c) offerings were reported on Form D by a total of 1,911 issuers (some issuers had multiple offerings). During this time a total of $32.5 billion was reported as being raised. As a comparison, during the same time period there were 24,500 Rule 506(b) offerings that raised $821.3 billion. Moreover, even after the enactment of Rule 506(c), the number of new 506(b) offerings continues to increase and vastly outpace the number of new Rule 506(c) offerings.
I am not surprised by this information as I think that the 506(c) marketplace has taken its time to find its place in the private offering market as a whole, and continues to do so. From my own experience it is clear that accredited investors do not just look at a website and send money! Offerings are sold, not bought, and the advertising and marketing is good for lead generation, ease of information flow, and general exposure, but does not cause a sophisticated investor to part with their money without more. Even though the accredited verification process has become easier with services such as Crowdcheck, it is clear that issuers, placement agents, and the investing public still prefer the old-fashioned Rule 506(b) and avoiding the accredited verification process. See, for example, my blog HERE discussing new SEC guidance and the Citizen VC no action letter.
I still strongly believe in the benefits of Rule 506(c) and its viability. The SEC Report does as well, pointing out that issuers will become more comfortable with market practices, accredited investor verification procedures, and methods of advertising and solicitation over time.
During this same time period there continues to be a decline in the use of Rules 504 and 505. For example, there were only 544 Rule 504 offerings and 289 Rule 505 offerings in 2014. The SEC Report contains quite a bit of comparative information on Rules 504 and 505 for those interested in further information. As I’ve previously written about, the SEC has proposed new amendments for Rules 504 and 505 which may increase their use, though I do not expect a big impact. My blog on these proposed rules can be read HERE.
Both foreign issuers and public companies rely on Regulation D. For example, 20% of all Regulation D offerings from 2009-2014 were completed by foreign issuers. Public issuers are active in PIPE transactions as well, with 13% of Regulation D offerings being completed by public companies. At the end of this blog I have a section with 2015 data on the PIPE market from other sources.
Regulation D market participants
Pooled investment funds such as hedge funds, venture capital and private equity funds represent the largest business category, by amount raised, utilizing Regulation D. From 2009-2014 pooled investment funds raised $4.8 trillion as compared to $905 billion by non-funds. Non-funds, however, use Rule 506(c) more than pooled funds, representing 75% of those offerings. Moreover, non-funds account for a much higher percentage of total offerings by number of offerings, representing 60% of all new Form D filings.
Companies completing Rule 506(c) offerings usually check the “other,” “other technology,” “other real estate,” “oil and gas,” or “commercial” industry boxes of their Form D filings. Counting all non-funds using all Regulation D offerings, the industries in order of most often used are banking, technology, real estate, health care and energy. Interestingly, the number of offerings by banking entities and manufacturing industries have both decreased during the study period. There has been a big uptick in real estate offerings in 2013 and 2014, which makes sense in light of the improved real estate market since 2008.
The median offering size for these non-fund issuers is $1 million compared to $11 million for hedge funds and $30 million for private equity funds. As mentioned above, this information indicates that small businesses are utilizing Regulation D, which the Report finds is consistent with the regulatory objectives.
The majority of issuers decline to disclose revenue and of those that did, most disclosed less than $1 million. This is consistent with the findings that Regulation D is widely used by small businesses. Beyond that, I can’t find a lot of meaning in that information, other than that smaller issuers are most likely to file a Form D without the assistance of counsel, and counsel usually recommends not disclosing revenue.
The Form D’s do show that a majority (67%) of companies that file a Form D are less than 3 years old. This is true for both fund and non-fund entities. I note that this is consistent with the SEC Advisory Committee on Small and Emerging Companies’ consistent message that new entities are the most in need of methods to raise capital and secondarily that those same new entities create the most new jobs.
Most U.S. companies that file Form D’s have their principal place of business in California and New York with Texas, Florida and Massachusetts following. These are also the most common states of investor location. Most investors are accredited.
Less than a fifth of all issuers reported repeat offerings but 25% of non-fund issuers had repeat offerings. Form D filings do not tell of the success of an offering; however, 31% of issuers had raised 100% of their offering at the time they filed the Form D, which is typical of PIPE transactions offerings with a small handful of investors.
Form D’s will also not tell the final investor count or breakdown, but compiling Form D information shows that only 300,000 investors participated in Regulation D offerings in 2014 and only 110,000 in non-financial issuers. That seems to be a very small number of investors overall and clearly shows the importance of properly packaging an offering and presenting it to the right audience.
Only 21% of offerings for the period 2009-2014 used a placement agent, with a decrease in their use in 2014 compared to 2009-2013. Issuers in non-financial industries paid an average of 6% commission and in financial industries, an average of 1.4%. This is likely because the size of the offering is much larger and number of investors much smaller in the financial industry. On average, higher fees are paid for Rule 506(c) offerings than 506(b), which makes sense in light of additional work (verification of accreditation) and risk associated with advertising.
2015 PIPE Market
A PIPE is a private placement into public equity, or in other words, a private placement by a public company. According to PrivateRaise, a private placement data service, PIPE’s raised $89.97 billion in 2015, up 14.8% from 2014. The amount was spread over approximately 1,000 offerings.
Click Here To Print- LC PDF Printout SEC Study On Unregistered Offerings
Note 1: Read Part I of this Article. Click HERE
Note 2: Original appeared on Legal & Compliance, LLC on 30 June 2015. Click HERE
Securities attorney Laura Anthony is the founding partner of Legal & Compliance, LLC, a corporate, securities and business transactions law firm. The firm’s experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances.
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