I’m just bringing on some investors—everyone does it: Private Placements and the “Accredited Investor” Rule
You have some discussions with prospective investors on a land or development deal. You hear that perhaps there are questions as to the applicability of the Federal and State securities laws and the availability of various exemptions as to certain transactions.
Without the usual roadmap as to the whys, you know from experience that deals are being done all over the USA every hour which, though subject to the securities laws, are handled without even a token effort to address compliance.
While each may have its separate, independent grounding in one or another aspect of the securities laws, the reasons for the blithe ignorance may be variously:
- the friendship/prior relationship between the deal guy and the investor
- the nature of the deal
- the role of the investor in the deal
- the financial wherewithal or nature of the investor
When, however, the prospective investor is not within the inner circle of the promoter, and the raising of funds becomes an independent component of the deal (i.e., fund raising as an operation) it is likely that only the last base (the financial wherewithal or nature of the investor) is adequate for purposes of keeping securities lawyers at a distance. Meaning also that more than mere token attention to the requirements of the applicable exemption (being most obviously Section 4(2) of the 1933 Securities Act—the so-called “private placement” exemption) is needed.
The Only Assured Escape Device
Again without lengthy background and grounding, suffice it to say that in order to maintain exemption from the requirement to provide a complete “Private Placement Memorandum” (“PPM”, also called a “Confidential Memorandum” or “Offering Circular”), it is necessary to sell the securities only (with absolutely no exceptions, the price of a single failure being to “blow” the entire exemption, and requiring an offer of “rescission”—perhaps via a full registered prospectus—to all investors) to “accredited investors.”
This is a very crude summary and does violence to many issues involved, but for purposes of many clients’ deals, is the essential element.
What You Need to Know About “Accredited Investors”
Read the full “accredited investor” definition here. There are more than a dozen different categories of people and entities who may qualify as “accredited investors,” but in almost all cases for our typical clients, this means either a net worth of $1mm or net taxable income for the past two years of at least $200,000.
Since the Dodd-Frank banking legislation of 2009, this means without taking into account any net worth attributable to primary residence equity (and deducting the “under water” amount). Prudence usually requires setting the net worth standard at 1.5mm to allow a safety factor for the promoter, as the test is not the developer’s good faith (or careless) belief but the facts.
There are many permutations of these rules, bearing for example, on IRA’s, 401’s, trusts etc. and by whom and how it is all determined. The promoter should have an attorney experienced in the laws surrounding private syndications take a look at the investors and the structure of the deal.
Sign ’em Up!
There is next a question of the investor’s subscription. How does this investor come into the deal? What has he been told? What representations have been made to him? What representations from him? Much depends on the deal, the solicitation, the relationship, how it all came about etc.
But what goes for one must go for all. This subscription matter then needs consideration. It may be that there is no reason not to have a subscription agreement. However, though a client may say “sure,” he may not like many of its ramifications. It becomes unavoidably a kind of mini-offering memo, and it has a tendency to creep outwards towards a short-form offering which has been one way we have developed to handle these quasi-PPM deals at a much lower cost than a $15,000-$35,000 full blown PPM and all that entails.
Exemption under the “private placement” rules has absolutely no consequence with respect to the continued applicability of the so-called “anti—fraud” provisions of the 1934 Securities Exchange Act, which remain fully in place in (almost) all aspects. Meaning that full disclosure is required, and any failure is a “federal offense”, meaning an attorney rounds up all the investors, and the best you can hope for is having only to give their money back. (Most of those law suits you see daily in the Wall Street Journal alleging wrongdoing—whether brought privately or by the SEC itself—are based on those anti-fraud provisions.)
The Dreaded “Manner of the Offering”
No “general solicitation” allowed. (Much discussed at seminars, in regulatory actions etc. as to what is/is not.) But it pretty much covers all the usual sales tools. This is complicated but there must be a “pre-existing relationship” with the person contacted.
This truly requires input of the lawyer. We find that much of the cost in a syndication (not counted on or understood by clients at the outset) consists of a long stream of “Can I?” and “What if?” questions and finding resolutions during the offering period.
NOTE: Sales must be by the promoter, or through a registered NASD broker-dealer. There is a developing case and regulatory law on all sorts of cute “finder fee” arrangements. See an attorney here.
NOTE: There are many other issues that come up even in these no PPM deals. A small example that comes to mind is the issue of how and where the investor funds are held, and subject to what conditions they are to be released. The newly minted “corroboration” theory conditioning the delivery of funds comes into play here.
Nothing for Free
It is fair to say that the promoter’s “price” for avoiding the cost of a “full-blown” offering and to make an effort at compliance is to add a line item to his “cost of funds” for legal oversight, none of which can, in the circumstances noted, constitute a formal “blessing”.
One positive outcome of initial thinking about the quandaries of a private placement or problems with the accredited investor route is finding alternative means to the client’s needs to raise capital.
Attorneys have no reason to push a Private Placement memorandum because it is far more productive to do successful smaller jobs than unsuccessful large ones, and the number of initial proposals which actually make it to a printed Private Placement Memorandum is minuscule. And there are alternatives!