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Verification of Accredited Investor Status

In my earlier post on the liberalization of general solicitation and advertising in Rule 506 offerings (to be effective September 23, 2013), I briefly mentioned the more stringent requirement, when general solicitation or advertising is used, for verifying each investor’s status as an “accredited investor.”  I’d like to get into more detail about what that entails.

Trust... but verify | Andrew Abramowitz

Current practice is for companies conducting Rule 506 offerings to have prospective investors check a box on a simple accredited investor questionnaire, and that is generally sufficient to establish the investor’s accredited investor status without further investigation by the company.  Going forward, Rule 506 offerings that are not accompanied by general solicitation or advertising will continue to operate in the same manner.  However, when general solicitation or advertising is used, the company must take “reasonable steps” to verify each investor’s accredited investor status.  This is a “principles-based” standard that is dependent on the facts and circumstances of the investors and the offering, but clearly a checked box on a questionnaire will not suffice.

Email vs. Phone/Meeting

A near-constant theme in my interactions with clients and other attorneys is the relative merits of various modes of communication — email, phone or in-person meetings.  After a long email chain, someone will get frustrated and say, “Why don’t we just get on the phone and figure this out?”  But those same people will, on another occasion, dial into a conference call, quickly get bored, and hone their skills at computer Solitaire.

Share Transfer Provisions for Startups

In preparing a stockholder agreement or operating agreement for a startup (for a corporation or LLC, respectively) with multiple owners, the section of the agreement that generally requires the most thought and discussion with the client relates to share transfers.  While it’s possible to punt on all of these questions by having the agreement simply say that no transfers are permitted except as may be agreed by the owners, it’s advisable to at least consider the various scenarios and include appropriate provisions in the agreement.  The following are some common ones:

  • Permitted Transferees – Share transfers may be made to related persons (like a trust for the benefit of a family member) without consent of the company or other owners.
  • Right of First Refusal/Offer – With a right of first refusal (ROFR), if an owner receives an offer from a third party to purchase the owner’s shares, the owner must first offer to sell the shares to the company or existing owners on the same terms.  A right of first offer (ROFO) requires the owner to first solicit offers from the company or existing owners, and then the owner can sell to a third party if a deal is not reached. …

How to Be a Good Client

The best attorney mentors I had in my early years of practice emphasized that law is a service business. Attending to the basics like responding promptly to emails and calls is at least as important, to this way of thinking, as being able to come up with an ingeniously complicated transaction structure. While I therefore have a “the customer is always right” orientation, I’d be lying if I said that it doesn’t matter whether the client was similarly responsive, organized, etc. With that in mind, here are a few tips for how clients can make the attorney-client relationship run smoothly:

Use of General Solicitation and Advertising in Rule 506 Offerings

Generally, the terms “public offering” and “private offering” have the meanings that the words imply: a public offering of securities is made to hundreds or thousands of investors who may have no connection to the company, and a private offering is made to a select group of investors known to the company or its broker. Historically, private offerings made under widely-used SEC Rule 506 (part of Regulation D) were required to be completed without the use of any “general solicitation or general advertising.” However, a provision of the federal JOBS Act, enacted in 2012, blurred the lines between private and public offerings by permitting general solicitation or advertising in Rule 506 offerings, subject to conditions imposed by the SEC. The SEC has now done its imposing, establishing rules to become effective in September 2013.

Use of “Profits Interests” for LLC Equity Compensation

With limited liability companies (LLCs) having become a widely-used form of business entity for new private companies, I am often asked by LLC clients about compensating employees and other service providers in company equity.

The basic tax planning goal in setting up these equity grants is to avoid triggering an immediate tax to the recipient prior to any distribution of cash to pay this tax.  This is not a practical issue with true startup companies that have no or very limited value, since there is not a significant tax.  However, if the company does have value, and it makes a simple grant of equity to a recipient, there is taxable income to the recipient equal to the fair market value of the equity.

Use of Finders in Securities Offerings

In private securities offerings where the company does not engage an investment banker who is a registered broker-dealer to market the offering to investors, companies will often seek the assistance of so-called “finders,” who are not registered as broker-dealers, to connect the company with potential investors.  These finders are often paid a pre-determined percentage of the amount ultimately raised by the company from the investors introduced by the finder.  Though this practice is extremely common, this area of the law is very much a gray area, and there are significant risks to both the finder and the company that should be considered.

Welcome to My Blog

Welcome to the inaugural entry in my new corporate and securities law and transactions blog. The focus of this blog will NOT be a place to find exhaustive summaries of the latest SEC rule proposal or decision of the Delaware Chancery Court.  That sort of thing is covered effectively by my former brethren (and sistren) at large firms and by other legal blogs.  I will link to such summaries that I think readers will find useful.  Rather, my goal here is to provide attorneys, along with business people and other non-attorneys who work on transactions, some practical tips and thoughts on issues that I frequently come across in my practice.  I will aspire to write in what the SEC calls plain English, though you can rest assured that it will not be a good beach read.