Suppose your organization needs growth capital and you’ve talked about doing a securities offering of some sort. But you’re reluctant to commit the time and resources that it takes to gear up for a securities offering without having some confidence that it will be successful. What you’d really like to do is to put some feelers out there, at a minimal compliance cost, to see if potential investors would be interested. Then you could make a better-informed decision.
This is what we call “testing the waters.” In addition to helping your organization decide whether to launch a securities offering, a testing-the-waters campaign could potentially also help you choose from among several capital raising strategies.
For example, if you find there is strong interest among accredited investors but less interest among non-accredited investors, you may opt for a Rule 506 offering targeted to accredited investors. If you find the opposite, you might choose a Regulation Crowdfund offering or a direct public offering. You might also gauge interest among out-of-state investors, which can help you decide whether to do an intrastate offering or a multi-state offering.
Legal Strategies for Testing the Waters
It has always been possible for organizations to speak privately with potential investors to test the waters. But the last few years have given us some new ways of doing this publicly. For example, the expanded Regulation A, which went into effect in 2015, has its own testing-the-waters provisions in Rule 255, for organizations contemplating a Reg A Tier 2 offering.
Then last November, an SEC final release gave us two new testing-the-waters pathways: Rule 206 for organizations contemplating a Regulation Crowdfund offering; and Rule 241 for organizations that haven’t yet decided on an offering strategy.
This trio of testing-the-waters rules has some similarities. All of them generally require the following:
- No money may be solicited or accepted when testing the waters.
- Testing-the-waters materials must state that:
- No money is being solicited or will be accepted;
- Offers to buy securities will not be accepted; and
- Indications of interest are non-binding.
- The issuer must keep a copy of testing-the-waters materials, and any such materials that are made publicly available (or otherwise used in general solicitation) must be included with a subsequent filing under Reg A or Reg CF.
There are some important differences, which we’ll break down in the table below, to make it easy to compare them. But first, we’ll add one more: Rule 506(c) under Regulation D is not designed as a testing-the-waters strategy, but rather as a strategy for raising capital from accredited investors (with verification). But it can be advertised, and that opens the door for its use as a public testing-the-waters strategy.
Comparison of Testing-the-Waters Strategies
With four testing-the-waters options now, it can get a little confusing. So here’s how we break them down:
|TTW Strategy||Rule 255||Rule 206||Rule 241||Rule 506(c)|
|Subsequent offering strategy||Reg A Tier 2 only||Reg CF only||Any||Potentially any|
|Requires standard TTW disclosures||Yes||Yes||Yes||No|
|Can take investment money||No||No||No||Yes, but only from investors verified as accredited|
|Other key elements||May do TTW before or after filing Form 1-A||May not do TTW after filing Form C||May not use Rule 241 after deciding on a strategy||Requires 30-day waiting period after TTW to avoid integration with any subsequent offering|
We’ll draw attention to one critical differentiator among these rules: preemption of state laws. Most testing-the-waters rules preempt state laws, which means that an organization can safely test the waters under those strategies, even publicly on the organization’s website, without worrying about violating state laws.
But Rule 241, the testing-the-waters rule for organizations that have not decided on an offering strategy, does not preempt state law. Many (and perhaps most) states’ securities laws do not permit testing-the-waters publicly, or allow it under only limited circumstances. So an organization should be very cautious in planning a Rule 241 testing-the-waters campaign so as to ensure it does not inadvertently violate state laws. As a practical matter, Rule 241 may not be very usable for this reason. Instead, organizations who want to test the waters but have not yet settled on either Reg A or Reg CF as their intended offering strategy may be better off using Rule 506(c).
With all of these strategies, there are some important nuances, and no organization should test the waters without first getting legal advice. Naturally, this discussion should be regarded as informational only and not as legal advice. If you’d like to talk with us about testing the waters or other securities strategies, don’t hesitate to reach out to us.
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Let’s say you decide to do a private placement of securities under the federal exemption from registration requirements Regulation D, Rule 504. Under Rule 504, you can raise up to $1 million. Let’s say you raise $950,000 under this offering.
Two months later you decide to do another securities offering under Rule 504 and your raise another $950,000.
Chances are, you will have violated the requirements of Rule 504. Why? Because the SEC will integrate the two offerings into one and you will have raised $1.9 million total which exceeds the $1 million maximum of Rule 504.
How can you prevent two separate securities offerings from being integrated?
The SEC looks at the following factors when determining whether two offerings should be integrated:
- Whether the two offerings are part of a single plan of financing
- Whether the two offerings are for the same class of securities
- How close together the two offerings are in time
- Whether the same type of payment for the securities is being received in both offerings
- Whether the two offerings are for the same general purpose
It may be difficult to tell whether two offerings are likely to be integrated by the SEC. Luckily, there is a “safe harbor” rule you can use to make sure that two offerings will not be integrated. As long as the end of one offering is separated by at least six months from the beginning of another offering, they will not be integrated.