Posted In: Business Transactions & Corporate Counseling & Securities
Industry:
Financial Institutions
Business Blog: Revisiting Capital Structure and its Importance - Private Capital Raising Options
on October 19, 2022
In the current economic environment, cash and the availability of liquidity have become king. These economic circumstances are causing many businesses to reevaluate their capital structure, even those with strong balance sheets. Private businesses exploring capital raising options have two primary decisions to make: (1) which type of security to offer, and (2) which method to use in order to comply with securities laws.
1. Capital Structure Options: Which Security to Offer
Rising interest rates are making raising equity capital or more equity-like alternatives more attractive to founders and business owners seeking to finance growth. The chart below illustrates capital structure options from senior debt (much like a typical collateralized bank loan) to common equity.
CAPITAL STRUCTURE
|
Senior Debt |
|
Mezzanine Debt |
|
|
Hybrid Financing (e.g., Convertible Debt, Convertible Equity) |
|
|
Simple Agreement for Future Equity (SAFE Note) |
|
|
Preferred Stock |
|
|
Common Equity |
|
2. Methods to Raise Private Capital
After deciding upon the security to be offered, issuers typically evaluate four primary factors in determining the type of securities offering to pursue: (1) dollar size of the offering, (2) whether the offering will require general solicitation to be successful, (3) whether the funds can solely be raised from Accredited Investors—either through the issuer’s friends and family or through contacts of a broker-dealer or crowdfunding platform, and (4) what type of SEC filing is required.
After changes made by the JOBS Act and the adoption of Regulation CF, the key difference among exempt offering methods is whether the offering allows for general solicitation. This is also the most influential factor as to the risk the offering poses to the issuer. General solicitation offerings require additional compliance efforts. Below is a summary of the offering exemptions based upon the aforementioned factors. While there are other things to consider, like whether the securities will be restricted following the offering, or what requirements apply (e.g., “Bad Actor” disqualifications apply or audited financial statements must be provided), the crux of the evaluation of which offering is appropriate often boils down to these factors for middle-market and small businesses.
Capital Raising Methods and Exemptions Available
Nature of Exemption |
||||
Offering $ Limit within 12-month Period |
Prohibits General Solicitation |
Allows General Solicitation |
Accredited Investors Only |
SEC Filing Required |
None |
Reg. D Rule 506(b) |
Unlimited accredited investors, limited to 35 sophisticated investors in 90 day period |
Yes. Form D |
|
None |
§4(a)(2) Transactions must not involve any public offering. Typically involve institutional buyers conducting due diligence that don’t need protection of the 1933 Act. SEC v. Ralston Purina Co. |
No |
No, but state registration requirements are not preempted by federal law. |
|
None |
Reg D, Rule 506(c) |
Only accredited investors and reasonable due diligence steps required |
Yes. Form D |
|
$5 million |
Regulation CF |
Non-accredited investors subject to investment limits based on income and net worth. Requires use of regulated crowdfunding platform, like Dealmaker, Republic.com |
Yes. Form C (including 2 years financial statements, certified, reviewed or audited, as required) |
|
Individual state limits generally $1 to $5 million |
Intrastate rules: §3(a)(11), Rule 147, Rule 147A |
In-state requirements for issuer and investor |
No SEC filings, but states vary as to notice/registration filing requirements |
|
$10 million |
Rule 504 |
In-state requirements for issuer and investors |
Yes |
|
$20 million |
Reg A, Tier 1 |
None |
Yes |
|
$75 million |
Reg A, Tier 2 |
Non-accredited investors subject to investment limits, unless issuer listed |
Yes |
3. Securities Filings Required: State or Federal
The vast majority of exemptions require the filing of a securities filing with state and/or federal regulators, (e.g., Form D, Form C, Form 1-A, or state filings) and preparation of subscription agreements and disclosure documents. Many offerings also require audited financial statements and the providing of an offering circular to each investor. These documents should be prepared by a sophisticated securities attorney. For additional information on securities offerings, contact Brouse securities attorney Molly Brown at 216-830-6813.
This blog is intended to provide information generally and to identify general legal requirements. It is not intended as a form of, or as a substitute for legal advice. Such advice should always come from in-house or retained counsel. Moreover, if this Blog in any way seems to contradict advice of counsel, counsel's opinion should control over anything written herein. No attorney client relationship is created or implied by this Blog. © 2024 Brouse McDowell. All rights reserved.