Under the Securities Act of 1933, every offer and sale of securities must either be registered with the Securities and Exchange Commission or qualify for an exemption from registration. Regulation D provides several exemptions that private companies frequently use to raise capital without conducting a registered public offering. (sec.gov)

Companies relying on Rule 504, Rule 506(b), or Rule 506(c) of Regulation D generally must file a Form D notice with the SEC within 15 calendar days after the first sale of securities in the offering. The company may also have notice-filing, consent-to-service, and fee obligations under applicable state securities laws. (sec.gov)

Important Regulation D Requirements

The applicable requirements depend on the exemption selected.

Offering limits: Rule 504 permits eligible companies to offer and sell up to $10 million of securities during a 12-month period. By contrast, Rule 506(b) and Rule 506(c) do not impose a maximum offering amount. (sec.gov)

Investor eligibility: Rule 506(b) permits sales to an unlimited number of accredited investors and up to 35 qualifying non-accredited investors within the applicable period. Rule 506(c) requires every purchaser to be an accredited investor.

General solicitation: Rule 506(b) generally prohibits general solicitation and advertising. Rule 506(c) permits general solicitation, but the company must take reasonable steps to verify that every purchaser is accredited. Rule 504 generally prohibits general solicitation, although limited exceptions apply. (sec.gov)

Restricted securities: Securities sold in most Regulation D offerings are restricted securities. Investors generally cannot resell them freely into the public market unless the resale is registered or qualifies for an exemption.

Rule 144 provides a nonexclusive safe harbor for certain resales. Restricted securities of a qualifying SEC reporting company generally must be held for at least six months. Restricted securities of a non-reporting private company generally must be held for at least one year. Additional conditions may apply depending on whether the seller is an affiliate of the company. (sec.gov)

Investors’ Registration Rights

The goals of a startup’s founders and investors may not always align. Founders may want to maintain control and pursue long-term growth, while investors may eventually want an opportunity to sell their shares.

Investors sometimes address this issue by negotiating a registration rights agreement. Registration rights are contractual rights; they are not automatically provided by the federal securities laws.

Demand Registration Rights

Demand rights allow qualifying investors to require the company to register specified shares for resale, subject to the agreement’s conditions and limitations.

A demand right does not necessarily allow an investor to force the company to conduct an IPO. Depending on the agreement and the company’s circumstances, it may instead require the company to file a resale registration statement for shares held by investors. Demand rights commonly specify:

• when the rights may first be exercised;
• the minimum number or value of shares required;
• the number of demands permitted;
• whether the company may postpone registration;
• who pays the registration expenses;
• whether the offering must be underwritten; and
• circumstances in which underwriters may reduce the number of shares included.

Piggyback Registration Rights

Piggyback rights allow investors to request that their shares be included in a registration initiated by the company or another eligible shareholder.

These rights are usually subject to exceptions and limitations. For example, the managing underwriters may be permitted to reduce the number of investor shares included in an offering if they determine that including all requested shares could adversely affect the offering. (sec.gov)

Protections Commonly Negotiated by the Company

A company may negotiate limitations that prevent registration rights from unduly interfering with its operations.

Postponement rights: The company may be allowed to postpone a demanded registration if proceeding would interfere with a material transaction, require premature disclosure of confidential information, or occur during seriously unfavorable market conditions.

Minimum offering thresholds: Demand rights may apply only if the proposed offering exceeds a stated dollar amount or involves a minimum percentage or number of registrable shares.

Waiting periods: Investors may be prohibited from exercising demand rights until a specified date or until the company has reached a particular stage of development.

Limits on frequency: The agreement may restrict how many demand registrations investors can require or impose a waiting period between registrations.

Underwriter selection: The agreement may give the company or its board the right to select the managing underwriters, sometimes subject to investor approval rights.

Underwriter cutbacks: The managing underwriters may have authority to limit the number of investor shares included in an offering.

Lockup obligations: Investors may be required to refrain from selling their shares for a specified period following an IPO or another underwritten offering.

Can Investors Ultimately Force an IPO?

The answer depends primarily on the company’s governing documents, financing agreements, and registration rights agreement. Share ownership alone ordinarily does not give an investor the unilateral right to force an IPO.

A carefully drafted demand registration right may require a company to pursue registration once the contractual conditions are satisfied. However, it may still leave important decisions—such as timing, offering structure, underwriter selection, and postponement—with the company or its board. Corporate-law duties, securities-law requirements, market conditions, and the precise contractual language will also affect the outcome.

Registration rights agreements are voluntary when negotiated, but they become legally binding once executed. Companies and investors should therefore define clearly when registration rights may be exercised, what exceptions apply, who controls the offering process, and how the related expenses will be allocated.

The securities lawyers at Corporate Securities Legal LLP assist founders, companies, and investors with private offerings, registration rights agreements, corporate governance, and preparations for registered offerings. Contact the firm to discuss how registration rights may affect your company or investment.

Reasons a Company May Prefer to Remain Private

Reduced Public Disclosure: Privately held companies generally are not required to disclose publicly the same extensive information required of SEC reporting companies. Subject to applicable law and contractual obligations, they may have greater confidentiality regarding their financial performance, executive compensation, business strategy, material agreements, and operations.

Private status does not, however, eliminate all disclosure obligations. A private company may still be required to provide information to shareholders, investors, lenders, regulators, and taxing authorities.

Lower Compliance Burden: Public reporting companies must devote substantial financial and management resources to SEC filings, audited financial statements, internal controls, shareholder communications, and, if exchange-listed, applicable stock-exchange requirements. SEC reporting commonly includes annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K for specified events. (sec.gov)

Potentially Lower Liability Exposure: Directors and officers of both private and public companies can face liability for breaches of fiduciary duty, fraud, self-dealing, and violations of applicable law. Public companies, however, face additional exposure under the federal securities laws for materially false or misleading statements, material omissions, insider trading, reporting violations, and failures to comply with other public-company obligations. The SEC recognizes that a company and its management may face liability if public-company obligations are not satisfied. (sec.gov)

Greater Management Flexibility: Public companies are subject to federal securities laws, SEC rules, and—if listed—stock-exchange requirements. Certain transactions may also require shareholder approval. These requirements can reduce management flexibility and increase the time and expense involved in corporate decision-making.

Greater Control Over Ownership: A private company may have more control over how and to whom its shares are issued, subject to corporate law, securities laws, existing agreements, and shareholder rights. Remaining private can therefore help founders and existing investors manage dilution and changes in voting control.

Reduced Short-Term Market Pressure: Public companies are closely monitored by investors, analysts, and the financial media. Market expectations concerning quarterly performance can create pressure to prioritize near-term results. Remaining private may allow management to pursue longer-term strategies without the same degree of public-market scrutiny.

Access to Private Capital: Venture capital, private equity, growth-equity funds, strategic investors, family offices, and other private financing sources can enable a company to raise substantial capital without conducting an IPO. Private financing can nevertheless involve significant dilution, investor consent rights, board representation, liquidation preferences, and other negotiated restrictions.

When a Private Company May Become Subject to SEC Reporting

Under Section 12(g) of the Securities Exchange Act of 1934, a company may be required to register a class of equity securities with the SEC even if it has not completed an IPO.

For most companies, registration may be required if, on the last day of the company’s fiscal year:

1. The company has more than $10 million in total assets; and
2. The relevant class of equity securities is held of record by either:
   • 2,000 or more persons; or
   • 500 or more persons who are not accredited investors. (sec.gov)

These calculations are subject to important definitions and exceptions. For example, certain securities issued under employee compensation plans may be excluded from the holder-of-record calculation. Conditional exemptions may also apply to qualifying Regulation Crowdfunding and Regulation A securities. Banks, bank holding companies, and savings and loan holding companies are subject to different holder thresholds. (sec.gov)

Crossing the applicable threshold does not require the company to conduct an IPO or list its shares on a stock exchange. It may, however, require the company to register the relevant class of securities and begin filing periodic reports with the SEC. The company could therefore become a public reporting company while its shares remain unlisted and relatively illiquid.

Once subject to Exchange Act reporting, a company may be required to file annual, quarterly, and current reports and make information concerning its financial condition, operations, management, material agreements, executive compensation, and specified corporate events publicly available. The precise disclosure requirements depend on the company’s circumstances and filer status; eligible emerging growth companies and smaller reporting companies may use scaled disclosure requirements. (sec.gov)

A company approaching the Section 12(g) thresholds should evaluate its capitalization table, holder-of-record count, investor accreditation information, applicable exclusions, and reporting alternatives before the end of its fiscal year.

Potential Benefits of Going Public

Access to Capital: A registered public offering can raise substantial capital for expansion, research and development, debt repayment, acquisitions, and other corporate purposes. Public-company status may also broaden opportunities for future financing. (sec.gov)

Potential Liquidity: A public trading market may allow founders, employees, and investors to sell shares more easily. Liquidity is not guaranteed, however, and sales may be limited by lockup agreements, securities-law restrictions, company trading policies, market conditions, and the availability of buyers.

Acquisition Currency: Publicly traded shares may be used as consideration in mergers and acquisitions, potentially reducing the amount of cash required for a transaction. (sec.gov)

Employee Recruitment and Retention: Public-company equity and stock options may help a company attract, compensate, and retain employees. (sec.gov)

Visibility and Credibility: An IPO and public listing may increase brand awareness, publicity, and market recognition. (sec.gov)

Transparency and Investor Information: Public reporting provides investors with standardized financial and operational information that may assist them in evaluating the company. This transparency, however, also gives competitors and other third parties access to information that a private company might otherwise keep confidential. (sec.gov)

Conclusion

The decision to remain private, become an SEC reporting company, or pursue an IPO requires careful consideration of the company’s capital needs, shareholder base, financial condition, growth strategy, governance structure, and tolerance for regulatory and disclosure obligations.

Counsel from experienced securities lawyers can help a company monitor its Section 12(g) status, structure private financing transactions, manage its capitalization table, prepare for SEC reporting obligations, and evaluate whether and when a public offering is appropriate. Corporate Securities Legal LLP can advise companies, founders, directors, and investors on these considerations.

There are several other sources for a business to obtain financing. They include:

• Mergers & Acquisitions (M&A) is teaming up with another company and its resources
• Capital Markets (IPOs, Secondary Offerings) raise money from investors based on required prospectus documents which you file as an accurate representation of the status of your company
• Private Equity & Venture Capital receives money from specialized investors who take stock in your company and demand certain voting rights so they can have a say in the operations of the company. Their goal is to help your company grow fast so they can sell their stock and make a healthy profit
• Equity Financing involves selling shares of stock in your company and diluting your share of the ownership and control of your company
• Hybrid Securities start as a loan but can convert into equity
• Derivatives are hedges against market fluctuations in interest rates or commodity prices, including futures, options, and swaps
• Government Grants do not require repayment but they come with strict compliance requirements and usage limitations

All these alternative forms of business financing deal with money from other parties and carry significant risks. They are strictly governed by statutes relating to securities, taxes, contracts, and corporate governance. Violation of these laws takes the forms of debt default, breach of contract, misrepresentation, and regulatory non-compliance. Violations result in various consequences, including:

• Acceleration of Debt and Penalties
• Seizure of Collateral
• Personal Liability for Debts
• Lawsuits and Judgments
• Forced Bankruptcy
• Loss of Equity and Control
• Regulatory Fines
• Contractual Disputes

Why Legal Expertise Matters

The legal complexities of business financing can be overwhelming to anyone who does not fully understand the risks associated with the different types of financing. Missteps can create severe financial consequences, legal disputes, or loss of business control. Risks can be mitigated in a variety of ways that are sound and legal. The experienced business finance lawyers at Corporate Securities Legal LLP specialize in business finance law and can assist you in securing and managing your business finances effectively.

The process involves filing a registration statement—including a prospectus, financial statements, and other disclosures—followed by staff review, comment letters, amendments, and final approval. Once all regulatory requirements are satisfied and the company formally requests effectiveness, the SEC may declare the registration statement effective, allowing the company to proceed with its public offering.

Initial Staff Review

The SEC staff conducts an initial review of the registration statement to confirm compliance with disclosure and accounting requirements. The goal of the review is to ensure that the filing contains sufficient information for investors to make informed decisions.

Importantly, the SEC does not evaluate the merits of the transaction or determine whether the investment is appropriate for any particular investor.

The scope of review generally takes one of three forms:

• Full Review: A comprehensive examination of the entire filing for compliance with securities laws and disclosure standards.
• Financial Statement Review: A focused review of financial statements and related disclosures to ensure compliance with applicable accounting standards.
• Targeted Issue Review: A limited review focusing on specific disclosure issues or regulatory concerns.

Staff Comment Letter

After reviewing the filing, the SEC staff may issue a comment letter identifying deficiencies, questions, or areas where additional clarification is required.

Comment letters may request:

• Expanded disclosure to enhance investor understanding;
• Additional financial information;
• Clarification of statements that could potentially be misleading;
• Supplemental information that assists the staff in evaluating the filing.

Company Response to Comments

The company must respond to each staff comment, typically through a written response letter submitted alongside amendments to the registration statement.

Companies may address comments by:

• Providing additional explanations or analysis;
• Revising disclosure language within the filing;
• Supplying supplemental information requested by the staff.

If the company does not fully understand a comment, it may seek clarification from the reviewing examiner before responding.

Certain technical accounting issues may also be addressed with the SEC’s Office of the Chief Accountant, while disclosure issues are typically handled by the reviewing division.

Iterative Review Process

The SEC staff reviews the amended filing and the company’s responses. Depending on the adequacy of the revisions, the staff may issue additional comment letters requesting further clarification.

This iterative process—involving comments, responses, and amendments—continues until both the SEC staff and the company agree that the registration statement satisfies regulatory requirements.

Request for Effectiveness

Once all comments have been resolved, the company may formally request that the SEC declare the registration statement effective. This request signals that the company believes the filing is complete and compliant with applicable disclosure rules.

Declaration of Effectiveness

If the SEC staff determines that the filing satisfies all requirements, the Commission will declare the registration statement effective. The SEC confirms this determination through a formal notice and records the effectiveness on the EDGAR system.

Once the registration statement becomes effective, the company may legally proceed with its public offering of securities.

Legal Guidance During the SEC Review Process

Preparing and navigating a registration statement review requires careful coordination among legal counsel, accountants, and company management. Errors or incomplete disclosures can significantly delay the process or trigger additional regulatory scrutiny.

The attorneys at Corporate Securities Legal LLP assist companies throughout every stage of the public offering process—from preparing registration statements to responding to SEC comment letters and securing the final declaration of effectiveness.

Contact Corporate Securities Legal LLP to learn how experienced securities counsel can guide your company through the SEC registration review process and help ensure a successful public offering.

Board members hold fiduciary duties of care, loyalty, and obedience, which require them to protect company assets, oversee management, and ensure that corporate operations comply with applicable laws and governing documents.

Strategic Oversight and Corporate Governance

The number of directors serving on a board typically depends on the needs and size of the company. Boards provide strategic guidance and long-term planning, while the day-to-day execution of business operations is delegated to executive officers.

As part of their governance responsibilities, boards are expected to:

• Provide strategic direction and long-term planning;
• Oversee executive management performance;
• Protect company assets and financial stability;
• Identify and mitigate operational and regulatory risks;
• Ensure transparency and ethical business practices.

The powers and responsibilities of the board are defined in the articles of incorporation and corporate bylaws. Major corporate decisions—such as amendments to governing documents or mergers with other companies—generally require approval from shareholders, who ultimately own the corporation.

Fiduciary Duties of Directors

Directors are generally protected from liability for decisions made in good faith while performing their fiduciary duties. However, this protection only applies when directors act responsibly and within the scope of their obligations.

The three primary fiduciary duties include:

Duty of Care
Directors must act with the same level of diligence and prudence that a reasonably careful person would exercise under similar circumstances.

Duty of Loyalty
Directors must place the interests of the corporation above personal interests and avoid conflicts of interest when making decisions on behalf of the company.

Duty of Obedience
Directors must ensure that the corporation operates in compliance with applicable laws and its own governing documents.

Corporate governing documents may limit liability for certain decisions, but they generally cannot eliminate liability for breaches of fiduciary duties involving fraud, misconduct, or illegal activity.

Directors of publicly traded companies may also face liability for violations of federal securities laws, including the Securities Act of 1933 and the Securities Exchange Act of 1934, particularly when anti-fraud or disclosure requirements are violated.

Indemnification of Directors

Most state corporate statutes provide indemnification protections for directors who successfully defend themselves against legal claims related to their service on the board.

Corporations may also voluntarily indemnify directors when the board determines that the individual acted:

• In good faith;
• In a manner reasonably believed to be in the corporation’s best interests.

These protections help encourage qualified individuals to serve as directors without undue personal risk.

Roles Within the Board Structure

Although the board acts collectively when making decisions, individual directors may hold specific leadership roles within the organization.

Common board positions include:

• Chairperson – Leads board meetings and guides the board in overseeing the company’s strategic direction.
• Vice Chairperson – Assists the chairperson and assumes responsibilities when necessary.
• Chief Executive Officer (CEO) – Implements the strategic decisions and policies adopted by the board.
• Chief Financial Officer (CFO) – Oversees financial management and reports to the board on financial performance and compliance matters.
• Corporate Secretary – Maintains board records, meeting minutes, and official corporate communications.
• Independent Directors – Provide objective perspectives and unbiased oversight in board decisions.

Board Committees

Boards frequently establish committees to assist with oversight responsibilities. These committees provide recommendations to the board but do not exercise the board’s full authority.

Common board committees include:

• Audit committees responsible for financial oversight;
• Compensation committees reviewing executive compensation structures;
• Governance committees addressing corporate governance policies and practices.

Preparing for Public Company Governance

Companies preparing for an initial public offering (IPO) must establish formal corporate governance policies and board procedures that comply with federal securities regulations and stock exchange requirements.

The attorneys at Corporate Securities Legal LLP assist companies in developing governance frameworks, advising boards of directors regarding fiduciary duties, and implementing the governance practices required for publicly traded companies.

Contact Corporate Securities Legal LLP to learn how effective corporate governance practices can strengthen your organization and prepare it for future growth and public market opportunities.

When the time comes to take your private company, public, through an Initial Public Offering (IPO), what steps can you take to make it as successful as possible? Your company is your prized possession that you have built over a long period of time, and you don’t want to be disappointed or lose some of the investment you have put into it.

Deloitte, one of the big four CPA firms, says that timing is important. A survey of 3000 private company executives, across several industries, say it is the most important factor, but planning for and executing at the right time is very difficult, because of the many market factors that are out of your control.

Running a close second, as the most important factor in the survey, was building a strong team and business infrastructure. Those things are in your control, and will be a strong key in the success of your IPO. The critical steps to take, according to Deloitte, are to create a business model that has the potential to sustain growth. After that, rally around you a strong team to walk you through the IPO process and beyond. That includes knowledgeable people on IT systems, internal controls and processes, business and legal matters, and leadership team effectiveness.

Remember that financial planning, reporting and forecasting are key, so build your infrastructure to enable those systems. Finally, make your financial reporting closing process as smooth as possible, and implement appropriate risk management practices. Once you have strengthened your business with these steps, you are ready to begin the IPO process, but don’t rush it. Give it adequate time to develop so it is done right.

This advice is supported by Cooley LLP in its 25 Considerations in Preparing for an IPO, by Entrepreneur Magazine in its 5 Essential Steps to Prepare for an IPO, and by the other three big four CPA firms, E-Y, KPMG, and PWC.

With a strong business structure, and a knowledgeable and experienced team, like the Bradshaw Law Group, your chances of a successful and profitable IPO will be greatly increased. They will walk you through the entire, complicated IPO process, from inception to completion, making it understandable and comfortable for you.

Making sure you are in full compliance with all SEC regulations and procedures is the primary focus of the law firm of Wilson, Bradshaw & Cao, LLP a boutique securities law firm in Irvine, California and New York City. Your success in filing your initial public offering and staying in good standing with the SEC will bring lasting benefits to your company.

Initial Public Offerings are on the Rise

On July 5, 2018, Marketwatch reported that the 2018 second quarter filings for Initial Public Offerings (IPO) was the busiest quarter since 2015, and the trend looks like it will continue. Ernst & Young also reported that the first quarter of 2018, globally, was at a high level, compared to the first quarter of 2017, which was the most active first quarter since 2007.

This trend was not unexpected. Last December, Business Insider reported that, “Americas IPO activity ends the year (2017) on a high, driven by strong equity markets performance married with increased investor demand.” It also projected a very busy 2018, “as a result of lower volatility across regions, equity indices still hitting all-time highs and increasing investor confidence.”

It quoted Dr. Martin Steinbach, an IPO expert, saying, “Everything is in place for an exceptional 2018. The stronger-than-expected turnaround in economic activity in the Eurozone has boosted expectations for global economic growth. All the major engines of growth in the global economy are now synchronized in an upward trajectory for the first time since the end of the global financial crisis.”

If you’re thinking about taking your privately held company public, now may be a very good time to do it. Forbes Magazine summarized the benefits of going public. “Not only does it validate the business, but it also gives the company access to funds to use for growth and expansion. Investors and founders benefit from the liquidity it provides. While it can be a complex process, when done properly, it can be a major turning point for a brand.”

That complex process is condensed by the magazine into five steps to preparation for going public. However, those steps don’t need to be overwhelming if you use The Bradshaw Law Group, an experienced and affordable advisor in the IPO process, from start to finish.

Your finances need to be in order and presented in a way that is appealing to investors. It is important to have team members who are well connected to the investor community and can present your company in the best possible light.

You also need to identify the elements of highest value in your business. If your brand is not well recognized, you can focus on the valuable services you offer, and the desirability of your product.

The next step is probably the most crucial, and the one where a knowledgeable advisor can help. That is to present a simple and compelling story, which shows the most favorable and interesting elements of your business. That will be your strong selling point.

Assembling your team of advisors, with the capability to handle and deliver the growth that you are looking for, is critical. They may already be among your current employees, but in many cases you will need to be referred to more exceptional talent.

Finally you will need to keep your capital structure simple and low in debt. A good advisor can guide you through converting debt to equity and other steps to achieve a clean balance sheet. Remember that “A successful IPO has several benefits, including credibility, market validation and a strong signal in terms of sustainability. While not an easy task, the payoff — growth and profit potential — can be well worth the effort.”

Making sure you are in full compliance with all SEC regulations and procedures is the primary focus of the law firm of Wilson, Bradshaw & Cao, LLP. Your success in filing your initial public offering and staying in good standing with the SEC will bring lasting benefits to your company.

Spotify, however, chose to go the route of a direct public offering, a process typically used by small companies who cannot afford the high cost of an IPO. Under that process the company sells its own existing shares and eliminates the services of the banks. There is no dilution of the value of the shares, because no new shares are issued. It is a shorter process and less expensive.

However, without the assurances of the banks to maintain a steady price of the shares, a direct public offering runs the risk of a discount in the price of the shares, which can be caused by heavy trading. Spotify, though, can reduce that risk by approaching existing investors and negotiating lock-up periods, to restrict the supply of shares on the market. According to the Wall Street Journal, Spotify “is expected to use private market trading to guide investors towards a public market stock price.”

The question arises as to why Spotify chose the direct public offering. The company’s cash flow is positive and it has unlimited access to capital, with a worldwide brand and 70 million subscription users. The company was valued at $19 billion last December. Also, the company is known and understood worldwide, to it did not need the help of bankers to convince investors of its value. Spotify said it chose the direct public offering route because it can “list without selling shares”, it “offers liquidity to shareholders, and would provide equal access to buyers and sellers. It also wanted the process to be transparent and allow the market to set the price of the shares.”

With all that said, the bottom line is still that the a direct public offering is always less expensive than the traditional route of an IPO.

According to a NYSE spokesman, Spotify will be the “very first NYSE direct listing” of a foreign company. It is unlikely that many other companies will go the same route as Spotify, because they don’t have all the same unique attributes. However, there is speculation that maybe the market, which has hasn’t seen many changes in a long time, is ready for some kind of disruption. More direct public offerings could be what’s next.

The law firm of Bradshaw, Wilson & Cao, LLP routinely assists companies who are going public via direct registration, like Spotify, or using traditional underwriters. Call us at (949) 752-1100 or email gil@securitieslegal.com if you have any questions or want to schedule a free consultation about an initial public offering.