In November, the SEC amended its rules under the Securities Act of 1933 to “simplify, harmonize, and improve” aspects of its exempt offering framework. The SEC is adamant about retaining investor protections, and they believe the updated framework will remove ambiguity and unnecessary complexities in the registration process, thereby attracting more private capital to US businesses. Private Equity firms with the capacity to expand operations stand to benefit in a number of ways from these recent amendments.
Introduction to Securities Registration
Securities must either formally register with the SEC or qualify for an exemption. Registration can be a lengthy and expensive process, which can be prohibitive for early-stage and smaller companies with limited resources. Exemptions are designed to facilitate investments in those sorts of businesses without compromising investor protections, as in the cases of certain crowdfunding activities or the oft-cited Regulation D private placements. However, qualification for the various exemptions can be complex and ambiguous, especially when an issuer aims to make use of multiple regulatory exemptions that each have different limitations on use.
The recent SEC amendments address “various costly and unnecessary frictions and uncertainties” in these integrated exemptions. They are intended to make it easier and more clear for issuers to move from one exemption to another and increase the investment limits on certain types of issues. Of particular note were some changes toward more clear rules regarding “demo days” and “test-the-water” activities.
PE Demo Days
Demo days allow for organizations such as universities, incubators, angel funds, and government agencies to host events at which issuers can present to prospective investors. The new amendments have expanded the types of communications at demo days that will not be considered general solicitations, thus exempting them from registration requirements.
Further, the amendments have potentially created a situation in which private funds, which have profit interest in raising capital for issuers, are allowed to sponsor these demo days. Sponsors still cannot receive compensation for introductions, charge attendance fees, participate in investment negotiations, or provide specific advice to attendees. Ultimately, the new changes could lead to an increase in private equity and venture capital investing volumes, with PE firms utilizing these avenues to attract investors for new funds.
Assessing New Investor Interest
The SEC also made it easier for issuers to gauge investor interest before selecting an exemption. The new “testing-the-waters” rule expands upon prior rulings that allow companies to engage in general solicitation with prospective investors without a registration requirement. The old rules also limited these interactions to institutional investors, so this may open the door to more diverse sources of capital.
A company seeking private capital can now interact more extensively with a broader group of prospective investors. It’s easy to see how this could lead to more opportunities for private equity deals, and firms that are willing to test-the-waters could be among the top beneficiaries. However, there are some key elements to the regulation that could limit its efficacy. First, the new amendments do not allow issuers to circumvent state blue sky laws, so the testing-the-waters provisions aren’t applicable everywhere. Further, if testing-the-waters communications aren’t property composed, then they could prohibit later qualification for the Reg D private placement exemption. That’s obviously an issue that might cause many companies to ignore the new leniency entirely.
The new SEC exempt offering amendments are groundbreaking. They expand significantly upon the existing framework, and will likely lead to new capital raising activity that would not have occurred otherwise. It’s still early to say how significant of an impact these new regulations will have on private investing. Nonetheless, when raising funds for applicable investments, PE firms could utilize the amendments to court a wider range of investors, potentially leading to larger commitments and fund sizes.