The SEC recently issued guidance on what constitutes a “pre-existing, substantive relationship.” The guidance is helpful for companies raising money for a number of reasons.
The SEC guidance is especially helpful because there has been a fair amount of uncertainty about how to make sure a securities offering is not considered to have been generally solicited or generally advertised. If you are considered to have generally solicited or generally advertised your offering, you have to verify the accredited investor status of your investors. This means asking your investors for personal financial statements or their personal tax returns. Most companies want to avoid this, and thus want to make sure that their offerings fit snugly into Rule 506(b).
But how do you do this exactly? How do you make sure your offering is not considered to have been generally solicited or advertised? Well, one way is to be super scrupulous about not doing anything in the media or at public events to announce your offering.
This is why you do not see companies at Demo Days talking about their offerings. This is why you see companies exercise a lot of care during the middle of an offering when talking to the media.
But, what happens if you slip up? What if you mention in a meeting at which members of the general public were invited that you are raising money? What if a reporter catches you off guard and reports that you are raising money? Are you sunk? Do you have to go and change your offering from a Rule 506(b) to a Rule 506(c), and ask all of the investors in your round so far to give you their personal financial statements or personal tax returns?
Maybe not. At least, that is what the new SEC guidance indicates.
Here is what the SEC guidance says, exactly:
“The existence of such a pre-existing, substantive relationship is one means, but not the exclusive means, of demonstrating the absence of a general solicitation in a Regulation D offering.”
How Do You Establish a Pre-Existing, Substantive Relationship?
How do you establish a “pre-existing, substantive relationship” with your investors? Well, first, your relationship with the investor has to pre-date the start of your offering.
Second, you have to do the following:
A “substantive” relationship is one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor. Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship. [August 6, 2015]
The CitizenVC ruling is helpful in showing you how to establish a pre-existing, substantive relationship.
Do You Have To Have a Substantive Relationship With All of Your Investors?
Do you have to have a “substantive, pre-existing relationship” with all of your investors in order for your offering to qualify as a Rule 506(b) offering?
No. There is no requirement in order to conduct a Rule 506(b) that you have to have a pre-existing, substantive relationship with all of your investors. Having such a relationship is just one means, and “not the exclusive means of demonstrating the absence of a general solicitation.”
The best way to keep your offering within the confines of a Rule 506(b) offering to super scrupulous to generally solicit or generally advertise the offering. Just don’t slip up. Why? Because it is not possible if you already started your offering when you meet a prospective new investor for the first time to have a pre-existing relationship. And also because the substantive relationship test is not necessarily an easy one to meet. If you want to see the lengths to which one company went, the CitizenVC letter is a good read.