As expected, we are starting to see issuers who want to run a 506(c) Reg D offering concurrently with their Title III/4(a)(6) Reg CF crowdfunding offering.
However, I didn’t expect it to be reactionary. In hindsight, I was a tad naïve in thinking that a company or portal could plan this in advance. The reality is that no matter how good the portal is, how great the issuer is, or how fantastic their securities offering is, you don’t really know if investors are going to invest until…well…until they actually invest.
SITUATION: The result has been some oversubscribed Reg CF offerings, with issuers then scrambling to spin up a 506(c) offering and quickly move accredited investors out of the Reg CF and into the Reg D. Quite a mad scramble that’s more like a Chinese fire drill than an orchestrated securities offering.
PROCESS: Since it’s not really possible to know which offering(s) will be over-the-top successful, and thus worth putting the time and money into pre-planning a 506(c) offering to coincide with a 4(a)(6) launch, we need to look at creating processes to handle this on an as-needed (instead of pre-planned) basis. And yes, I’m a huge fan of Michael Gerber, creating a successful business means building defined, replicable processes into your portal.
So, what are the considerations for developing a process to handle an oversubscribed 4(a)(6) offering?
First, do NOT yet close the 4(a)(6) offering. You’re going to need some time to execute and if you close now then escrow will have no choice but to send all the oversubscribed funds back to investors.
Second, create a 506(c) offering for the issuer. Note that a full blown PPM is NOT required, you should easily be able to re-purpose the Form C with some minor tweaks and call it an “offering memorandum”. You will, of course, need a new subscription agreement; which may also be a tweaked version of the CF subscription agreement. Run these by your attorney.
Third, do NOT yet cancel any accredited investors commitments in the 4(a)(6) offering (more on that in a moment). Yes, I know the CF offering is oversubscribed and you are anxious to move them out of that and into the D, but take a breath and follow the process or you’ll be shooting yourself in the foot.
Fourth, the issuer (or their appointed agent, which might be employees of the portals parent company, but should not be the portal directly since it is not authorized to engage in Reg D business) can take the data of all the accredited investors in the 4(a)(6) offering and post it to (create investments for) the 506(c) offering. Those investors should be contacted beforehand to let them know what’s happening, and the offering memorandum sent to them via email.
Fifth, the system should now email those investors a link they can click to go to a page where they can review & esign the subscription agreement for the 506(c) offering. This should NOT be on the portal, since it’s not authorized to conduct Reg D business, so instead should be either on the issuers website or perhaps on the portals parent company’s website (check with your CCO).
Sixth, once signed, the investors accreditation now must be confirmed. An issuer can do this directly or via a third-party service (at FundAmerica we tie into VerifyInvestor.com to do this). You have no choice in this, as the Reg CF is considered a form of general solicitation you cannot move investors into a 506(b), only 506(c).
Scenario A. The investor signed the subscription agreement and their accredited status has been confirmed.
=> cancel their investment in the 4(a)(6) offering, have escrow wire funds from the 4(a)(6) escrow over to the 506(c) escrow (which must be separate). An alternative to this, in case your CCO requires funds to be returned directly to the investor (which a strict reading of the rules could reasonably be interpreted to mean) is to have funds delivered to the investors custodial account, and then directed to invest funds into the 506(c) offering.
Scenario B. The investor either refuses to sign the 506(c) subscription agreement or fails accreditation.
=> not a problem, just leave their 4(a)(6) investment as-is. This is exactly why you did not cancel their investment in the 3rd step of the process!
Seventh, now that you’ve moved all the qualifying accredited investors out of the Title III offering, go ahead and close it.
Eighth, continue the 506(c) offering for as long as the issuer wants.
Consideration 1: before launching the concurrent 506(c), be sure to check with your attorney as to whether this will constitute a material change to the 4(a)(6) offering or disclosures. If so, address that first (with either an updated Form C and/or sending investors a notice). I’ve heard arguments on both sides of this, so rely on your securities attorney and CCO to make this decision (and bake it into your processes for future events).
Consideration 2: if you (or an issuer) enters the investors data into the 506(c) offering, then are you acting as an unregistered investment adviser? On one hand, you (or the issuer) are not actually making the investment for the investor, as the investor has to directly sign the subscription agreement and go through the accreditation process, and you are (hopefully) not being compensated for doing this. On the other hand, regulatory interpretation could be such that you may be deemed to be acting in a manner requiring registration. Check with your attorney and your CCO first. If “no problem“, then create your process along the lines as I’ve described here. If “oops, yes” then either have someone on your staff file with the SEC as an RIA or just send the investors a link to an Invest Now form for them to input their data directly.
The good news for the industry is that we are seeing some Reg CF offerings get oversubscribed, and thus the “concurrent” provisions in the rules are needed! However, since this is generally going to be a reactionary event, portals and service providers like FundAmerica need to think through these issues ahead of time and put processes in place so as to cause the least amount of disruption to investors, issuers and the portals operations team.