Issuers May “Test-the-Waters” Before Choosing a Securities Exemption
April 18, 2021
Perhaps the most vexing threshold issue faced by any company considering a capital raise is which securities exemption to pursue. The chosen exemption largely depends on the targeted amount of the raise, as well as the manner in which potential investors will be solicited and the type of disclosure to be provided. But this presents a capital-raising Catch 22 for issuers: you can’t know for sure how much can be raised and from whom without first soliciting interest, but until recently soliciting interest would generally constitute a general solicitation which could blow the ultimate exemption used. The SEC has attempted to rectify this Catch 22 by adopting new Rule 241 which allows issuers to “test the waters” by making a generic solicitation of interest in an offering prior to deciding on which exemption to pursue.
New Rule 241, adopted as part of the SEC’s significant exempt offering reforms which became effective March 15, provides that, prior to selecting an exemption for a particular offering, an issuer may solicit investors to determine the extent of investor interest. Communications under the Rule would be deemed securities offers for fraud liability purposes, and Rule 241 will not preempt applicable blue sky registration or qualification. No solicitation or acceptance of money is allowed, nor is any investor commitment permitted until the issuer commences an offering meeting the requirements of a particular exemption.
To protect prospective investors, Rule 241 communications must state that (i) the issuer is considering an exempt offering but has not determined the specific exemption, (ii) no money or other consideration is being solicited, and none will be accepted, (iii) no offer to buy the securities can be accepted and no part of the purchase price can be received until the issuer determines what the exemption will be and any applicable filing, disclosure and qualification requirements are met, and (iv) a prospective investor’s indication of interest involves no obligation or commitment of any kind. Such communications may include the means by which a person may indicate his interest, and may require the person’s name, address, telephone number and/or email address in any response form.
The new test-the-waters exemption under rule 241 is similar to the one available in connection with registered public offerings. Rule 241 is broader in scope, however, in that it allows generic solicitations of interest to anyone, whereas those for registered offerings may only target qualified institutional buyers and institutional accredited investors.
One trap for the unwary here is that a Rule 241 test-the-waters communication may be deemed to be a general solicitation, depending on facts and circumstances. An issuer would not be able to engage in a solicitation of interest constituting general solicitation and then pursue an offering exemption that prohibits general solicitation, such as under Rule 506(b) or Section 4(a)(2). The SEC provided in its final rules release that an issuer may reasonably conclude, depending on the facts and circumstances, that a test-the-waters communication targeted only to qualified institutional buyers and/or institutional accredited investors would not constitute general solicitation. Accordingly, issuers contemplating an exemption that prohibits general solicitation may decide to solicit interest only from qualified institutional buyers and/or institutional accredited investors.
If an offering is launched under Regulation Crowdfunding or Regulation A within 30 days following a Rule 241 communication, the issuer must file the written communication or broadcast script (as applicable) as an exhibit to the Form C or Form 1-A, as applicable, which is filed with the SEC. If a Rule 241 communication is followed within 30 days by a Rule 506(b) offering in which any securities are sold to a non-accredited investor, the written communication or broadcast script must be provided to such non-accredited investor a reasonable period of time before the sale.
For Regulation Crowdfunding issuers, Rule 241 will serve to complement new Rule 206 and Rule 204. Rule 206 allows test-the-waters communications after an issuer decides to rely on Regulation CF but before it files a Form C. Rule 204 was amended in connection with these new rules explicitly in order to permit oral communications after filing Form C, clarify that an issuer may include a description of the planned use of proceeds and progress information and permit issuers to provide information about the offering in a concurrent offering (e.g., under Regulation A). The combination of these test-the-water rules should be enormously helpful to companies contemplating Regulation CF campaigns as it will allow them to gauge investor interest before committing significant resources.