Counseling Clients on Equity Financing Transactions

Business counselors need to have a full understanding of the basic principles of corporate equity financing as well as the procedures that generally apply whenever the corporation raises capital in a private placement. Investment capital can come from a variety of sources. In many cases, the founders and managers may have relatives, friends, neighbors or business acquaintances that can serve as capital providers and/or provide leads to other prospective investors.  Alternatively, the company may look to various types of outside investors including business partners; management-oriented investors; institutional investors and venture capitalists.

A variety of outside investment sources may be tapped by a company depending on the type and size of business and the projected growth of the company over the period that the investors are expected to hold the securities purchased in the offering.  In each case, the transaction, generally referred to as a “private placement”, is defined by the issuance of equity securities (e.g., common or preferred shares) or, in some cases, debt securities convertible into common shares, which results in the investor group holding a significant ownership interest in the company.  The private placement market is not unregulated. For example, offerings in the private placement market are distinguished by the fact that the market efforts associated with the solicitation of potential investors must be strictly limited. As such, the securities may not be offered or sold by any form of general solicitation or advertising, including any advertisement or article published in a newspaper, magazine or similar media, or by any seminar or meeting in which the participants have been generally solicited.

Management should investigate the financing strategies of other companies involved in similar lines of business. Many investors tend to specialize in a particular industry or product line and management may be able to put together a list of persons and entities that might be willing to review the business plan. Trade groups are another way to network with potential investors and many industry associations are now sponsoring regular financing forums that allow companies to make presentations to investors. Service providers, such as attorneys, accountants, and commercial bankers, can also provide assistance with introductions to investors. Alternatively, the company may turn to a finder or broker to provide assistance in locating suitable investors.

Completion of an equity financing for a corporation generally raises the same types of issues that exist whenever a corporation decides to issue new shares. The situation may be complicated by the need to amend the charter documents to reflect the terms of the security being issued to the investors. Counsel should be sure to comply with state statutory requirements governing the conditions for valid authorization and issuance of securities. In addition, as part of that process, it is likely that formal action will be required by both the board of directors and by the shareholders of the corporation.  Federal and state securities laws apply only to the offers and sales of “securities.” It is fairly clear that shares, both common and preferred, are considered to be “securities” for purposes of the securities laws.

This month’s update to Business Transactions Solution on WESTLAW includes new tools for helping business counselors advise their clients on equity financing transactions:

  • Slide Deck presentation: Equity Financing (§154:414)
  • Business Counselor’s Training Materials: Equity Financing (§154:415)

A large library of additional materials is available in the chapter on Corporate Equity Financing (§§ 154:1 et seq.), which covers capital-raising activities by a corporation in the form of sales of equity securities to outside investors in transactions that are intended to be exempt from the registration requirements of the federal securities law. The materials include Master Forms for a subscription agreement, an investment agreement, a warrant to purchase common shares, an investors’ rights agreement, a legal opinion from company counsel, and instructions to investors for completing all the documentation in a subscription book for a private placement. The transaction memorandum discusses the basic principles of corporate equity financing, including various types of equity securities, and the procedures for completing an investment financing transaction. The Specialty Forms library includes complete forms of investment agreements for equity financings; materials for use in the due diligence investigation; certificates of preferences for various types of preferred stock; registration rights agreements; management rights letters; warrants; rights offering documents; board and shareholder resolutions; forms of officers’ certificates, and legal opinions.

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