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Posts from the ‘Finance’ Category


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.


Counseling the Finance Function


Financing is an essential element for establishing a new business, launching a new product or service, or expanding an existing business through internal growth or acquisition.  For example, cash is necessary in order for a company to continue operations while awaiting payment from customers and anticipated increases in sales; expand the volume of sales of existing products through increased advertising and promotion; develop or acquire new technical skills and assets, including acquisitions of other firms; enter specified new markets, including new facilities and recruitment of personnel; create new products that address a specified market need, including research and development; replace or upgrade ageing or obsolete facilities or equipment; or comply with regulatory requirements, such as health standards or environmental laws.

It is likely that entrepreneurs and managers will, regardless of the size of their businesses, need to venture into the world of finance several times over the life cycle of the enterprise.  In that world they will encounter a wide range of participants, including banks, venture capitalists, investment bankers, government agencies, and business advisors, each of which will provide unique resources and experience.  Capital suppliers have become increasingly innovative in devising financing techniques that are tailored to their needs and the goals and objectives of the businesses they serve.  However, before managers can begin the onerous process of securing funding, they must develop a careful plan for identifying the financial requirements of the business, the terms upon which the company hopes to secure the necessary funds, and the potential sources for the funding.  Of course, this assumes that management has already developed a “plan” for the business, product, concept or service, and has developed an outline of all of the requirements for successfully completing the plan (i.e., capital resources, human resources, other assets, marketing strategies and tactics).

As a business counselor, one of the most important things that you will be doing is providing advice and transactional support to your clients on their financing activities.  Chapter 250 of Business Transactions Solution (§§ 250:1 et seq.) on WESTLAW provides a general overview of business financing activities which should be reviewed along with the specific types of financing transactions listed below. The materials include a Master Form of a questionnaire for use in assisting management in developing information on financial aspects of the business which can be used in presentations to prospective investors. The chapter discusses some of the steps to be taken to determine the financing requirements of a business, as well as various sources of capital. The chapter also analyzes the relationship between the company’s stage of development and financing alternatives and lists various considerations that the company should always take into account in selecting among financing proposals. Also, the role of legal counsel in the company’s financing strategy is covered.

This month we are adding several new training and practice tools to help you become better counselors to the finance function:

  • Slide Deck presentation: Counseling the Finance Function (§150:104)
  • Business Counselor’s Training Materials: Basic Elements of the Capital Structure (§150:105)
  • Business Counselor’s Training Materials: Counseling the Finance Function (§150:106)
  • Business Counselor’s Training Materials: Organization and Management of the Finance Function (§150:107)

Related issues are covered in the transactions on Corporate Equity Financing (§§ 154:1 et seq.), Corporate Debt Financing (§§ 155:1 et seq.), Venture Capital Financing (§§ 156:1 et seq.), Registered Public Offerings (§§ 288:1 et seq.), and Commercial Debt Financing (§§ 157:1 et seq.). Other transactions cover Offering and Disclosure Documents (§§ 152:1 et seq.), Finders’ Arrangements (§§ 153:1 et seq.), Underwriting and Distribution Arrangements (§§ 289:1 et seq.), Issuance of Corporate Securities (§§ 37:1 et seq.), Business Valuation (§§ 293:1 et seq.), Securities Law Compliance (§§ 151:1 et seq.), and Noncorporate Investment Financings (§§ 56:1 et seq.).


Preparing Use of Proceeds Disclosures

Registration statements, as well as private placement disclosure documents, typically include a discussion of the proposed use of proceeds collected from the offering.  The attached template is an illustration of the presentation that might be used when the company needs to tell investors how their funds will be spent if the offering is not fully subscribed.


Checklists for Preparation of IPO Registration Statement

The recently updated chapter on Registered Public Offering of Securities (Chapter 288) now includes drafting (§ 288:149.24) and review (§ 288:149.25) checklists for a registration statement for the initial public offering of a smaller reporting company.  These checklists can be used to ensure that all applicable disclosure requirements have been satisfied and as a tool for educating clients about the information they will need to prepare in order for their registration statement to be complete.  Updates have also been made to the board of directors’ resolutions for filing of a registration statement and related matters (§ 288:154) to highlight certain optional topics that the board may wish to address in specific circumstances.



Expanded Coverage of Registration Statement Preparation in Business Transactions Solution

This month’s Business Counselor Update on Westlaw Next includes updated and expanded coverage of the preparation of registration statements for public offerings in Registered Public Offerings (Ch. 288).   The timetable for a registered public offering included in that chapter has been updated and a new Master Form of a registration statement for the initial public offering of a smaller reporting company with a limited operating history has been added to the materials.  In particular, illustrations have been provided about how to address the requirements for disclosures in key areas including: 

  • Prospectus summary (§288:149.04)
  • Risk factors (§288:149.05)
  • Use of proceeds (§288:149.06)
  • Management’s discussion and analysis of financial condition and results of operations (§288:149.10)
  • Description of business (§288:149.11)
  • Security ownership of principal and, if applicable, selling stockholders (§288:149.13)
  • Management and corporate governance §288:149.17)
  • Executive compensation (§288:149.18)
  • Certain relationships and related transactions (§288:149.19)

While registration statement preparation is often thought of as the exclusive preserve of larger law firms, business counselors working at smaller firms can assist their clients with capital raising through a registered public offering that takes advantage of the streamlined disclosure rules that are applicable to smaller reporting companies.  In addition, knowing how to draft a registration statement can provide dividends in assisting clients who are raising funds privately and need help with creating their private placement memorandum.


D&O Questionnaires for Public Companies & Private Placements

When preparing a registration statement for a public offering of securities or periodic report required under the Securities Exchange Act of 1934, as amended, counsel will rely heavily on the information provided in questionnaires circulated to officers, directors and principal shareholders (i.e., shareholders that beneficially own 5% or more of any class of the company’s securities). While the requirements for each form or registration statement may vary, each document must include a wide range of detailed information regarding officers, directors and principal shareholders, including biographical information on officers and directors, a description of shareholdings, and compensation for senior executives. The primary focus of the questionnaire is to obtain objectively verifiable information, not opinions from the respondents regarding the company's business activities or internal controls. For example, while directors should presumably be aware of the existence of disclosure controls and procedures, background information on that topic is best collected through interviews and observations, as well as copies of written policies adopted by the board of directors. The questions should, of course, be adapted to the company's particular circumstances and line of business. If the company is subject to other types of regulation, additional questions may be inserted into the questionnaire to collect information that may be of interest to regulators other than the Securities and Exchange Commission.  For example of questionnaires that can be used for public companies, see the Master Forms appearing at §§ 151:138 and 290:90 in Business Transactions Solutions on Westlaw Next.

An abbreviated form of a public company questionnaire should also be used by private companies in conjunction with any private placement memorandum, prospectus, business plan, or other document containing disclosures about a proposed or existing business entity to facilitate full disclosure and satisfy due diligence requirements. A number of the questions may be inapplicable where the entity is yet to be formed; with minor revisions, however, the form may be used in conjunction with a pre-incorporation agreement.  See the Master Form appearing at § 152:167 in Business Transactions Solutions and the fuller discussion in Offering and Disclosure Documents (Ch. 152).


Seed Financing from Wealthy Individuals and Angel Investors

Wealthy individuals have always been benefactors of fledgling businesses, particularly when a company is involved in an area in which the individual has substantial prior experience.  In addition, so-called “angel” investors, who are high net worth individuals, often businesspeople or professionals with high incomes or individuals from wealthy families, may have an interest in participating in high-risk/high-return investment opportunities.  This report provides an introduction to some of the key characteristics of angel investor preferences and contributions to a firm and describes several financing structures might be appropriate for the company and the members of an angel investor group.


SEC Adopts Final Rules for New Regulation A+ Exemption

Regulation A is long-standing, albeit relatively little used, exemption from the registration requirements of the Securities Act of 1933 that allows qualified issuers to offer and sell up to $5 million of securities in any 12-month period, including no more than $1.5 million of securities offered by security-holders of the company, provided that certain relatively complex disclosure requirements are satisfied.  Title IV of the JOBS Act included a mandate to the SEC to promulgate a rule or regulation that would add a class of securities to the securities exempted from registration pursuant to § 3(b) of the Securities Act.  The SEC adopted the final rules for this exemption, which appear as § 3(b)(2) of the Securities Act (15 U.S.C.A. 77c(b)(2)) and is often referred to as “Regulation A+” on March 25, 2015 (to become effective 60 days after publication in the Federal Register).  The final rules for Regulation A+ provide for two tiers of offerings: 

  • Tier 1, which would consist of securities offerings of up to $20 million in a 12-month period, with not more than $6 million in offers by selling security-holders that are affiliates of the issuer.
  • Tier 2, which would consist of securities offerings of up to $50 million in a 12-month period, with not more than $15 million in offers by selling security-holders that are affiliates of the issuer.

In addition to the limits on secondary sales by affiliates, the rules also limit sales by all selling security-holders to no more than 30 percent of a particular offering in the issuer’s initial Regulation A offering and subsequent Regulation A offerings for the first 12 months following the initial offering.

For offerings of up to $20 million, the issuer can elect whether to proceed under Tier 1 or Tier 2.  Both tiers would be subject to basic requirements as to issuer eligibility, disclosure, and other matters, drawn from the provisions of Regulation A.  Both tiers would also permit companies to submit draft offering statements for non‑public review by SEC staff before filing, permit the continued use of solicitation materials after filing the offering statement, require the electronic filing of offering materials and otherwise align Regulation A with current practice for registered offerings.

In addition to these basic requirements, companies conducting Tier 2 offerings would be subject to other requirements, including: a requirement to provide audited financial statements; a requirement to file annual, semiannual and current event reports; and a limitation on the amount of securities non-accredited investors can purchase in a Tier 2 offering of no more than 10 percent of the greater of the investor’s annual income or net worth.

Eligibility for the Regulation A+ is limited to companies organized in and with their principal place of business in the United States or Canada.  The exemption is not be available to companies that:

  • Are already SEC reporting companies and certain investment companies.
  • Have no specific business plan or purpose or have indicated their business plan is to engage in a merger or acquisition with an unidentified company.
  • Are seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas or other mineral rights.
  • Have been subject to any order of the Commission under Exchange Act Section 12(j) entered within the past five years.
  • Have not filed ongoing reports required by the rules during the preceding two years.
  • Are disqualified under the “bad actor” disqualification rules.

The rules exempt securities in a Tier 2 offering from the mandatory registration requirements of Exchange Act Section 12(g) if the issuer meets all of the following conditions:

  • Engages services from a transfer agent registered with the Commission.
  • Remains subject to a Tier 2 reporting obligation.
  • Is current in its annual and semiannual reporting at fiscal year-end.
  • Has a public float of less than $75 million as of the last business day of its most recently completed semiannual period, or, in the absence of a public float, had annual revenues of less than $50 million as of its most recently completed fiscal year. 

An issuer that exceeds the dollar and Section 12(g) registration thresholds would have a two-year transition period before it must register its class of securities, provided it timely files all of its ongoing reports required under Regulation A. 

In light of the total package of investor protections included in amended Regulation A, the rules provide for the preemption of state securities law registration and qualification requirements for securities offered or sold to “qualified purchasers,” defined to be any person to whom securities are offered or sold under a Tier 2 offering.

For further discussion, log on to Westlaw Next and search for § 151:187 of Business Transactions Solutions.



Warrants in Bridge Debt Financing Transactions

Clients may be interested in issuing warrants or options to purchase additional company securities as part of their debt financing transactions.  The terms of the warrant are described in a separate document, including the type of security issuable upon exercise of the warrant, the number of units of the covered security issuable upon full exercise of the warrant, the exercise price, the term of the warrant, rules for adjusting the number of units covered by the warrant and the exercise price, and procedures for exercising the warrant and issuing the new securities to the investor.

A common use of a warrant is in connection with a bridge financing arrangement in anticipation of the closing of another round of equity funding. In this situation, investors providing a bridge loan will be issued warrants to purchase additional shares of the securities issued in the equity transaction.  While a bridge financing may, and often does, involve a single investor/lender, companies may obtain funding from two or more investors, all of which would receive identical promissory notes and warrants even though the loans may be made at different times over a mutually agreed window of time (e.g., one to three months).  While preferences among the bridge lenders are uncommon and unwieldy to create, management may reward an investor willing to make the first loan with a warrant to purchase a fixed number of common shares at the then-current fair market value of the common shares that they investor can exercise over a relatively short period of time.  If such a warrant is issued the company must disclose the terms to other investors and be prepared to field requests for equal treatment; however, the company can reasonably argue that the warrant were issued in recognition of special risks undertaken by the initial investor in providing funds when it may not have been clear that the company would be able to raise additional financing.

A full discussion of warrants and options, including other examples of form documents, is provided in Chapter 154 of Business Transactions Solution on Westlaw Next (Corporate Equity Financing).



Understanding Recordkeeping Requirements Under Securities Laws

Make sure you remember the recordkeeping requirements applicable to your clients under the securities laws by reviewing my recent post on the Legal Solutions Blog.