Here’s What You Need to Know About Private Offerings

Nathan Gordon

With interest rates continuing to rise, obtaining debt financing for a real estate transaction can be a challenge. High borrowing costs continue to sink deals that just one year would have been a home run. Many sponsors are finding solutions to this challenge by financing their transactions entirely through equity utilizing private offerings.

Raising capital in a private offering can be a complex and daunting task, particularly for those who are unfamiliar with the legal requirements and regulations involved. Private offerings, also known as private placements, involve the sale of securities to a limited number of investors (who are generally accredited investors), as opposed to the general public. While private offerings provide an opportunity for sponsors to access capital outside of traditional financing methods, there are several key legal issues that must be carefully considered to ensure compliance with relevant laws and regulations.

Securities Regulation Compliance

One of the most significant legal issues involved in a private offering is compliance with securities regulations. The Securities Act of 1933 regulates the sale of securities and requires companies to file a registration statement with the Securities and Exchange Commission before they can offer and sell securities to the public. However, private offerings are exempt from registration requirements, provided that the offering complies with certain conditions. For example, the most common exemption for sponsors raising equity for a real estate transaction is Rule 506(b) of Regulation D. That exemption allows sponsors to raise an unlimited amount of capital from an unlimited number of accredited investors. However, the sponsor may not generally solicit investments from the public. Companies must carefully navigate these requirements and work with legal counsel to ensure that their private offering is structured in compliance with applicable regulations.

Accredited Investors

In a private offering, all investors must generally be accredited, meaning that they meet certain income or net worth requirements established by the SEC.  While there are exemptions from registration that allow for private offerings to non-accredited investors, the requirements are so burdensome that most of time it is not practical to include non-accredited investors as part of the offering. Generally, sponsors should ensure that each investor completes an accredited investor questionnaire confirming he or she is an accredited investor. Also, depending under which rule the offering qualifies, sponsors may need to take additional steps to verify that each investor is accredited, which may involve reviewing financial statements or obtaining certification from a third-party.

Disclosure Requirements

Sponsors should ensure that investors are fully informed about the risks and potential rewards of the investment. Sponsors should provide comprehensive information about the investment, including financial information and risk factors associated with the investment. Inadequate disclosures can result in legal action and potential liability for the sponsor. Sponsors should always consult with legal counsel to ensure their disclosures are adequate and contain proper disclaimers.

Broker-Dealer Requirements

Sponsors must also be mindful of SEC requirements regarding registration as a broker-dealer. A broker is a person who is in the business of selling securities for another person. Typically, broker’s receive fees based on the amount of sold in the offering. Unless a sponsor is a registered broker, sponsor’s should ensure that any compensation they receive in connection with the transaction does not resemble a broker’s commission or finder’s fee. Further, sponsors who are engaging in private offerings on a regular basis risk being classified as a broker. Many times, sponsors fail to consider broker-dealer issues, but failure to comply with applicable rules can result in rescission of the offering and legal action against the sponsors.

State Securities Laws

In addition to federal securities regulations, sponsor’s must also comply with state securities laws, which vary by jurisdiction. Some states require companies to file a notice or registration statement before conducting a private offering, while others impose specific disclosure requirements. Companies must work with legal counsel to ensure that their private offering is compliant with relevant state securities laws.

Investor Relations

Once a private offering has been completed, companies must maintain ongoing relationships with investors to ensure ongoing compliance with applicable laws and regulations. This includes providing regular updates on the business and financial performance, as well as addressing any questions or concerns that investors may have. Failure to maintain adequate investor relations can damage the company’s reputation and potentially result in legal action.

Raising capital through a private offering involves complex legal requirements that must be carefully navigated to ensure compliance with applicable regulations. Sponsor’s must work closely with legal counsel to structure their offering in compliance with securities regulations, verify investor accreditation, comply with broker-dealer rules, provide adequate disclosure, comply with state securities laws, and maintain ongoing investor relations. Understanding these key legal issues is critical to effectively raise capital through a private offering while minimizing legal risk.

Nathan Gordon is an attorney in the Birmingham office of law firm Baker Donelson and is a shareholder in the Firm’s Corporate Group.