- March 8, 2010
Businesses confront a common dilemma when launching a program to sell stock or debt securities. If they wait for their lawyers to draft the perfect 100-page document that discloses everything and complies perfectly with securities rules, investors will be long gone. If they slap together a few slides and aggressively promote the stock to strangers, they have exposed themselves to significant personal liability should the company fail to deliver the promised returns.
Companies need a middle way — a solution to test the waters for investors without triggering onerous disclosure requirements and liability. While the only bullet-proof solution is the hefty disclaimer-laden offering memorandum, businesses can limit their liability while testing the waters by honoring a few simple rules. Thus, they can use a short business summary, a deck of PowerPoint slides and a brief speech to a private group without unduly exposing themselves to claims of misrepresentation and improper securities sales.
1. Keep the Presentation Simple
For companies testing the waters before a private offering, short and simple is best. This means a business plan of about ten pages, or a general PowerPoint deck of less than 20 slides. Financial information should be general, but not misleading. Projections should be as tight as possible, preferably no more than three years. Businesses often blurt their secrets — whether a secret-sauce process or a business arrangement. Resist the temptation. This is only a preliminary presentation. If the investors want more information, you can either give them a full offering prospectus later or permit them to review the books and records of the company as part of a formal due diligence investigation.
2. Stick to the Anchors
Just as shopping centers have department stores as anchor tenants, most private offerings have two or three major purchasers as anchor investors. When discussing the business plan with potential investors, it is safer to skip the friends-of-friends-of-friends. Companies should focus on serious investors who would purchase a significant portion of the offering. The smaller investors can wait until the company has completed a more formal private offering memorandum available for broader distribution. Also, by sticking with anchors, businesses will less likely be speaking to potential competitors or toxic investors on the prowl for an unlucky company to sue. Firms selling securities also have the luxury of negotiating the basic terms with serious anchor investors. Once these terms are finalized, the company will have far more confidence in the structure of the offering and the chances that they will sell the shares needed.
3. Manage Paper and Protect Emails
Disgruntled investors seeking reimbursement often assert that the company selling the stock aggressively solicited many, many people. This triggers a variety of state and Federal laws that expose the persons selling securities to liability. Companies should undertake a course of conduct that creates a clear record of precision and care in disseminating materials. These precautions protect against claims that the issuer of securities effectively “advertised” the offering and should be subject to heightened standards of disclosure. Therefore, companies should (a) password protect electronic copies of documents, (b) stamp documents as confidential (preferably in color), (c) require confidentiality agreements from the recipients, (d) number the copies of documents distributed, (e) warn recipients against re-distribution, and (f) require that only the company or its designated advisor may distribute any information.
4. Aim to Disclaim
Companies should use some of the standard disclaimers for preliminary offering materials. These include disclaimers concerning (a) the use of “forward-looking statements” such as projections, (b) the qualification of the materials by a definitive offering memorandum, (c) the incompleteness of the information, (d) the absence of a formal offer to sell the securities, (e) the absence of any intended registration of the securities under state or Federal law, and (f) the high risk of the company and the chance that any purchaser of the stock could lose all of the purchaser’s money.
5. Be Exclusive
Companies often present preliminary business plans to small groups of investors at invitation-only meetings, whether at law firms or in hotel suites. Businesses should confirm with the organizers that the persons have been invited and have a pre-existing relationship with the organizer. Open-call meetings, especially those posted on the internet, mass mailings or newsletters, create the appearance that the company was indiscriminately “advertising” the opportunity to any stranger who would listen. Instead, companies should stick to private and well-controlled meetings.
6. Leave “Don’t Ask Don’t Tell” to the Army: Disclose Significant Problems
With company officers pressured to raise funds, discussing a flaw with the business plan or a past failure is as painful as announcing an embarrassing personal medical condition. Rather than avoid the problem, companies should address the situation and solution directly. For example, companies often gloss over losses, a negative net worth or lack of an operating history. Alternatively, the critical piece of intellectual property might be licensed from a third party. This will arise sooner or later — might as well have a convincing story up front. Companies need not give all the confidential details — names, dates and terms — but should be open about the general situation.
7. Beware the Unregistered Finder
Companies might use the services of an agent to find investors. At times, firms might use an agent that is not a registered broker dealer with the Securities Exchange Commission or has not passed the necessary examinations required for securities licenses. When unregistered finders represent a company and distribute the preliminary business plans, the entity issuing the securities might lose the benefits of exemptions from registration. The result — investors receive an easy excuse to demand their money back, with interest. It’s better for the company itself to simply promote the securities or use a registered broker-dealer.
8. Walk Away Empty Handed
Nothing suggests that a company was selling securities more than taking a check or having a prospect sign a subscription agreement. If the firm is still testing the waters and feeling out potential investors with preliminary business plan presentations, then closing the sale should come later. If a company would like to take the check, it will not only need a full private offering memorandum, but the potential investor should receive the document with enough time to read the memorandum and ask follow up questions of the management. Acceptance of payment should await formal delivery of an offering memorandum or purchase agreement with robust disclosure schedules.
9. Stay Close to Home
Each state has its own set of securities laws. While state rules are generally consistent regarding testing of the waters and preliminary disclosures, variations are possible. If the company solicits investors outside of their home state, the firm should review the securities requirements of the other state. Places such as California, Texas and Florida pose particular problems for out-of-state firms selling their stock. A company should double-check these rules to avoid accidentally triggering claims that it was advertising or selling securities.
10. Other Than Death and Taxes, Nothing is Certain
Firms eager to sell stock commonly brag that they can guaranty investors a return on investment. In addition, companies assert that they “will” achieve a particular milestone, without qualification. These overconfident assertions of certainty are the cyanide of securities offerings. Investors time and again file complaints with the government or courts citing such promises. Definitive statements are like poison to an effective defense that a company never promised anything. Better to use softer words such as “anticipates” or “is likely” or “may”. Unless it is death or taxes, companies should guaranty practically nothing.
For more information, contact Craig McCrohon at firstname.lastname@example.org or 312/840-7006.