On October 7, 2020, the SEC proposed the creation of “limited, conditional” exemptions from broker-dealer registration for certain “finders” in private company capital raising transactions. This has long been a problem area for private companies, as current regulations impose restrictions that may prevent them from using unregistered finders to raise capital, or impose draconian penalties on them if they do. Since these companies are often unable to raise capital on their own and normally do not have access to the efforts of established, registered broker dealers, the already difficult challenge of raising early stage capital is made even more difficult. The SEC’s October 7, 2020 Press Release and Fact Sheet lay out these proposed exemptions in detail, and the Fact Sheet contains links to a chart and a video that may be helpful.
It’s too early to tell if these proposed exemptions will be beneficial to small companies. Will they actually facilitate small companies’ ability to raise early stage capital? That remains to be seen, but it’s a positive sign that the SEC is expending at least some efforts to help small companies in their capital raising efforts.
Here are the high points of the proposed exemptions:
- Two tiers (Tier I and Tier II) will be created for the classification of finders.
- Tier I finders will be able to conduct limited capital raising activities:
- Tier I finders’ activities will be limited to providing contact information of potential investors in connection with only a single capital raising transaction by a single issuer during a 12-month period. A Tier I finder will not be permitted to have any contact with a potential investor about the issuer.
- Tier II finders will be able to conduct more extensive capital raising activities:
- A Tier II finder will be permitted to solicit investors on behalf of an issuer, but the solicitation-related activities are limited to: (a) identifying, screening, and contacting potential investors; (b) distributing issuer offering materials to investors; (c) discussing issuer information included in any offering materials, provided that the Tier II finder does not provide advice as to the valuation or advisability of the investment; and (d) arranging or participating in meetings with the issuer and investor.
A crucial component of these new exemptions is that qualifying Tier I and Tier II finders will be allowed to accept transaction-based compensation under these new exemptions. This is a key item that is prohibited under current regulations.
Both Tier I and Tier II finders will be subject to a number of restrictions, including that the issuer is not required to make public filings, no general solicitation is used in the offering, and investors in the offering are accredited investors. A number of other restrictions will also be imposed, and Tier II finders will be subject to several additional restrictions. These Tier I and Tier II exemptions from registration will only be available to natural persons.
There is no assurance that the SEC will finalize these new conditional exemptions in this form or at all. Commissioners Lee and Crenshaw came out strongly against these exemptions, and Commissioner Crenshaw called them “a radical departure from established registration requirements” and cautioned that this relaxation of registration requirements was not good in an area that is “prone to fraud”. Her concerns are not wrong based on history, but I believe that this relaxation of registration requirements can have an overall positive effect. Since only accredited investors will be involved, smaller investors will be protected from harm since they won’t be able to participate. Chairman Clayton also made it clear that these exemptions from registration will be very narrowly drawn, and this should help to ensure that their potential negative effects are limited.
The next step will be a 30-day public comment period beginning when these new rules are published in the Federal Register. All interested parties should monitor this situation given its importance to private company capital raising and small companies generally. Here’s hoping that these conditional exemptions are enacted and that they will provide some much-needed relief and flexibility to private companies seeking capital.