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October 5, 2017
Private Securities Offerings: Background and Legislation
Companies turn to a variety of sources to access the funding
public offering (IPO, the initial offering of the stock of a
they need to grow and make new investments. Among them
private company to the public). Public companies may also
are capital markets, segments of the financial system in
issue private offerings.
which capital is raised through equity securities (assets that
As both public and private companies issue private
represent ownership stakes in a firm) and debt securities
offerings, public and private offerings differ by SEC
(assets that represent creditor relationships with a firm).
registration status, instead of issuer type. Below are
The Securities and Exchange Commission (SEC) is the
descriptions of key registration exemptions under federal
principal regulator of the nation’s securities markets. In
securities laws that enable the issuance of private offerings.
general, the agency requires that offers and sales of
Regulation D (17 CFR §230.501 et seq.), Rule 144A (17
securities either be registered with the SEC or be
CFR §230.144A), and Regulation A (17 CFR §230.251
undertaken with an exemption from registration. A
through §230.263) are examples of exemptions that
fundamental goal of registration is ensuring that investors
establish private offerings.
receive financial and other significant information on the
securities being offered for public sale.
Regulation D is the most frequently used exemption to sell
securities in unregistered offerings. Companies relying on a
Figure 1. Aggregate Capital Raised in Securities
Regulation D exemption do not need to register their
Markets in 2009-2014 by Offering Method ($Billions)
offerings with the SEC, but they face limitations regarding
size and investor type of their offerings.
Rule 144A is for resale transactions only. Issuers generally
use it in a two-step process to first facilitate a primary
offering on an exempt basis to financial intermediaries, and
then resell to qualified institutional buyers (QIBs, a
corporation that is deemed to be an accredited investor).
Regulation A is an exemption to facilitate capital access for
small to medium-sized companies. It has fewer disclosure
requirements than the registration process. Regulation A
was updated in 2015 with a two-tiered structure (Regulation
A+) to exempt from registration the offerings of up to $50
million annually, if specified requirements are met.
Source: Scott Bauguess et al., Capital Raising in the U.S: An Analysis of
Going Public or Remaining Private
the Market for Unregistered Securities Offerings, 2009-2014, October
Companies choose to go public to access capital that would
2015, https://www.sec.gov/dera/staff-papers/white-papers/
allow founders to cash out their investments, to provide
unregistered-offering10-2015.pdf.
substantial stock and stock options to employees and
Registered offerings, often called public offerings, are
management incentive plans, and to fuel the company’s
available to all types of investors. By contrast, securities
future growth. Public companies also benefit from
offerings that are exempt from SEC registration are referred
“liquidity premium,” which translates into better share
to as private offerings, private placements, or unregistered
pricing compared with stock from comparable private
offerings. They are mainly available to financial institutions
offerings, among other things.
or individual investors with certain financial or income
There are also advantages, however, for firms to remain
wherewithal known as accredited investors. As such, the
private.
SEC registration process, which enables investors to access
key financial information, can be viewed as a dividing point
Compliance costs. Proponents of the proposals believe the
between public and private securities offerings.
costs of registration are large in magnitude and
disproportionately burdensome for small and medium-sized
Private offerings, which can range from $100,000 to tens of
businesses, including startup firms. The direct costs include
millions of dollars, have outpaced public offerings in recent
underwriting, external auditing, legal and financial
years to become the preferred option for raising capital (see
reporting fees.
Figure 1). According to a SEC staff whitepaper, the private
debt and equity offerings for 2012 through 2016 combined
Business operations. Public companies are often perceived
exceeded the public offerings by about 26%.
to face incremental market pressure for short-term
Public and Private Securities Offerings
performance, reduction in insider control and decision-
making flexibility, and contention with increased
As stated earlier, companies may be able to access a variety
shareholder activism (which sometimes could be to a firm’s
of funding sources. Some private companies do conduct
financial benefit). Some research has indicated that going
private placements; some eventually go public via an initial
https://crsreports.congress.gov
Private Securities Offerings: Background and Legislation
public can adversely impact corporate innovation; however,
placements by expanding the exemptions for registration or
there are also many examples of innovative public
adjusting related definitions.
companies.
Section 452 of H.R. 10. The provision would direct the
Access to Private Offerings: Unicorns
SEC to revise Regulation D, which exempts certain
Versus Small and Emerging Companies
offerings from SEC registration requirements but prohibits
Although the vast majority of firms that conduct private
general solicitation or general advertising with respect to
offerings are small to medium sized, proponents of private
such offerings. Under this provision, the prohibition would
offerings point to unicorns as an example of how private
not apply to events with specified kinds of sponsors,
companies allow for rapid growth and innovation. The term
including “angel investor groups” that are unconnected to
unicorn refers to startup companies that have achieved a
broker-dealers or investment advisers, if specified
valuation of at least $1 billion, while remaining privately
requirements are met.
funded (which has often been done through private
Section 461 of H.R. 10. The provision would exempt
placements). According to the Wall Street Journal and Dow
certain micro-offerings from (1) state regulation of
Jones VentureSource, the number of U.S. unicorns grew
securities offerings and (2) federal prohibitions related
from 32 in January 2014 to 100 in August 2017.
to interstate solicitation. This exemption would allow for
Figure 2. Top 10 U.S. Unicorn Valuations ($Billions)
the participation of small offerings without triggering the
Securities Act registration and state Blue Sky securities
laws.
Section 497 of H.R. 10. The provision would expand the
number of non-accredited investors allowed for private
offerings under the SEC registration threshold.
Section 498 of H.R. 10. The provision would increase the
upper limit of offerings that are exempt from registration,
subject to eligibility, disclosure, and other matters as
specified in Regulation A+.
Section 860 of H.R. 10. Private offerings are generally
limited to more sophisticated institutional or individual
accredited investors who have higher net worth and income
levels than non-accredited investors. The provision would
expand the category of investors that may be considered
accredited investors for purposes of participating in private
offerings. The proposed change would expand the size of
the eligible investor pool for private offerings.
Key Policy Issues
Source: Wal Street Journal, August 2017, http://graphics.wsj.com/
bil ion-dol ar-club/
The policy debate surrounding the legislative provisions to
.
Note: U.S. companies valued at $1 bil ion or more by venture capital
promote private placements is an illustration of the
firms.
tradeoffs between investor protection and capital formation,
two of the SEC’s statutory mandates. Capital formation
Mutual funds, hedge funds, sovereign-wealth funds and
needs may be better met if issuers could elect their
other institutional investors not traditionally known for
preferred methods of fundraising without regard to
investing in startups are now allocating capital toward
registration, as the registration process raises the cost of
private offerings. Going public is arguably no longer a
accessing securities markets. On the other hand, the
necessity for certain private companies to raise capital.
investor protection challenges potentially increase as more
However, concerns persist that small and less technology-
investors gain access to private offerings. For example, will
driven companies face difficulties in accessing capital.
non-accredited investors and less sophisticated accredited
SEC’s Advisory Committee on Small and Emerging
investors be able to comprehend the higher relative risks
Companies stated in May 2017 that “identifying potential
often embedded in unregistered private offerings issued by
investors is one of the most difficult challenges for small
the small, medium-sized, and start-up companies that
businesses trying to raise capital.”
dominate private placements? Other policy considerations
include the choices between a “one size fit all” legislative
Legislation That Would Broaden Private
approach and the more tailored regulations to account for
Placements
factors such as a firm’s size, a firm’s industry, and the
Signed into law in 2012, the Jumpstart Our Business
investment limits to non-accredited and/or accredited
Startups (JOBS) Act expanded various exemptions to
individual investors.
facilitate capital formation. In the 115th Congress, the
Financial CHOICE Act (H.R. 10) has provisions that would
Eva Su, Analyst in Financial Economics
further modify the restrictions on private offerings. The
following legislative provisions, as passed by the House,
IF10747
are aimed at increasing capital formation through private
https://crsreports.congress.gov
Private Securities Offerings: Background and Legislation
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https://crsreports.congress.gov | IF10747 · VERSION 2 · NEW