Private Placement Bonds: Answers to FAQs

Learn Everything You Need to Know About Using Private Placements to Raise Capital Through Bonds

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Similar to raising capital through the issuance of shares in a private placement, privately issuing bonds requires a cautious approach and a commitment to federal compliance. In this scenario, bonds can be classified as “securities” under federal law, and this implicates a host of statutory and regulatory requirements.

With this in mind, companies that are considering a private placement of bonds need to ensure that they take all of the steps that are necessary to comply with the law. In most cases, this means complying with the requirements for conducting a private placement under either Rule 504 or Rule 506 of Regulation D.

When is a Debt Issuance Classified as a “Security”?

To understand when a bond can be classified as a “security,” we need to look at the definition of a “security” under federal law. This definition appears in 15 U.S.C. Section 77b(a)(1):

“The term ‘security’ means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights . . . or, in general, any interest or instrument commonly known as a ‘security,’ or any certificate of interest or participation in . . . any of the foregoing.”

Regarding bonds specifically, the U.S. Securities and Exchange Commission (SEC) explains:

“A bond is a debt security. . . . Borrowers issue bonds to raise money from institutional investors willing to lend them money for a certain amount of time. . . . When you buy a bond, you are lending to the issuer . . . . In return, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the principal, also known as face value or par value of the bond, when it ‘matures,’ or comes due after a set period of time.”

In short, while not all debt issuances are classified as securities, bonds are securities by definition. Thus, when issuing bonds, companies must either comply with the federal registration requirements for public securities offerings or else comply with the requirements for an exemption from registration. For most companies, establishing eligibility for an exemption is the most cost-effective path forward. After establishing eligibility for a registration exemption, companies can then conduct a private placement of bonds.

When is a Bond Issuance Classified as a Private Placement?

A bond issuance is classified as a private placement when the issuance involves offering investment opportunities to individual investors off-exchange and outside of the over-the-counter (OTC) market. Companies of all sizes routinely conduct private placements involving bonds—and these private placement transactions account for the substantial majority of bond issuances in the United States.

How does a “private placement” work? The SEC explains this as well. Since bonds are securities by definition, private placement refers to any unregistered bond issuance under federal law:

“Under the federal securities laws, a company may not offer or sell securities unless the offering has been registered with the SEC or an exemption from registration is available.  Offerings exempt from the SEC’s registration requirements . . . are often referred to as private placements.”

This means that if a company is issuing bonds and it has not registered its bond offering with the SEC, it is conducting a private placement. Since conducting an unregistered securities offering without qualifying for a registration exemption can trigger substantial penalties, it is imperative that bond issuers take a proactive approach to private placement market compliance. Along with meeting the requirements for an unregistered private placement under Rule 504 or Rule 506 of Regulation D, bond issuers should document their compliance efforts as well. In most cases, this involves using a private placement memorandum (PPM).

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Do You Need a Private Placement Memorandum (PPM) to Issue Bonds?

Technically speaking, companies do not need to use a private placement memorandum (PPM) when conducting an unregistered bond offering. There is nothing in the federal securities statutes or Regulation D that says a PPM is required.

However, using a PPM is still a very good idea, and this has become standard practice in recent years. Not only does preparing a custom-tailored PPM assist with documenting Regulation D compliance, but it also helps ensure that qualified institutional buyers receive the information they need to make an informed investment decision. Omitting or misrepresenting material information—whether intentionally or inadvertently—can expose bond issuers to securities fraud claims in civil litigation (in addition to exposing them to possible SEC enforcement action).

When conducting a private bond issuance, simply having a PPM is not enough. Recycling a previously used PPM or buying a generic PPM form off the shelf can be dangerous, as the terms of the PPM must be specific to the private placement debt offering in question. As a result, it is essential that prospective bond issuers work closely with experienced securities law counsel to ensure that their PPMs are appropriately custom-tailored to the private placement offering and investment risks at hand.

How Does a Private Placement of Bonds Work?

How a private placement of bonds works depends on whether the issuer chooses to rely on Rule 504 or Rule 506 (or another less-commonly-used exemption under federal law). While the process is fundamentally the same from a legal perspective, the rules for soliciting prospective investors differ—including the rules about who is eligible to invest. Here are some of the key distinctions:

Private Placement of Bonds Under Rule 504

Rule 504 of Regulation D allows companies to issue up to $10 million of securities in any 12-month period. As the SEC explains, in a private placement under Rule 504, “securities may be sold to any number and type of investor, and the issuer is not subject to specific disclosure requirements.”

As the SEC goes on to explain, in most cases, “securities issued under Rule 504 will be restricted securities . . . unless the offering meets certain additional requirements.” As their name suggests, restricted securities are subject to limitations (or restrictions) on resale, and it is imperative that bond issuers adequately disclose all pertinent restrictions prior to issuance.

This is one of several reasons why it is important to use a PPM—even though no specific disclosure requirements apply under Rule 504.

Although private placement investments under Regulation D are exempt from registration, filing requirements still apply. Specifically, under both Rule 504 and Rule 506, bond issuers must file Form D with the SEC after their first sale. While Form D is fairly simple, especially in comparison to the extensive filing and disclosure requirements for registered securities offerings, it is still critical that bond issuers complete the form correctly and file it on time.

Private Placement of Bonds Under Rule 506

Rule 506 of Regulation D allows companies to raise an unlimited amount of capital through unregistered private placements. For this reason alone, Rule 506 is preferred to Rule 504 in most cases. Under Rule 506, bond issuers can choose between two methods of qualifying for exemption from the federal securities registration requirements:

• Rule 506(b) – Rule 506(b) allows private companies to issue bonds to an unlimited number of accredited investors and up to 35 non-accredited investors. Non-accredited investors (or their advisors) must “have sufficient knowledge and experience in financial and business matters to evaluate the investment.”
• Rule 506(c) – Rule 506(c) allows companies to generally solicit their bond offerings and sell bonds to an unlimited number of accredited investors. However, companies relying on Rule 506(c) must take “reasonable steps” to confirm each individual investor’s accredited status.

Investors can qualify as “accredited investors” in a handful of ways. These include (but are not limited to):

• Earning income in excess of $200,000 (or $300,000 with their spouse) in each of the prior two years with a reasonable expectation to earn the same level of income in the current year;
• Having a net worth of more than $1 million (either alone or together with their spouse); or,
• Holding a Series 7, 65, or 82 professional securities license in good standing.

Trusts, financial institutions, and business entities can qualify as accredited primarily institutional investors as well. Here too, when confirming an investor’s status as an “accredited investor,” documentation is key—and bond issuers will want to work closely with their securities law counsel to ensure that they have the documentation they need to withstand scrutiny from the SEC if necessary.

While strict federal requirements apply to companies conducting private bond placements, companies can confidently and efficiently meet these requirements with the right approach. If you are interested in using bonds (or other debt instruments) to raise capital for your company, we invite you to contact us for more information.

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