Private Placement Debt Offering Guide

This Guide Explains the Key Legal Considerations and Steps Involved in Conducting a Private Placement Debt Offering

Contact Nick

Raising capital by issuing debt in a private placement market can be a desirable financial strategy for both new and existing companies in a wide range of circumstances. While working with traditional lenders will make sense in some scenarios, oftentimes, it will be more advantageous for companies to conduct private debt placements.

When conducting private debt placements, companies must determine what statutes and regulations apply, and they must take a proactive and comprehensive approach to statutory and regulatory compliance. In many cases, this will involve conducting a private placement debt offering in accordance with federal securities laws and the U.S. Securities and Exchange Commission’s (SEC) Regulation D.

When is a Private Placement Debt Offering Required?

A private placement debt offering is required when the specific type of debt issuance involved constitutes a “security” under federal law. Under 15 U.S.C. Section 77)(b)(a)(1), the definition of a “security” includes:

• Bonds
• Debentures
• Notes
• Other “evidence of indebtedness”

While not all forms of debt constitute securities asset class under federal law, many do. When companies seek to raise capital by issuing debt to institutional investors, the federal securities laws will almost always come into play. This means that companies conducting debt offerings must often either:

• Register their debt offerings with the SEC; or,
• Conduct a private placement in reliance on a federal securities registration exemption.

Due to the substantial costs involved with conducting a registered securities offering, conducting a private placement will be the preferred option in most cases. With regard to the legal aspects involved, to purchase private placements is comparatively cheap, and avoiding the need to register with the SEC substantially reduces the timeline involved as well.

But while conducting a private placement allows companies to raise capital through a debt offering without registration, there are still legal requirements involved. As a result, it is essential to understand how a private debt offering works—and to ensure that companies, such as large insurance companies, take all of the necessary steps to protect themselves against the risk of facing both fraud claims from investors and enforcement action from the SEC.

Put our highly experienced team on your side

Dr. Nick Oberheiden

Founder

Attorney-at-Law

Lynette S. Byrd

Former DOJ Trial Attorney

Partner

Brian J. Kuester

Former U.S. Attorney

Hon. Kevin McCarthy

55th Speaker, U.S. House of Representatives (ret.)

Government Consultant

Mike Pompeo

Of Counsel

Former U.S. Secretary of State

John W. Sellers

Former Senior DOJ Trial Attorney

Linda Julin McNamara

Federal Appeals Attorney

Nicholas B. Johnson

Former Prosecutor

Roger Bach

Former Special Agent (DOJ)

Chris J. Quick

Former Special Agent (FBI & IRS-CI)

Michael S. Koslow

Former Supervisory Special Agent (DOD-OIG)

Ray Yuen

Former Supervisory Special Agent (FBI)

How Does a Private Placement Debt Offering Work?

With this in mind, how does a private placement debt offering work? While individual companies’ needs vary widely, broadly speaking, the primary steps involved are:

1. Considering the Various Registration Exemptions for Debt Security Offerings

Several registration exemptions exist under the federal securities laws and regulations in the United States. In most cases, however, companies seeking to conduct private placement debt offerings will choose between three common options—all of which are available under Regulation D:

• The Rule 504 Exemption – Rule 504 of Regulation D allows companies to issue up to $10 million in debt securities in a 12-month period to both accredited and non-accredited investors (though non-accredited investors must be “financially sophisticated”).
• The Rule 506(b) Exemption – Rule 506(b) of Regulation D allows companies to issue an unlimited amount of debt securities to an unlimited number of accredited investors and up to 35 non-accredited investors.
• The Rule 506(c) Exemption – Rule 506(c) of Regulation D allows public companies to publicly promote and issue an unlimited amount of debt securities to an unlimited number of accredited investors, provided that they verify investors’ “accredited” status.

For an overview of the requirements for assessing “accredited investor” status, you can read this Investor Bulletin from the SEC.

2. Choosing the Most Suitable Registration Exemption

After considering the options that are available, company owners or executives will need to choose the registration exemption that is best-suited to their proposed private placement of debt. If the company is seeking to raise $10 million or less, then focusing on Rule 504 compliance may be the best approach. However, if the company is seeking to raise more than $10 million, then it will need to choose between Rule 506(b) and Rule 506(c) (unless it chooses another alternative).

Many companies opt to conduct unregistered debt security offerings under Rule 506(c). While this eliminates the option of issuing debt to non-accredited investors, (i) most investors in this type of public offering will meet the requirements for “accredited” status; and, (ii) choosing this option also allows companies to avoid concerns about inadvertently engaging in “public” promotions.

3. Preparing a Private Placement Memorandum (PPM)

Regardless of which option a company’s owners or executives choose, one of the next major legal steps in the process will be to prepare a private placement memorandum (PPM). While not strictly required under Regulation D, preparing a PPM serves several important legal functions, and most sophisticated investors will expect to receive a PPM when solicited for a private debt offering.

A PPM is effectively a disclosure document that informs prospective investors of the nature of the security being offered and the risks involved in investing. Private placement memorandums will also typically include information about the company and its executives, as well as an explanation of how investors’ funds will be used and the steps investors need to take in order to invest (or “subscribe” to the private placement). When drafting a PPM, a custom-tailored approach is key, as nearly all aspects of the document will need to reflect the unique aspects of the debt offering in question.

4. Performing Due Diligence on Prospective Investors

When deciding whether to issue a PPM to a prospective investor and deciding whether to approve a prospective investor to subscribe, due diligence is essential. This is true whether prospective investors are accredited or non-accredited, and whether the company is conducting its private debt placement under Rule 504, Rule 506(b), Rule 506(c), or another federal securities registration exemption. Ensuring that all investors are financially qualified will help mitigate the company’s risk of facing litigation related to its private debt placement—and will help to establish defenses in the event of litigation as well.

5. Issuing Debt Securities with Appropriate Terms, Conditions, and Documentation (and Filing Form D with the SEC)

Along with a PPM, companies conducting private placement debt offerings will also need a subscription agreement, and they may need a variety of other legal contracts and forms as well. These, too, should be custom-tailored to the debt offering in question. Including appropriate terms and conditions in the subscription agreement will be critical for mitigating the company’s risk of liability, and an experienced federal securities lawyer will be able to assist with putting the necessary terms and conditions in place.

Once a company issues its first debt security in a private placement, it must file Form D with the SEC. The company’s securities law counsel will be able to assist with this as well.

When Should a Company Consider a Private Placement of Debt?

When should a company consider a private placement of debt? If a company is seeking to raise capital through debt and is either unable to raise sufficient capital from traditional lenders or uninterested in working with a traditional debt funding source, then a private placement of debt may be the best (and perhaps only) option. As discussed above, issuing debt in this scenario will typically involve the issuance of securities—and, short of registering with the SEC, this brings the private placement provisions of federal securities laws and Regulation D into play.

What Are the Risks Involved in Conducting a Private Placement of Debt?

While conducting a private debt placement can be an attractive option in many scenarios, there are legal risks involved. These risks broadly fall into two categories:

1. Civil Litigation Risks

If investors in the corporate debt offering become dissatisfied, they may seek to recoup their private placement investment losses (plus additional damages) in civil litigation. As discussed above, the company’s PPM, due diligence documentation, and subscription agreement can all be critical for mounting a successful defense.

2. SEC Enforcement Risks

The SEC is increasingly pursuing enforcement in cases involving unlawful unregistered securities offerings. While most SEC enforcement actions are administrative or civil in nature (presenting risks for debarment from the securities industry, fines, and other penalties), Commission staff do not hesitate to pursue criminal charges working alongside prosecutors at the U.S. Department of Justice (DOJ) when warranted.

What Are the Alternatives to a Private Placement Debt Offering?

Along with private debt offerings, companies seeking to raise capital outside of the traditional markets have a variety of other options as well. For example, many companies also use PPMs and subscription agreements to issue equity securities—and, while these securities may be more high-risk for investors, they can present less risk for issuers (provided that they take the necessary steps to protect themselves).

Schedule a Call with a Federal Securities Attorney at Oberheiden P.C.

If you would like more information about the legal considerations involved in pursuing a private placement debt offering, we invite you to get in touch. We will be happy to schedule a complimentary initial consultation at a time that is convenient for you. To speak with a senior federal securities attorney at Oberheiden P.C. in confidence, give us a call at 888-680-1745 or request an appointment online today.