Section 4(a)(2) Private Placement Guide

Find Out What You Need to Know About Section 4(a)(2) Private Placements from the Securities Lawyers at Oberheiden P.C.

Attorney Nick Oberheiden
Section 4(a)(2) Private Placement
Team Lead

While selling securities can be a highly effective means of raising capital, not all companies that need to raise capital are in a position to conduct an initial public offering (IPO). Fortunately, conducting an IPO isn’t the only option. Although the Securities Act of 1933 generally requires securities offerings to be registered, it also provides for a handful of exceptions.

One of these exceptions is a private placement under Section 4(a)(2).

But while Section 4(a)(2) private placements are exempt from registration, companies seeking to raise capital privately still need to prioritize compliance. Failing to comply with Section 4(a)(2) (or one of its alternatives) can have serious legal ramifications. Not only can dissatisfied investors sue, but the U.S. Securities and Exchange Commission (SEC) can pursue enforcement action as well. With this in mind, here is an overview of what company owners and executives need to know about conducting a Section 4(a)(2) private placement:

What is Section 4(a)(2)?

Section 4(a)(2) is a provision of the Securities Act of 1933 that allows companies to conduct private securities offerings without complying with the Securities Act registration requirements. These “private placements” can be an efficient and cost-effective way for companies to raise capital from investors through the issuance of securities. While Section 4(a)(2) private placements are most often used to sell a company’s shares, they can be used to raise capital through the issuance of other types of securities as well.

What Are the Requirements for a Section 4(a)(2) Private Placement?

While Section 4(a)(2) compliance is deceptively complicated, there are two main requirements for conducting an unregistered securities offering under this section of the Securities Act of 1933. These requirements are:

The issuance must be “private;” and,
The company may only offer securities to “sophisticated investors.”

Unlike certain other securities registration exemptions, Section 4(a)(2) does not establish a maximum number of investors or a maximum dollar value of securities issued. As the SEC explains:

“The precise limits of the private placement exemption are not defined by rule. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show that the offering qualifies for this exemption. If your company offers securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Securities Act.”

Thus, when conducting private placements under Section 4(a)(2), companies must be extremely careful to not only ensure compliance—but to document their compliance with financial and business matters as well. In the event that the SEC questions the “private” nature of a Section 4(a)(2) offering, this documentation will be critical for avoiding unnecessary consequences.

What Constitutes a “Public Offering” Under the Securities Act of 1933?

Despite the importance of avoiding a public offering when relying on the Section 4(a)(2) of the Securities Act exempts registration, the Securities Act of 1933 does not define what constitutes a “public offering.” However, the SEC and federal courts have provided some guidance over the years. Deciding whether a securities offering is suitably “private” requires consideration of factors such as:

The number of investors who receive an offer to invest;
Whether the offering is made only to sophisticated investors;
Whether the issuer conducts any general solicitations or public advertising;
Whether the securities are restricted; and,
The information provided to prospective investors.

Avoiding a public offering is essential. When you engage an experienced securities lawyer to assist with your company’s offering, your company’s lawyer will be able to assist with ensuring the offering remains private in nature.

Who Qualifies as a “Sophisticated Investor” Under Section 4(a)(2)?

It is also essential to ensure that your company’s offering is limited to sophisticated investors. An investor can be deemed “sophisticated” based on either: (i) having sufficient knowledge and experience to “evaluate the risks and merits of the investment;” or, (ii) having sufficient financial resources to be able to bear the economic risk of investing.

How is Section 4(a)(2) Different from Regulation D?

Regulation D provides alternative routes to conduct a private placement—and it differs from Section 4(a)(2) in several critical respects. Among them, while Section 506(c) (one of the most commonly used Regulation D registration exemptions) allows companies to publicly advertise private placements, companies relying on Section 506(c) can only sell their securities to “accredited investors.”

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.)

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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 is Section 4(a)(2) Different from Rule 144A?

Section 4(a)(2) differs from Rule 144A in several critical respects as well. Most notably, while companies conducting private placements under Section 4(a)(2) must ensure that investors “agree not to resell or distribute the securities to the public,” Rule 144A deals specifically with resales of securities purchased through private placements. As a result, Rule 144A most often comes into play when investors seek to sell restricted securities acquired through a Regulation D private placement.

When Should Companies Choose Section 4(a)(2) over Regulation D or Rule 144A?

Whether a company should choose Section 4(a)(2) over SEC adopted Regulation D or Rule 144A depends on its specific goals and the prospective investors it is intending to target. There is no single “right” answer when it comes to choosing how to conduct a registration-exempt private placement. Instead, company owners and executives need to make informed and strategic decisions based on the specific circumstances of each individual offering.

Do You Need a Private Placement Memorandum (PPM) for a Securities Offering Under Section 4(a)(2)?

Prospective investors in a Section 4(a)(2) private placement must “have access to the type of information normally provided in a prospectus for a registered securities offering.” While the SEC does not specify how companies must provide this information, the private placement memorandum (PPM) has become the go-to disclosure document for private placements in recent years. A custom-tailored PPM is critical, as companies need to ensure that they provide prospective investors with all required information based on the specific details of their unregistered offerings.

Do You Need a Subscription Agreement for a Securities Offering Under Section 4(a)(2)?

Similar to a PPM, while a subscription agreement is not specifically required under the law, using one is essential for protecting the company (and its owners and executives) during a Section 4(a)(2) private placement. A well-crafted subscription agreement will clearly outline the terms of the securities issuance (including the restriction on transfer) while also incorporating other necessary legal protections.

Are There Risks Involved with Conducting a Section 4(a)(2) Private Placement?

Yes, as with any securities issuance, there are risks involved with conducting a Section 4(a)(2) private placement. Two of the most significant risks are:

The SEC deeming the securities issuance to be a public offering rather than a private placement; and,
Investors filing fraud claims based on inadequate disclosures and other alleged failures.

However, companies can effectively mitigate these risks with a proactive and detail-oriented approach to compliance. By using a custom-drafted PPM, subscription agreement, and other necessary documentation, companies can both: (i) establish compliance with Section 4(a)(2); and, (ii) ensure that they are prepared to withstand scrutiny from the SEC (or in court) if necessary.

Why Isn’t Section 4(a)(2) as Popular as Regulation D?

Regulation D is more frequently used than Section 4(a)(2) because it allows companies to raise funds from a larger pool of prospective investors. However, Section 4(a)(2) can be a better option in certain specific circumstances, and it is important to consider all of the options that are available before deciding how to proceed with a private securities offering.

Is Section 4(a)(2) Different from Section 4(2)?

No, there is no difference between Section 4(a)(2) and Section 4(2). The law formerly known as Section 4(2) was recodified as Section 4(a)(2) under the Jumpstart Our Business Startups (JOBS) Act of 2012.

Can Companies Conduct a Series of Private Placements to Avoid SEC Registration?

No, the Securities Act prohibits companies from conducting a series of private placements as a way to avoid conducting a registered public securities offering. If conducting a Section 4(a)(2) private placement does not adequately meet a company’s capital-raising needs, a Regulation D private placement may be a viable alternative—as this allows companies to target a larger pool of prospective investors while still avoiding the SEC registration process.

What is the First Step for Conducting a Section 4(a)(2) Private Placement?

If you are interested in conducting a Section 4(a)(2) private placement, the first step is to consult with an experienced securities lawyer who can guide you through the process and prepare all necessary documents (including, but not limited to, a PPM and subscription agreement). An experienced securities lawyer will be able to assist with evaluating potential alternatives to a Section 4(a)(2) private placement (such as a Regulation D private placement) as well.

Schedule a Call with a Section 4(a)(2) Private Placement Lawyer at Oberheiden P.C.

To discuss your company’s capital-raising goals with a Section 4(a)(2) private placement lawyer at Oberheiden P.C., contact us today to help you make an informed investment decision. Call us at 888-680-1745 or tell us how we can reach you online to schedule a call at a time that is convenient for you.