Developing new relationships and raising capital during this challenging environment for emerging managers has been facilitated by the confluence of regulatory modernization and technology adoption, providing tailwinds for those who choose to act.
Why have some private fund issuers decided to use this window and what are the benefits? How can managers avail themselves of modern marketing tools?
Josh Stone, principal of FundsLawyer PLLC. — a firm based in Miami that counsels investment funds and family offices — outlined what action regulators have taken so far over the issue of general solicitation.
“The SEC has given issuers, including private fund managers, more flexibility when conducting private placements to accredited investors in recent years, reflecting a desire to promote job growth from small businesses,” he said. “To implement specific requirements of the JOBS Act, in 2013 the SEC amended Regulation D to permit issuers to engage in general solicitation or general advertising when privately offering securities pursuant to new Rule 506(c).”
“This rule requires the issuer to take steps to verify that all purchasers are accredited investors. In furtherance of the SEC’s desire to promote the private placement markets, the definition of “accredited investor” was expanded in recent months to include, among others, persons with specific professional qualifications,” Stone added. “I would characterize the amendments as modest and not an opening of the floodgates.”
Looking toward the future, the SEC has proposed additional rules, exemptions and clarifications to facilitate issuers seeking to raise capital in the private placement markets.
Of particular note, just a few weeks back, the SEC issued a proposed exemption from broker-dealer registration to certain categories of “finders,” who are compensated for facilitating the raising of capital from accredited investors in private offerings. It was noted that this practice is currently taking place as part of a “gray market.” This is a significant step, and Stone said he would expect there to be strong opinions on both sides as the SEC receives comment letters on this proposal. For now, managers and their counsel still need to navigate the various no action letters and other guidance if they want to hire a third-party marketer in the U.S. that is not a broker-dealer.
A recent SEC release noted that in 2019, approximately $1.5 trillion was raised under Rule 506(b) of Regulation D (which prohibits general solicitation) and only approximately $66 billion was raised under Rule 506(c) of Regulation D (which allows general solicitation). The reasons for this are not completely clear to me as a practitioner. Perhaps issuers are hesitant to ask their investors for proof that they are in fact accredited investors. Maybe some fear that using 506(c) will attract more attention from the regulators. Certain larger issuers may believe that there is a difference in how they are perceived if they engage in general solicitation. Lawyers and other advisors may be discouraging the use of 506(c), since they view it as riskier or because they don’t see their peers recommending this course of action.
Issuers relying upon 506(b) that are interested in switching to 506(c) should be able to do so but should consult their counsel before making this change. We might expect to see additional efforts by the regulators to make issuers more comfortable using Rule 506(c) in the future, especially if the expansion of the private placement markets is seen as a politically advantageous move in favor of job growth.”
Is Rule 506(c) a panacea?
The SEC’s Rule 506(c), providing for general solicitation and advertising, presents a sea change for numerous managers. Whether you are planning an initial private fund launch, adding a new pooled investment vehicle to your product line-up or exploring means to widen overall marketing opportunities, the ability to broadly solicit and generally advertise a private offering (while complying with the additional conditions) opens enormous new channels of communication and use of modern marketing tools.
The SEC’s requirements for investor verification can be processed efficiently via secure online portals using established vetting technology provided by various service providers. In comparison with private offerings conducted under the longstanding and far more restrictive Rule 506(b), the newer Rule 506(c) offers regulatory tailwinds that facilitate relationship development and capital raising for those who are aware and willing to act.
How does the pandemic impact the opportunity set? During this unprecedented time while virtual meetings and digital marketing have become increasingly important if not critical to relationship development and growth, investment managers are well advised to take advantage of modern marketing tools to achieve wider message distribution and more robust communication.
Under Rule 506(c), managers of private offerings may communicate fund-specific information including investment strategy details and performance metrics to educate/inform prospective investors. Moreover, Rule 506(c) provides latitude for managers to discuss this type of information with the media and conduct press interviews covering fund specifics. The ability to cast a wider net in terms of reaching not only prospective investors but also the press should serve as welcome relief to all businesses seeking growth.
How many industry participants are even aware of this opportunity? Unfortunately, most private fund managers have not taken advantage thus far, as noted above in our discussion with FundsLawyer’s Stone, and the recent SEC Concept Release (Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets).
Why have some private fund issuers decided to use this window and what are the benefits?
“We filed for the 506(c) exemption primarily to access the broader set of marketing opportunities available to us. We are exploring additional marketing tools with a cautious approach rather than serve as a trailblazer in uncharted marketing paths,” said Matt Tullis, chief investment officer and founder of Regents Park Advisors. “Our firm uses an outsource vetting service that has worked extremely well. We don’t want to be in the investor vetting business.”
Jud Traphagen, founder and portfolio manager of Plough Penny Advisors, noted in conjunction with his use of the 506(c) exemption that digital marketing can help raise awareness about the firm’s fund, collect leads and reduce the amount of labor in the marketing and sign-up process.
“We will experiment with display ads, SEO, SEM, affiliate marketing, and social media to increase traffic to our site” he explained. “Investors will be vetted as Accredited Investors by an independent third party that specializes in doing online accreditation.”
How can managers avail themselves of modern marketing tools?
In conjunction with Rule 506(c), managers face a wide mix of modern marketing tools such as eblasts, social media, webinars, multimedia presentations with video, screen sharing and podcasts. New technology should be adapted to product-specific communication as well as development and dissemination of thought leadership content. Managers are advised to first develop an overall communications strategy and game plan to leverage digital marketing and PR.
The breadth of modern marketing tools for managers also includes virtual cap intro platforms which provide an important if not critical source of technology-driven relationship development to facilitate the capital raising process, particularly in this environment restricted to virtual meetings.
The cumulative effect of these tailwinds and marketing opportunities may be a panacea for some, or a potential sea change for many managers.