Solving the Rule 145 Problem in Reg CF Acquisitions
The Rule 145 “problem”
Several companies looking to raise on Wefunder have recently asked us whether having unaccredited investors will create problems in a future acquisition. In particular, Rule 145 under the Securities Act of 1933 has been identified as problematic in mergers where the payout is (at least partly) in acquirer stock. Under Rule 145, an acquiring company is deemed to be offering its securities to the target company’s investors if they have the right to vote on the acquisition, because investors who can vote are making an investment decision regarding the securities they would receive. This means the acquirer’s “offer” to the target’s investors would require registration or an exemption from registration (such as Reg D or Reg CF).
There has been much hand-wringing over the “Rule 145 problem,” with some securities lawyers advising their clients that raising from unaccredited investors will kill their ability to be acquired in the future. These concerns are vastly overblown. In almost all circumstances, Rule 145 either doesn’t apply, can easily be avoided, or can easily be complied with.
Easy solutions exist
Let’s break down the categories of acquisitions that a company might face.
First, Rule 145 only applies to acquisitions where the payout includes a private company’s stock. For acquisitions that are all-cash or by a public company (with registered shares), Rule 145 doesn’t apply.
Next, because Reg D is available where the target’s investors are accredited, Rule 145 only becomes an issue when the investors receiving the acquirer’s stock are unaccredited. Importantly, if investors are aggregated in an SPV which has at least $5 million in assets (ie., acquirer stock), then the SPV qualifies as an accredited investor and Reg D is available as an exemption. The acquirer would only need to file a Form D (a quick and easy filing). Wefunder has used SPVs for Reg CF raises since spring 2021, though to our knowledge all other platforms are still using direct investments or a custodial structure.
When the above solutions don’t apply, there is another simple solution: convert shares held by unaccredited investors into non-voting shares (ie., shares that don’t vote on acquisitions). Rule 145 only applies when an acquisition is “submitted for the vote or consent” of stockholders, either due to state law or the company’s governing documents. Thankfully, most of the common states for incorporation allow for shares that don’t vote in acquisitions, including Delaware, New York, California, Utah, and Nevada (although Texas does not). This means that if the company amends its governing documents so that the class of shares held by unaccredited investors has no right to vote on acquisitions, then Rule 145 won’t be triggered for those investors. Since the company already needs to get the consent of its board and stockholders to complete the merger, this boils down to just a couple pages of paperwork.
The circumstances described above probably constitute 99% of cases. The tiny sliver that remains are companies incorporated in Texas or another jurisdiction that provides for inalienable voting rights, that are unwilling or unable to re-incorporate elsewhere, and whose investors are not in an SPV or are in an SPV with under $5 million in assets. In this case there are essentially two solutions: pay out the unaccredited investors in cash, or use Reg CF as the exemption, requiring a Form C filing by the acquirer. In this case, Wefunder will draft and file the Form C for free on behalf of the acquirer.
Rule 145 was enacted long before fundraising from unaccredited investors was a common practice, and it appears that the SEC did not consider it when enacting Reg CF. It’s hard to believe they intended to hamstring companies taking advantage of this new regulation by precluding an important exit option. Therefore, we see Rule 145 as more of a legal technicality than a real-world problem.
Thankfully, the legal technicality has a number of simple solutions. Companies considering raising from their community should proceed with confidence that all the normal exit options will remain available to them.
1. An entity is an accredited investor if it (1) has total assets in excess of $5 million and (2) was not formed for the specific purpose of acquiring the securities offered (see Rule 501(a)(3)). Note that the SPV was formed for the purpose of acquiring the original Reg CF securities, not the acquirer securities being issued in the merger.
2. Many companies’ Certificate of Incorporation requires the vote of a class of investors in order to amend the Certificate in a way that is detrimental to that class. As long as the company has a Lead Investor or other proxyholder, usually only a single vote will be required for the Reg CF investors to approve this.
3. Technically, the acquirer in a merger is usually a merger subsidiary, which is an empty shell company (see the triangular merger structure). This means a Form C could be filed on behalf of the merger sub as the issuer, and any disclosures would reference that empty shell company. However, the parent company might be considered a co-issuer in this transaction - existing case law is unclear. If the acquirer wanted to be conservative, they could provide disclosures on behalf of the parent, including two years of financial statements. For example, 2019 and 2020 year-end financials would be required for Form C filings made up until April 30, 2022.