So long, Rule 505, We Barely Knew Ya'

The Securities and Exchange Commission (SEC) has repealed Rule 505 under Regulation D, effective May 22, 2017.

What is Rule 505, you might ask?  Exactly.  Rule 505 has been an exemption from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act") upon which virtually nobody has relied. And now it will soon be gone.

Overwhelmingly, issuers conducting private placements of securities have relied upon Rule 506 as the preferred exemption from the registration requirements under the Securities Act. Why? Because there are no dollar limits on the amounts that can be raised under Rule 506.  And because relying on Rule 506 has meant that state-level securities registration requirements were preempted. And if the issuer sold securities exclusively to accredited investors, there were no information disclosure requirements necessitating the preparation of a detailed private placement memorandum. Hence, Rule 506 offerings are generally quicker, easier, and less costly than a Rule 505 offering.

According to the SEC's final rule release abolishing Rule 505 (SEC Release 33-10238), less than 3% of the 132,091 Form Ds filed from 2009 to 2015 reporting private placements conducted under Regulation D were made in reliance on Rule 505.  And only 1.2% of the Form Ds in the study reported offerings exclusively under Rule 505 (as opposed to 1.7% of the offerings relying upon Rule 505 in addition to other rules under Regulation D).

In fact, in 2015, less than 1% of all new Regulation D offerings claimed an exemption under Rule 505.

And because Regulation 505 offerings are required by rule to be no more than $5 million in any 12 month period, the offerings have been smaller dollar-sized offerings, and thus Rule's 505 overall impact on our capital markets has been quite minor.  Securities offerings under Rule 504 and Rule 505 collectively accounted for less than 0.1% of all capital raised in Regulation D offerings from 2009 to 2015, according to the SEC release.  

In the same SEC final rule release, the SEC expanded the dollar limit for private placements made in reliance on Rule 504 in any 12 month period from $1 million to $5 million.  With that change, the SEC felt reliance on Rule 505 had become even less attractive to potential issuers of securities - so much so that Rule 505 had become obsolete.  

So Rule 505 will soon be abolished.  So long, Rule 505 - we barely knew ya'!

Fort Worth, Texas Magazine 2016 Top Attorney List

Special thanks to Fort Worth, Texas magazine for including me on their annual list of Top Attorneys for the third straight year.  I was among those honored in the Corporate Finance/Mergers and Acquisitions category.  The reception for award winners at the Fort Worth Club was a blast, as usual. What could be more fun than a night out with attorneys?!

Time to Sell: Five Tips

Thanks to FW inc. ("Greater Fort Worth's Premier Business Magazine") for publishing an article I wrote on preparing to sell your business.  The article is available here.

Survivng Boot Camp

A couple of weeks ago, I had the honor of speaking to the TCU MBA Entrepreneurship Boot Camp event hosted by the TCU MBA Graduate Entrepreneurship Organization (GEO). Specifically, I presented "Choosing the Right Entity for your Start-Up Business" to a group of bright and talented MBA students who were very engaged and asked a lot of great questions. The GEO and its chairman, Eric Coulter, put on a terrific event and really made me feel welcome at the TCU Neeley School of Business.

The future of entrepreneurship in North Texas appears to be in great hands!

Identical or Deceptively Similar Entity Names in Texas - A Change For the Better?

Among the corporate law changes enacted by the 2015 Texas Legislature is a new requirement that consents to use similar entity names must now be notarized prior to filing.

The Texas Business Organizations Code (TBOC) prohibits each Texas entity (and each out-of-state entity registering to do business in Texas) from having a name that is the same as, or deceptively similar to, an existing Texas entity (or an existing out-of-state entity registered to do business in Texas). Texas law has long recognized an exception to that rule if the existing entity consented to the use of a similar name in writing. Under the amended law, a consent to use a similar name must be notarized and filed with the Texas Secretary of State. This change impacted Section 5.053, 5.102 and 5.153 of the TBOC.

According to the bill's author, the purpose of this change was to protect existing Texas companies from new entities who might forge documents claiming that they have the consent of the existing entity to the use of a similar name when in fact no consent has been given.

While I agree that the notarization requirement does make it more difficult for a new entity to forge and file a consent to the use of a similar name, I am skeptical that this change in law was actually necessary or an improvement on existing law.  I have not heard or read about an epidemic of Texas companies who have suffered forged consents to the use of similar names. And existing law already made it a crime for a party to file an instrument known to be materially false with the Texas Secretary of State's office. Section 4.008 of the TBOC makes such a false filing a Class A misdemeanor - unless the offender had the intent to defraud or harm another, in which case the offense is a felony.

The bill's author acknowledged in the Bill Analysis submitted with this bill that a forgery is a crime, but argues that a forgery victim "likely will have a difficult time convincing a law enforcement agency to prosecute the crime."  That may well be the case - our law enforcement officials may choose to employ their limited resources in prosecuting other crimes. But Section 4.007 of the TBOC already grants forgery victims a private right of action against any party who signs or files a forged document in violation of Section 4.008 of the TBOC.

The new notary requirement will add a layer of administrative hassle to both new entities requesting consents and existing entities granting consents.  I can imagine a scenario where an existing entity might be willing to grant its consent, but not at the cost of locating and engaging a notary to witness a consent signing.

Nonetheless, the notary requirement is now law in Texas.

Texas Equity Crowdfunding Success Stories

Thanks to the Fort Worth Business Press for publishing an article I wrote on Texas companies who have successfully used the SEC's new Regulation Crowdfunding rules to raise capital via equity crowdfunding.  The article is available here.

Talking Two-Step Tender Offer Transaction Techniques for Texas Targets

Are we living in the Golden Age of the two step tender offer acquisition technique?  Probably so - last year, the process got a whole lot easier for buyers seeking to acquire publicly traded M&A targets incorporated in Texas.

What is Two Step Tender Offer?

A buyer seeking to acquire all of a public company (a Target) may either:
(1) propose a one-step merger - which generally must be approved by the Target's shareholders; or
(2) propose a tender offer - in which case the buyer offers to buy at least a majority of the Target's shares (STEP 1); followed by a "squeeze-out" merger in which a successful vote of the Target shareholders is already assured (because that was the minimum number of shares purchased in the tender offer) (STEP 2).

Historic Second Step Merger Thresholds Requirements

Historically, both the Delaware corporate law (Section 253 of the Delaware General Corporation Law (DGCL)) and Texas corporate law (Section 10.006 of the Texas Business Organizations Code (TBOC)) required that the buyer acquire at lease 90% of the Target shares after the tender offer in order to enter into a short-form merger.  Qualifying for short-from merger treatment was important because the short-form merger did not require a vote of the Target shareholders. It was presumed that such a vote would be meaningless because 90% of the shareholders would doubtlessly vote to approve the merger.

Shareholder merger votes cost time and money because state corporate law and SEC proxy voting rules require the preparation or a detailed disclosure document, an SEC review, and distribution of the disclosure document to the Target's shareholders.  

New Second Step Merger Threshold Requirements

Eventually, Delaware realized that a merger vote by the Target's shareholders would be equally meaningless if the buyer acquired at least a majority of the Target shares (or whatever the minimum number of shares otherwise necessary to approve a long-form merger under the DGCL and the corporation's certificate of incorporation).  So in 2013, Delaware adopted a new subsection (h) to Section 251 of the DGCL which permits the buyer to merge with a publicly traded Target (or a Target with more than 2,000 shareholders) following a tender offer under certain conditions.

Effective September 1, 2015, the State of Texas adopted new sub-sections (c), (d) and (e) to Section 21.459 of the TBOC, thereby granting public companies formed in Texas the right to merge without a shareholder vote following a successful tender offer.  The (relatively) new Texas rule is substantially similar to Section 251(h) of the DGCL.

Why do buyers like Two Step Tender Offers?

Simply put, a two step tender offer is a whole lot faster and cheaper than an acquisition via a traditional one-step merger, especially when the buyer is paying cash (rather than stock) to the Target's shareholders. This is because the SEC review process is generally more limited and more expedited for a tender offer than it is for a one-step merger.

According to a recent a survey conducted by the M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee of the Business Law Section of the American Bar Association (ABA), from the announcement of a public M&A deal until the closing of the deal, the average cash tender offer takes 49 days, the average stock tender offer takes 54 days, the average cash merger takes 129, and the average stock merger takes 199 days.  (Thanks to Richard E. Climan, Joel I. Greenberg, and Claudia K. Simon for providing the survey data in a recent webcast sponsored by the ABA).  

What are the requirements to use the Two Step Tender Offer?

In order for a buyer to take advantage of Section 21.459(c) of the TBOC to obtain a shareholder vote waiver following a tender offer, certain conditions must be met, including the following:

1. The Target's certificate of formation cannot prohibit merger without a shareholder vote;
2. The Target's shares must be listed on a national securities exchange or held of record by at least 2,000 shareholders;
3. The plan of merger must expressly: (A)  permit or require the merger to be effected under Section 21.459(c) of the TBOC; and (B) provide that the merger be effected as soon as practicable following the consummation of the tender offer;
4. The tender offer must be for all of the outstanding voting shares of the corporation on the same terms provided in the plan of merger, except that the offer may exclude shares owned by: (A)  the Target corporation; (B) the buyer; (C) any person who owns, directly or indirectly, all of the ownership interests in the buyer; or (D) any direct or indirect wholly owned subsidiary of any of the foregoing persons;
5. The buyer must acquire in the tender offer (together with shares held prior to the tender offer) a number of shares of the Target equal at least the percentage of the shares that, absent Section 21.459(c), would be required to approve the plan of merger under both: (A) the TBOC (generally, two-thirds (2/3) of the shares); and (B) the certificate of formation of the Target;
6. The buyer must merges with or into the Target pursuant to the plan of merger; and
7. Each outstanding share of the Target not purchased in the tender offer must be converted or exchanged in the merger into the same consideration as those selling in the tender offer.

Kudos to the Texas Legislature for following Delaware's lead in modernizing the two step tender offer rules for Texas Targets.