Integration in Securities Offerings
When companies raise money from investors, the transaction will be governed by securities laws. These securities laws have complex requirements that often “trip up” companies unfamiliar with the rules and their application. In today’s post, we tackle one of those areas of securities and startup law where companies often trip up: integration.
What is “Integration” in the context of a securities offering?
To better understand integration, you’ll need to first understand what a “securities offering” is. In very simple terms, a securities offering is a transaction where a company is offering to sell a security in exchange for (in most cases) cash. You can check out a discussion of the more precise definition of a security in our prior post.
Integration is a term in securities law that is used to describe a situation where the regulating authority (the Securities and Exchange Commission (SEC) and state securities regulators) determines that multiple securities offerings should be considered one large securities offering, or an “integrated” securities transaction.
Why should you care about integration?
If multiple securities offerings are integrated, then each offering must comply with a single exemption. This is important because often companies will raise funds in different rounds of financing, and they may rely on different securities exemptions for the different offerings. If those offerings are later determined to be integrated, there is the chance that one or more of the offerings failed to satisfy the exemption the company was relying on for another offering. If that occurs, the company has failed to comply with securities regulations, and investors may have the right to sue the company for rescission – the right to be paid back the money they invested (with interest and potentially penalties).
How do you prevent separate securities offerings from being integrated?
The SEC uses a 5-factor balancing test to determine whether multiple offerings should be integrated:
- Are the offerings part of a single financing plan?
- Do the offerings involve issuing the same class of security?
- Are the offerings made at or about the same time?
- Is the same type of consideration (e.g. cash, property, IP) being received by the company?
- Are they made for the same general purpose?
Under this 5-factor test, it is often difficult to determine whether multiple offerings should be integrated. For example, if a company raises money from a single investor at one price and then raises additional funds from several other investors a few months later at a higher price, will the offerings be integrated? Under the five-factor test, probably. Assuming the company sold the same type of security, for the same consideration (cash), for the same general purpose, and at or about the same time, it’d be difficult to argue that the offerings should not be integrated. The difficulty with this balancing test is that each situation requires an in-depth analysis to determine whether the offerings will be integrated.
Luckily, the SEC has provided a “safe harbor” under Rule 502 of Reg D. Rule 502 says that any securities offerings made within six months after or before another securities offering will not be considered integrated. This means that you can avoid having multiple securities offerings integrated by ensuring that you do not raise funds within the six-month window after raising a prior round of financing.
If you want to avoid the risks related to integration, don’t raise funds within six months of the last time you raised funds. If you can’t comply with the safe harbor, you’ll want to ensure at minimum that each individual offering complies with the same exemption. Securities laws are complex, require strict compliance, have serious penalties for non-compliance, and are difficult to navigate even for seasoned entrepreneurs. Ensure you understand and comply with the rules surrounding your securities offering, including the rules regarding integrated securities transactions.