Business-Minded Legal Solutions

Businesses can use securities to raise capital

There comes a time for many growing businesses to seek funding from outside investors. One option is to offer securities in the business. The investor pays for an interest in the business that can be structured in many ways, equity, debt, convertible securities or a combination. In many cases, a business that is looking for investors is offering securities.

The definition of securities is quite broad, covering many types of investments. It can be equity such as stock or membership interests or partnership interests, a loan relationship, or other structures.

Many Laws and Regulations Apply

The Securities Exchange Commission (SEC) regulates securities at the United States federal government level, and there are a lot of rules. The SEC’s fundamental role is to protect investors. Each state also has its own set of laws and rules regulating securities that are offered, sold or issued in the state.

Generally, unless an exemption from registration applies, a business that is offering securities for sale must register under federal and applicable state securities laws. Federal registration is complicated and expensive, so many issuers opt to take advantage of the many available exemptions from registration.

Federal exemptions under Regulation D

Private offerings of securities do not need to be registered with the SEC. The safe harbor rule for private offerings is a set of rules known as Regulation D. Regulation D offerings are often called private placements of securities. These are some available exemptions under Regulation D:

  • Rule 504: Eligible businesses (and there are exclusions) can offer and sell securities to accredited and unaccredited investors up to a total of $10 million per 12-month period, but the offerings cannot be made through general advertising or solicitation. Form D must be filed with the SEC.
  • Rule 506b: Businesses can offer securities to an unlimited number of accredited investors and up to 35 sophisticated unaccredited investors, in any 90 day period. General solicitation and advertising the offering is strictly prohibited. Issuers must have a pre-existing relationship with potential investors or rely on intermediaries. And finally, for any non-accredited investors, the business must provide substantial information such as a private offering memorandum, and an opportunity to ask questions, all before making investment decisions.
  • Rule 506c: This rule allows a business to offer securities without a dollar cap and to an unlimited number of accredited investors (Rule 501). No unaccredited investors may participate in a 506c offering. General advertising is allowed. The business must verify the status of the accredited investors such as by checking tax returns, examining credit reports, and conducting diligence that involves collection of documentation. A private offering memorandum is not required, but is often used.

Businesses and their personnel that do not follow the rules risk fines, audits, investigations, other penalties and criminal charges.

Securities regulation in Texas

The Texas Securities Act regulates the securities industry in Texas, and the Texas Securities Commission oversees registration of securities offered, bought or sold. It also regulates firms and individuals who sell securities or offer guidance. Texas law has, some of which track the federal exemptions under Regulation D and some of which are distinct. The act also outlines penalties for violations and fraud.

Compliance is essential

Securing funds is generally a goal when offering securities, but it is also a priority that businesses remain compliant with all state and federal regulations when soliciting investment. Attorneys who handle investment transactions can be a tremendous asset for protecting the client’s interests in avoiding missteps and remaining compliant with all applicable laws and regulations.

Should health providers partner with private equity?

Some may be surprised that 30% of doctors work in independent practices, while hospital systems, health insurers or private equity firms employ 70% of medical doctors. The largest increase among the three employers is private equity and health insurers, with a 32% jump between 2019 and 2020.

Profits versus patients

Private equity firms have targeted medical practices and health systems for several years. The practices and systems are attracted to PE firms to get an influx of capital, and some sound financial guidance while operating a complicated business operation. Doctors study medicine to treat patients and often are minimally interested in the day-to-day needs of running a profitable practice. Private equity can streamline and eliminate redundancies, negotiate better contracts when the practice becomes part of a larger organization, purchase infrastructure, and ideally run profitably.

Still, inserting private equity firms into medicine has been a cause for alarm, with even the Biden Administration voicing concern about the private equity deals in healthcare. Increased emphasis on business and profits can cause anxiety among patients and staff. It’s also typical for private equity not to buy and hold but to seek to sell a medical practice or organization for a profit. While the new buyer may be a larger medical organization or another business group, the doctors involved may find that they subsequently work for someone they would not have picked.

Oversight may be an issue for investors

Health care is highly regulated, with state and federal governments able to file lawsuits against practices, businesses or organizations that act irresponsibly or violate regulations. These actions can lead to large financial penalties and other issues investors want no part of.

Make the right deal

Not every private equity group puts profits over patients, nor is every private practice operating altruistically. Finding the right partners is essential, making it a win-win for both sides. Still, a healthcare sector PE Deal cannot happen without a clear plan for moving forward together. Negotiating the right deal with common or shared goals is often essential.