The Current Problem with Demo Days

Under U.S. federal securities law, any offer and sale of securities must either be registered with the Securities and Exchange Commission (SEC) or be conducted in compliance with an exemption from registration. For years there has been a question as to whether a start-up company’s demo day presentation may disqualify it from relying on certain private placement exemptions available for the sale of stock or other securities. Demo day events feature groups of start-up companies making presentations to prospective investors and other attendees. Although each presentation typically focuses on the start-up company’s business, they often conclude with the company’s capital raising plans. Such statements to inform the audience that the company is currently raising funds may inadvertently fall within the broad definition of a "securities offering" as currently interpreted by the SEC.

In 2019, the vast majority of capital was raised in reliance on the private placement exemption provided under Rule 506(b) of Regulation D. In order to comply with this favored exemption, issuers must avoid general solicitation or general advertising. In 2015, the SEC issued guidance that suggested that the offering of securities at a demo day may constitute a general solicitation unless the attendees are limited to an audience exclusively made up of persons (i) with whom the issuer or the organizer of the event has a pre-existing, substantive relationship or (ii) who have been contacted through a personal network of experienced investors with sufficient financial experience and sophistication. Companies wishing to present at demo days are therefore placed in a difficult position since often the audiences do not fit into this narrowly defined group. This SEC guidance specifically provided that:

Whether there has been a general solicitation is a fact-specific determination. In general, the greater the number of persons without financial experience, sophistication or any prior personal or business relationship with the issuer that are contacted by an issuer or persons acting on its behalf through impersonal, non-selective means of communication, the more likely the communications are part of a general solicitation.

The SEC recently issued a Release that included proposed rule changes to, among other things, clarify and streamline certain private placement exemptions. The SEC recognized that the current system of private placement exemptions was built over many decades and was filled with gaps and uncertainties. One of the proposed new rules, Rule 148 under the Securities Act of 1933, addresses the problem faced by companies making presentations that include discussions of their capital raising efforts. Once adopted, this newly proposed Rule will make it easier for companies to remain in compliance with the SEC’s private placement exemptions while promoting themselves to potential investors.

The Fix – Proposed Rule 148

Proposed Rule 148 provides criteria for the structure of and communications at a compliant demo day to ensure that certain communications are not deemed a general solicitation or general advertising. Listed below are the specific requirements included in the proposed rule:

Event Structure and Restrictions on the Event Sponsors

• The communications must be made in connection with a seminar or meeting hosted by (i) an angel investor group, incubator, or accelerator, (ii) a college, university or other institution of higher education, (iii) a local government or (iv) a nonprofit organization.
• The sponsor of such event must not make investment recommendations or provide investment advice to attendees and must not engage in negotiations between the issuers and investors attending the event.
• To the extent the sponsor charges a fee to attend the event, the attendance fee must not be more than a reasonable administrative fee for attendance.
• The sponsor may not receive any compensation for introductions between attendees and issuers or for investment negotiations between the parties, and the sponsor would not be permitted to receive any compensation with respect to the event that would require them to register as a broker dealer or as an investment adviser.
• Any advertising for the event must not reference any specific offering of securities by an issuer.

Restrictions on Presenting Company Communications

Under the newly proposed Rule, companies would be allowed to discuss their securities offerings, provided they only cover the following information:

• Notification that the issuer is in the process of offering or planning to offer securities.
• Description of the type and amount of securities being offered.
• Description of the intended use of the proceeds from the offering.

Based on the simplicity of proposed Rule 148, we expect to see substantial compliance by industry participants. Although the proposed Rule has not yet been finalized, practitioners are hopeful that it will be adopted in substantially the proposed form, thereby providing a straightforward path to compliance and much needed clarity. We intend to provide a further update once the SEC makes a final decision on this proposed Rule.