The $4.2 Million Private Placement
Cobalt Grid Systems, Inc., headquartered in State D, wants to raise $4.2 million of convertible notes. Management decides to rely on Rule 506(b) and sells to 22 purchasers over eight weeks: 19 accredited investors and 3 non-accredited buyers - two long-time hourly employees who each put in $15,000 of savings, and a local dentist who invests $50,000. Cobalt does not advertise, does not use finders, and sells on identical terms to everyone. After the closing the CFO wants to run a newspaper thank-you notice naming the investors, and asks whether anything must be filed with State D. Four months later, one investor resells her note to a friend.
1. What must Cobalt file in State D, and what may State D not do?
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Because a Rule 506 offering is a covered security, State D cannot require registration or qualification and cannot impose merit review. What it may do is impose a notice filing: typically a copy of the Form D, a consent to service of process, and a filing fee, due shortly after the first sale (commonly within 15 days) and subject to annual renewal in some states.
Map that onto the facts: first sale February 10 means the clock on the notice filing started then, not at closing. Missing the window does not destroy the federal exemption, but it can trigger state penalties, a late fee, and - in aggressive states - a rescission right for State D purchasers.
So the CFO's question has a short answer: file the notice, pay the fee, file the consent - and stop assuming that "federal exemption" means "nothing to do at the state level."
2. Do the three non-accredited purchasers destroy the exemption? What must Cobalt be able to prove?
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No - but only if Cobalt can document the right thing.
Rule 506(b) permits up to 35 non-accredited purchasers, and 3 is well inside the cap. The limit is not the number; it is the quality of those purchasers. Each non-accredited buyer must, alone or with a purchaser representative, have enough knowledge and experience in financial and business matters to evaluate the merits and risks of the investment.
That is where this offering is exposed:
- Two hourly employees investing $15,000 of savings are not disqualified by modest income - sophistication is about understanding, not wealth, and a person who has worked in the business for years may well qualify. But the file must show the basis for that conclusion, contemporaneously.
- The dentist's $50,000 is the larger exposure only if the diligence is thinner.
Cobalt should have a signed investor questionnaire, a written sophistication determination for each non-accredited buyer, and disclosure of the information the purchaser had access to. Also confirm the negative: no general solicitation anywhere in the eight weeks, including the CFO's own social media. A single public post converts this into a failed 506(b) - and 506(c) is unavailable because the three non-accredited buyers could not then participate at all.
3. Assess the proposed thank-you notice and the later resale of the note.
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The notice. Once the offering is closed, a factual tombstone is generally permissible and is not itself general solicitation - but three conditions matter:
- Consent. Naming investors without permission invites claims; get written releases.
- Content. No implied endorsement by any regulator, no performance or return claims, no characterization of the notes as safe or approved.
- Timing and integration. If Cobalt is contemplating another raise, a public notice naming investors in the last one can be read as part of a general solicitation for the next one, destroying 506(b) for that offering.
The resale. The notes are restricted securities and must be legended. The investor's sale four months later is a private resale: it is exempt only if it fits an available exemption, and the buyer takes restricted securities. The danger is not the investor's exposure so much as Cobalt's - if the issuer facilitated the resale, or if the resales are part of a distribution, the seller can be deemed an underwriter and the issuer's original exemption can be undermined. The correct response is to route the resale through counsel, confirm the buyer's status, and re-legend the note rather than blessing a handshake transfer to a friend.