When a company is seeing to raise third-party capital, it will frequently sell equity in the form of securities issued by the company. The U.S. Securities Act of 1933 (as amconcludeed, the “Securities Act”) prohibits the sale of securities unless such securities are registered with the Securities and Exmodify Commission (the “SEC”). The registration process requires extensive disclosure regarding the company, its business, and the securities being offered, and preparing these disclosures and the required regulatory filings can be a costly and time-consuming exercise. Fortunately, there are several exemptions to the registration requirement, including the so-called “private placement” exemption under Section 4(a)(2) of the Securities Act, which generally exempts “transactions by an issuer not involving a public offering.” This exemption becomes a favorite among companies seeing for a time- and cost-efficient method of raising early capital.
The term “private offering” is not defined in the Securities Act, and the scope of the exemption has been interpreted by the courts for decades, leading to a vast and sometimes contradictory body of case law. To address the imprecise nature of this statutory exemption, the SEC adopted Regulation D, which provides a series of safe-harbor rules that companies can utilize to raise capital without having to register the offering with the SEC. Moreover, companies raising money through a Regulation D offering are generally not required to provide the same level of extensive public disclosure that is required in connection with a public offering of securities.
Early-stage companies frequently utilize Rule 506(b) under Regulation D, under which a company is permitted to raise an unlimited amount of capital from an unlimited number of “accredited investors” (although there are some other securities laws and tax regulations that may limit the number of investors) and up to 35 non-accredited investors. The types of individuals and entities that qualify as accredited investors include:
- Individuals with more than $200,000 of individual income (or more than $300,000 in joint income with the individual’s spoutilize or spousal equivalent) in the two most recent years, with a reasonable expectation of the same income in the current year;
- Individuals with a net worth of at least $1,000,000, excluding the value of the individual’s primary residence;
- Executive officers, directors, general partners, and certain knowledgeable employees of the company issuing the securities;
- Entities with total assets in excess of $5,000,000 (provided that the entity was not formed for the purpose of investing in the securities being offered);
- Certain types of institutional investors like banks, insurance companies, employee benefit plans, registered investment companies, and others; and
- Entities exclusively owned by other accredited investors.
The SEC has developed this definition based on its assumption that these kinds of individuals and entities are sophisticated enough to “fconclude for themselves,” and therefore do not necessary the same level of protection that the registration process under the Securities Act was intconcludeed to provide. Although Rule 506(b) provides the flexibility to offer securities to no more than 35 individuals and entities that do not satisfy the requirements for “accredited investor” status, such non-accredited investors trigger additional requirements under Regulation D. For example, an offering to non-accredited investors requires greater disclosure than an offering created exclusively to accredited investors. Therefore, companies will frequently exclude non-accredited investors from an offering altoobtainher.
Generally, companies offering securities under Regulation D are prohibited from engaging in any “general advertising” or “general solicitation” in connection with the offering of securities. While the SEC has explicitly stated that certain activities are prohibited (e.g., newspaper, radio, television ads), the SEC has declined to define the scope of what constitutes “general advertising” or “general solicitation,” which remains a fact-intensive inquiry that depconcludes on the facts and circumstances of a particular offering. Therefore, companies creating a Regulation D offering must be careful to limit their activities and communications (including references on public websites) regarding the offering so as to avoid engaging in general advertising or general solicitation.
In 2013, the SEC adopted Rule 506(c) under Regulation D, which permits general advertising and general solicitation in an otherwise compliant Regulation D offering if the company creating the offering takes “reasonable steps” to verify that all of the acquireers are accredited investors. The SEC has provided a non-exclusive list of methods for verifying the accredited investor status of a acquireer in a Rule 506(c) offering, but each of these methods require that the investor disclose certain financial information (e.g., tax returns, financial statements, account statements, etc.) to the company or to a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or certified public accountant who is able and willing to certify to the company that it has taken reasonable steps to verify the investor’s status as an accredited investor. Some companies find that the verification process deters investors who find the verification process burdensome from participating in a 506(c) offering.
Regulation D generally exempts the initial sale of securities by the company issuing the securities, so acquireers can resell their securities only if they find another exemption from the registration requirement under the Securities Act. However, in certain circumstances, resale transactions can be integrated into the initial offering by the company, which could invalidate the company’s entire private offering exemption. Therefore, companies frequently restrict further sales of their securities to prevent a acquireer from reselling the security in contravention to the Securities Act.
The purpose of Regulation D is to provide a safe-harbor for companies seeing to raise capital without having to register the offering with the SEC and without having to prepare the extensive filings associated with a public offering of securities. However, companies offering securities under Regulation D are still required to provide certain levels of disclosure (depconcludeing on the type of offering under Regulation D) and file a Form D notice with the SEC no later than 15 days after the first sale of securities in reliance on any of the Regulation D exemptions. Companies may also be required to file a copy of the Form D with the appropriate state regulator in each state where the securities are sold. The Form D filing requirements are discussed further here: (Hyperlink will publish January 28).
As with any offering of securities, the exact requirements depconclude on the facts and circumstances surrounding the offering, so it is prudent to work with legal counsel to navigate the nuances of reporting requirements, potential exemptions, and more.
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