Fundraising: Regulation D and Private Placements | Dunlap Bennett & Ludwig LLC
Many start-up founders and entrepreneurs need to raise funds for their new ventures. Typically, you raise funds through the sale of securities. What are titles? Under federal law, 15 USC Sec. 77(b)(a)(1), the term security includes, but is not limited to, shares, capital stock, convertible notes and SAFEs, and “any put, call, straddle, option or lien on any title… .” Generally, under the Securities Act of 1933 (the “’33 Act”), securities must be registered with the Securities and Exchange Commission (SEC), unless the sale of securities qualifies for the one of the exemptions from registration. SEC Regulation D provides exemptions for fundraising by private placement, that is, the sale of securities to pre-qualified investors or institutions.
A few definitions before a brief description of the most common exemptions under Reg D:
An “accredited investor” includes a natural person who has:
(i) earned income greater than $200,000 (or combined income of $300,000 for spouse) in each of the two preceding years, and reasonably expects the same to current year, or
(ii) has a net worth greater than $1 million, which excludes the value of their home, either alone or in combination with their spouse’s assets; or
(iii) holds a certification or professional designation in good standing as so designated by the SEC, such as a Certified General Securities Representative (Series 7), Certified Investment Counsel Representative (Series 65) ; and Chartered Representative in Private Placements of Securities (Series 82); or
(iv) certain entities such as a trust, corporation, partnership, not-for-profit entity, limited liability company or bank, which meet the relevant criteria under Reg D.
A restricted security is a security that has been previously issued to a holder, which cannot be freely transferred. A restricted security may only be sold if the intended transaction is registered or if certain conditions of Rule 144 are transferred.
Companies making a bid in reliance on Rule 506(b) can raise an unlimited amount of money to an unlimited number of accredited investorsas used in Reg D, and up to 35 unaccredited investors through the sale of restricted securities, but the company is prohibited from engaging in general solicitation or advertising to market the securities.
The issuer must be able to provide proof of a prior relationship between the parties before the offer of securities is presented to them. Rule 506(b) permits self-certification of accredited investor status, but non-accredited investors must meet the criteria of having sufficient financial and business knowledge and experience in order to have the required ability to weigh relevant and material facts to determine investment risk.
In addition, if non-accredited investors are participating in the offering, the company must provide the non-accredited investors with disclosure documents containing the same type of information and disclosures that would be required under Regulation A of the 1933 Act. , provide financial statements in accordance with Rule 506, and answer questions from potential non-accredited investors. Buyers under Rule 506 receive restricted securities, which are securities that can only be sold if the issuer registers the security or if the security qualifies for another exemption.
Even though Rule 506(b) permits the offering and sale of securities to non-accredited investors, meeting the additional information and disclosure requirements that are triggered under Rule 506(b) may be s prove prohibitively expensive. Buyers receive restricted securities and the company is required to file a Form D with the SEC within 15 days of the first sale of securities under the offering, and notwithstanding that a company complies with a 506(b) offering is exempt from state qualification and registration, the company must still comply with state notification requirements and state filing fees.
Companies that make an offering in reliance on Rule 506(c) can raise an unlimited amount of money from an unlimited number of verified accredited investors. Issuers relying on Rule 506(c) may solicit and generally advertise and must comply with all relevant Reg D requirements. Buyers receive restricted securities and the company is required to file a Form D with the SEC within 15 days of the first sale. of securities under the offering, and although a company’s compliance with a 506(c) offering is exempt from state qualification and registration, the company must still comply with the notification requirements of the state and at the state filing fee.
The exemptions in the article are not the only methods to raise capital, but they may be the easiest route for a start-up startup to raise capital. Although disclosure is not necessary for potential investors, depending on the particular rule you are relying on, disclosures provide cover against investors who have not experienced the return on investment they can expect. Disclosure can help isolate or reduce the issuer’s exposure to potential liability. This article is intended to provide information on some of the regulations that apply to raising capital through private placement. This is not legal advice or a complete guide to Rule D, Rule 506(b), or Rule 506(c) exemptions for private placements. Capital raising and securities regulation is a complex subject, and you should consult one of our experienced attorneys.