When companies are looking to raise capital, selling equity is an attractive option, but for many private companies, the cost and effort involved in a public offering of shares can be quite onerous. Registering an issuance of stock with the SEC requires many disclosures and certain financial reports for years to come. Private placements that are exempt from registration, on the other hand, require much less documentation and work. Regulation D offerings are exempt from registration and are the most common way for companies to make private placements of stock.
Regulation D offerings offer companies vital capital, but they still have strict legal requirements unless you want to risk falling afoul of the SEC. If you are considering selling stock through a Reg D offering, it is important to fully understand all the requirements and legal implications. A Priori securities lawyer can help you decide which Reg D exemption is best for your needs and understand all the legal issues involved.
Understanding Regulation D
The Securities Act of 1933 requires any offer to sell securities to be registered with the SEC with just a few exemptions. Under Regulation D, three of these exemptions are established. Regulation D offerings allow companies to issue private placements of stock in order to raise capital without the onerous requirements of making a public offering. Generally, all Reg D offerings are only available to sophisticated investors who should be aware of the risks involved, which makes SEC oversight less important.
While each regulation D exemption is slightly different and therefore has slightly different requirements, there are four basic conditions laid out in Rule 502 of Regulation D that must be met in order to qualify for Reg D at all.
- All Regulation D offerings must integrate all issuances of stock within the within the six months preceding and following the first reported offering.
- Proper disclosures of all risks of the investment and related financial information of the company must be given to relevant non-accredited investors through a private placement memorandum.
- There can be no public advertising or general solicitation of investors for any stock issuances that include non-accredited investors.
- All stocks sold in Regulation D offerings must be restricted securities.
Regulation D offerings make a distinction between accredited investors and non-accredited investors— a distinction that is important in determining both whether or not the offering can be publicly advertised and if exemptions apply. The definition of an accredited investor is defined in SEC Rule 501. Under Rule 501 of Regulation D, the following legal persons and entities can be considered accredited investors:
- Individuals earning at least $200,000 per year or $300,000 jointly with a spouse;
- Individuals or married couples with a net worth exceeding $1 million;
- Companies, trusts, and employee benefit plans holding at least $5 million worth of assets;
- Directors, executive officers, and general partners of the issuing company; and
- Investment companies, business development companies, banks, insurance companies, and other sophisticated investment corporations
Reg D Exemptions
There are three exemptions from SEC registration of securities required under the Securities Exchange Act of 1934 established in Regulation D rules. These are detailed in Rule 504, Rule 505 and Rule 506.
Under Rule 504 of Regulation D, a company can sell up to $1 million worth of restricted securities in a given year to investors without registering them with the SEC. This amount is cumulative, which means it must include any securities sold under other exemptions. Rule 504 also allows an unlimited number of non-accredited investors and requires no additional disclosures unlike Rules 505 and 506. Also, unlike other exemptions, however, Rule 504 does not exempt companies from state registration requirements under blue sky laws, which means that for practical reasons Rule 504 exemptions are rare—and usually require some disclosures regardless.
Under Rule 505 of Regulation D, any company can sell $5 million worth of securities without registering them with the SEC in any 12-month period provided that:
- No more than 35 of the investors are non-accredited (although an unlimited number of qualified accredited investors is permitted);
- The company informs investors that the stocks are restricted and cannot be resold within six months unless they are registered; and
- The offering is not advertised for general solicitation.
Under Rule 506 of Regulation D, any company can raise an unlimited amount of funds from an unlimited number of investors by selling securities without complying with blue sky laws, so long as they qualify under one of two versions of Rule 506. In Rule 506(b) offerings, only up to 35 investors can be non-accredited, and investors must be properly informed of all risks both through a private placement memorandum and the company making itself available to answer any questions put forth by prospective purchasers. In addition, no public advertising of the offering or general solicitation of investors is permitted.
In Rule 506(c) offerings, which were established under the crowdfunding rules in Section 201(a) of the JOBS Act, all investors must be accredited. Companies are then, therefore, are allowed to advertise the offering publicly as a means of general solicitation. The only caveat is that companies are required to take reasonable steps to verify that these investors do strictly qualify as accredited investors, such as by reviewing documentation like W-2s, tax returns, bank and brokerage statements and credit reports.
While companies do not have to register Reg D offerings, they do have to give notice by filing a Form D with the SEC. Any issuer making a private offering under Regulation D exemptions must notify the SEC within 15 days of the first offering. Form D names the company’s promoters, executive officers, and directors, and it provides some basic details about the offering. After a company files Form D the offering is listed in the public EDGAR database for future investor reference.
What is the difference between Regulation A and Regulation D offerings?
Both Regulation A and Regulation D offerings exempt sales of securities from registration with the SEC, but Reg A applies to small public offerings and Reg D applies to private placements. In addition, Reg A offerings require companies to issue an offering statement with the SEC and an offering circular to prospective investors, while Reg D offerings require companies to give notice to the SEC through Form D and issue a private placement memorandum to prospective investors.