By: Ron Diaz  [5/23/22]

Many start-up founders and entrepreneurs, need to raise money for their new ventures. Typically, you would raise money through the sale of securities. What are securities? Under Federal Law, 15 U.S.C. Sec. 77(b)(a)(1), the term security includes, but is not limited to, stock, equity units, convertible notes, and SAFEs, and “any put, call, straddle, option, or privilege on any security….” 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 one of the exemptions to registration. SEC Regulation D provides exemptions for private placement capital raises, which is the sale of securities to pre-selected investors or institutions.

A few definitions before a brief description of the most common exemptions under Reg D:

Accredited Investor

An “accredited investor” includes a natural person that has:

(i) earned income greater than $200,000 (or $300,000 combined income spousal income) in each of the prior two years, and reasonably expects the same for the current year, or

(ii) has a net worth over $1 million, that excludes the value of their home, either alone or combined with their spouse’s assets; or

(iii) holds a professional certification or credential in good standing that the SEC has so designated such as a Licensed General Securities Representative (Series 7), Licensed Investment Adviser Representative (Series 65); and Licensed Private Securities Offerings Representative (Series 82); or 

(iv) certain entities such as a trust, corporation, partnership, non-profit entity, limited liability company, or bank, that satisfies the relevant criteria under Reg D.

Restricted Security

A restricted security is a security that was previously issued to a holder, that may not be transferred freely. A restricted security may only be sold if the contemplated transaction is registered, or if certain conditions under Rule 144 are transferred. 

506 (b) 

Companies that conduct an offering relying on Rule 506(b) can raise an unlimited amount of money to an unlimited number of accredited investors, as used in Reg D, and up to 35 non-accredited investors through the sale of restricted securities, but the company is prohibited from general solicitation or advertising to market the securities.

The issuer must be able to provide evidence of a prior relationship between the parties before the offering of securities is presented to them. Rule 506(b) allows for self-certification of accredited investor status, but non-accredited investors must meet the criteria of having sufficient knowledge and experience in financial and business matters so that would have the requisite ability to weigh the relevant, material facts to determine the risk of investing.

Also, if any non-accredited investors participate in the offering, the company must provide the non-accredited investors disclosure documents with the same type of information and disclosures that would be required under Regulation A of the ’33 Act, provide financial statements as per Rule 506, and answer questions from prospective non-accredited status investors. Purchasers under Rule 506 receive restricted securities, which are securities that cannot be sold unless the issuer registers the security, or the security qualifies for another exemption.

Even though 506(b) allows for the offer and sale of securities to non-accredited investors, satisfying the additional information and disclosure requirements that are triggered under Rule 506(b) may be cost-prohibitive. The purchasers receive restricted securities, and the company is required to file a Form D with the SEC within 15 days after the first sale of securities under the offering, and despite a company’s compliance with a 506(b) offering is exempt from state qualification and registration, the company must still comply with any state notice requirements and state filing fees.

506(c)

Companies that conduct an offering relying on Rule 506(c) can raise an unlimited amount of money to an unlimited number of verified accredited investors. Issuers relying on Rule 506(c) may solicit and generally advertise and must comply with any relevant requirements of Reg D. The purchasers receive restricted securities, and the company is required to file a Form D with the SEC within 15 days after the first sale of securities under the offering, and despite a company’s compliance with a 506(c) offering is exempt from state qualification and registration, the company must still comply with any state notice requirements and state filing fees.

Summary

The exemptions in the article are not the only methods to raise capital, but they may be the simplest track for an early-stage startup to raise capital. While disclosure may not be necessary to prospective investors, depending on the particular rule that you are relying on, disclosures provide cover against investors who did not experience the return on investment that they may expect. Disclosure can help insulate or reduce the issuer’s exposure to potential liability. This article is meant to provide some information on some of the regulations that apply to raising capital through private placement. It is not meant as legal advice or as a comprehensive guide to Reg D, Rule 506(b), or Rule 506(c) exemptions for private placements. Raising capital and securities regulation is a complex subject, and you should consult one of our experienced lawyers.

For more information on how Dunlap Bennett & Ludwig can help your business, contact us by calling 800-747-9354 or emailing clientservices@dbllawyers.com.


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