For small businesses and startups who cannot afford a traditional public offering, here's what to know if you want to raise capital under Regulation D.

How Do Startups Raise Capital?

In some cases, starting a small business can be done with relatively low costs.  This is especially true for those who offer online services.  For most small businesses, however, some amount of startup capital is needed to get operations off the ground and maintain funding for at least the first six to twelve months.

Seeking investors is one option that many business owners explore.  However, once a company decides to take on investors, they are subject to SEC (Securities and Exchanges Commission) rules and regulations.  In other words, you may have to register with the SEC and jump through additional legal hoops in order to secure funding.

For most small businesses and startups, a traditional public offering (IPO) is well beyond their means and positioning.  But, the cost, time, and hassle of an IPO can be avoided with a Regulation D exemption.  Here’s what you need to know if you want to raise capital under Regulation D.

What Is Regulation D?

This regulation pertains specifically to private placement exemptions.  A private placement is when a company seeks to raise capital by selling securities (equity ownership or debt) to investors without filing a full registration statement with the SEC and without conducting a full IPO.

A private placement is an exemption to the general rules associated with a public offering, so it’s no surprise that there are a great deal of complex and disparate rules that govern private placements. A Regulation D offering is only one such exemption, but there are a number of other fantastic exemptions as well that may also be available to startups and small businesses.  In any event, the Regulation D exemption process can save a company a lot of time and money and reduce the hassles usually involved in filing a registration with the SEC.

What Is a PPM?

Whenever a company conducts a Regulation D offering, in order to protect themselves from legal exposure and enforcement action by the SEC as well as state regulators, it is imperative to prepare a private placement memorandum or PPM for investors.  Essentially, the PPM is a legal document that spells out the terms of the investment for investors.

A PPM also includes information such as a description of the business, financial statements, and a rundown of objectives and potential risks for investors.  It may also set forth a payment schedule or maturity date if debt is being offered.

Ultimately, it is extremely important to provide this legal document to investors when seeking Regulation D capital, and using the services of an experienced corporate securities lawyer is essential to get this document right.

Is Regulation D Rule 506 Right for My Business?

Before you issue or sell securities, you must select your exemptions — and selecting the wrong rule can have serious consequences. As you prepare for a private placement, you likely have questions about Regulation D Rule 506 and other exemptions. At Weingold Law, we can explain your options, and help you decide which one best suits your needs.

Regulation D Rule 506: The Most Popular Exemption

Regulation D lets you raise private capital with securities (such as equity shares) that are exempt from SEC registration. Rule 506 is beloved by real estate syndicators and other securities issuers for good reason. Under this rule, you:

  • Can raise an unlimited amount of money
  • Sell securities to an unlimited number of accredited investors
  • Do not have to register your securities with the SEC
  • Do not have to meet any state-specific filing or other requirements.

There are also some limitations to Regulation D Rule 506 offerings. For example, Regulation D Rule 506 securities are restricted. Typically, investors cannot sell them for six months to a year unless they register them with the SEC. Additionally, you can only sell securities to 35 non-accredited investors.

When you involve non-accredited investors, you must provide them with significant information about the risks and opportunities involved in a private placement memo (PPM). Before you sell securities to a non-accredited investor, you should always consult with an experienced PPM lawyer.

Many Rule 506 private placements opt to only sell their securities to accredited investors. By doing this, you avoid certain disclosure requirements. You can also advertise your private placement and solicit accredited investors under certain circumstances.

While you don’t have to meet federal disclosure requirements under Regulation D Rule 506, it’s still in your best interest to craft a PPM with an experienced securities lawyer. A PPM typically discloses your transaction structure, the investment terms, risks, disclaimers, and other important legal and financial information. This document can help you comply with the SEC’s anti-fraud regulations and can give potential investors peace of mind.

What Is Rule 506(c)?

Rule 506(c) is a section of Regulation D that allows businesses the opportunity to raise unlimited capital through accredited investors, with certain restrictions.  Those operating under Rule 506(c) may not have to register with the SEC, although they will still have to file certain forms (including a Form D) in order to legally proceed.  A suitable Regulation D lawyer can determine if Rule 506(c) applies to your company and help you to file appropriately.

Rule 504: Limited Security Sales and Fewer Disclosures

In 2016, the SEC made significant changes to Regulation D and its exemptions. Under the revised Rule 504 you:

  • Can sell up to $5 million in securities each year, and
  • Offer securities to both accredited and non-accredited investors.

Under very limited circumstances, you can also advertise your private placement and solicit investors. However, consult with a PPM lawyer before you begin an advertising or marketing campaign.

Still, Rule 504 has significant drawbacks:

  • You must comply with state blue sky laws and might have to register your private placement with state securities agencies
  • You’ll need to assess state exemptions and how they impact your offering
  • You must guard against the participation of “bad actors”

Your investors will receive restricted securities which cannot be sold for six to twelve months unless they register them.

Before you select a Rule 504 exemption, you should always consult with a PPM lawyer. Many times, Rule 504 is not in your best interest. And if you opt for a Rule 504 exemption, you’ll still need to craft a PPM that clearly details your placement’s structures, risks, and other processes.

Do You Need Help Choosing Between Regulation D Rule 506 and Rule 504?

Choosing an exemption, whether it is Regulation D Rule 506, 504, or another option, is a difficult process. Even the most adept real estate investors and entrepreneurs can struggle with securities laws. And the wrong decision can have serious consequences. If you choose the wrong exemption — or fail to comply with your Regulation D exemption’s requirements — you might face serious penalties from the SEC and state securities agencies. You might also open yourself up to civil liability and criminal prosecution.

Rather than take these risks, it’s always best to consult with a skilled PPM lawyer. A lawyer typically will assess your project and build a private placement strategy that meets your long-term and short-term goals — while complying with federal and state securities laws.

 

Schedule a Consultation With a PPM Lawyer to Learn More About Regulation D Rule 506

At Weingold Law, we focus our practice on private placements involving real estate and crowdfunding. We have decades of securities law experience and pride ourselves on customized PPM solutions. If would like to learn more about our personalized approach to private placements and your Regulation D options, contact us for consultation.

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