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Regulation D (also referred to as Reg D) includes two important exceptions to the general requirement securities registration with the SEC set forth in the Securities Act of 1933. Through Reg D, you can raise capital from investors without having to register the securities (i.e., the securities you are selling to your investors to fund your deal) with the SEC.
The volume of transactions completed through Reg D far outpace those of the other two common money-raising options: Reg A and IPOs. The Reg D transaction volume in 2017 across 40,000 offerings was $1.7 trillion, compared to $250 million for Reg A.
Reg D states that the issuer (i.e., the person selling securities) is exempt from registering with the SEC if the following requirements are met:
Work with your securities attorney to make sure you are filing these notices on time and accurately.
The two distinct Reg D registration exceptions are 506(b) and 506(c).
If you sell securities under the 506(b) exception, here are the general guidelines:
The SEC defines a pre-existing relationship as “one that the issuer has formed with an offeree prior to the commencement of the securities offering…”. In other words, it is a relationship that began prior to them investing in your deal.
The relationship must also be substantive, which the SEC defines as “a relationship in which the issuer (or person acting on its behalf) has sufficient information to evaluate, and does, in fact evaluate, a prospective offerees financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor…self-certification alone without any knowledge of a person’s financials circumstances or sophistication is not sufficient to form a substantive relationship.”
The SEC has made it clear that the establishment of a substantive, pre-existing relationship results from actual effort on the part of the issuer in getting to know the individual investor, and their current financial situation and wherewithal, rather than just checking a self-certification box, subscribing to your email list, or waiting a set amount of time.
When in doubt about whether your relationship with an individual investor will qualify as a substantive, pre-existing relationship in the eyes of the SEC, speak with your securities attorney.
In 2013, the second exception of Reg D was introduced – 506(c).
If you sell securities under the 506(c) exception, here are the general guidelines:
For 506(c) offerings, you must take reasonable steps to verify the accredited investors status. To do so, you can have your CPA, attorney, or a registered broker-dealer review the investors financials, such as W-2s, tax returns, brokerage statements, credit reports, and the like. Self-certification is not permissible.
The major differences between the 506(b) and 506(c) are:
So, if you are interested in raising capital from non-accredited investors with whom you have a pre-existing relationship, 506(b) may be your best option. If you are interested in mass marketing your deals online to accredited investors you do not know, 506(c) may be your best option.
One of the other capital raising options you may identify is Regulation A (also referred to as Reg A). Reg A allows qualifying companies to raise capital from the public without taking on the exorbitant costs and legal requirements needed for filing a traditional IPO.
At its inception in the Securities Act of 1933, the Reg A requirements set forth were:
For comparison purposes, there were over 100 Reg A filings in 2017 totaling more than $250 million. So a much smaller volume compared to Reg D.
In 2015, there was an update to the JOBS Act which broke the Reg A filings into two tiers. For tier I Reg A, the annual limit is $20 million. For tier II Reg A, the annual limit is $50 million. To find more information about Reg A offerings, click Definitive Guide to Regulation
For more information on Regulation D, listen to my following podcast episode:
Contributor: Roland Wiederaenders, Wiederaenders Law Firm, roland@rpwlegal.com
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.