When a business decides it is time to go out and raise capital, it isn’t as easy as some CEOs would like to think. The Securities and Exchange Commission (the “SEC”) is an organization tasked with protecting investors. While they have countless rules and regulation designed to protect the investing public, the focus of this article is on exempt offerings. Specifically, we will look at Regulation D 506(c) offerings.
Regulation D, or Reg D, offerings are considered exempt offerings. By exempt I mean that the issuer, the company raising the capital, has satisfied specific conditions so that the transaction is deemed to not involve any public offering as defined in section 4(a)(2) of the Act. Regulation D offerings are a type of private placement, an offer that is made to private investors, and are an important part of the capital raising process for private companies. These offerings can involve either debt, equity, or a mix of the two.
Exempt offerings come with many benefits for companies, most notably that the cost and timing components are significantly less than those required to go public. A private placement will involve your typical offering documents – a blind teaser and CIP – as well as a private placement memorandum (the “PPM”). Since private placements are intended for private, sophisticated investors the issuer must also have a strategy for determining investor eligibility and suitability.
Regulation D 506 offerings come in two primary flavors. The below table provides a high-level overview of different Reg D 506 exemptions. Issuers should remember that the SEC simply provides the guidelines for the exemptions. The burden of proof of compliance falls on the issuer.
One of the biggest differences between 506(b) and 506(c) offerings is the ability for the issuer to generally solicit. Under Reg D 506(b), general solicitation is not allowed. The issuer is forced to rely on their personal network and those they have professional relationships with. Rule 506(c) was introduced as part of the JOBS Act of 2012 and allows issuers to generally solicit their offering. This greatly expanded the universe of potential investors for an offering. Issuers in a variety of industries have taken advantage of Rule 506(c) to advertise their offerings online to expand their reach.
Both Rule 506(b) and 506(c) refer to “accredited investors”. This requirement was put in place to ensure that only investors who were sophisticated enough and who could afford to risk their capital on private, non-registered opportunities could participate. Investors can be accredited by either a high net worth or high annual income.
The annual income requirements looks to the two most recent calendar years and the investor must have a reasonable expectation that they will earn that amount in the current year.
When an investor receives a security under a Regulation D offering they are receiving what is deemed a “restricted security”. This comes with certain restrictions and requirements for both the issuer and investor.
The investor is required, per Rule 144, to hold the security for either six months or one year. The timing requirement is dependent on whether the issuer has been filing reports with the SEC. Investors who hold restricted securities should check with their legal advisor prior to selling such securities to avoid crossing any regulatory boundaries.
Issuers of securities under Regulation D are required to file a notice with the SEC using Form D within 15 days of the first sale of a security. Form D requires the issuer to supply basic information about the offering and the issuer. Typical information contained on Form D includes the issuer’s industry, whether a broker-dealer was involved, and the amount being raised.
It is true that the Securities Act does provide federal preemption from state registration for issuers. Offerings that qualify for exemption under the Securities Act do not need to be registered or qualified by the state regulator. However, each state has the authority to enforce what are known as “blue sky” laws and investigate and bring enforcement for acts of fraud. This enforcement is done by the state’s securities regulator. States also have the authority to require the issuer to notice file and pay state fees. Issuers must notice file with each state in which securities are sold within 15 days of the first sale. Failure to properly file and pay applicable fees may cause state regulators to suspend the offer or sale of the issuer’s securities in their jurisdiction.
Filing fees will vary per state. The following table provides the fees as of September 2018. Fees are subject to change and issuers should verify individual state fees prior to their offering. Penalties may be incurred if the issuer does not file within the required 15-day period from the first sale. Additionally, some states do charge annual renewal fees.