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Regulation D and the JOBS Act |

New Regulation A and the JOBS Act

The JOBS Act is primarily known for opening the door to investment crowdfunding.  It also had a provision to eliminate the ban on general solicitation, which the SEC is implementing under Rule 506c of Regulation D.  Both of these changes will make it easier for the general public to become aware of investment opportunities and participate in private offerings.  While crowdfunding will be available to everyone, Rule 506c is open to Accredited Investors only.  What many do not realize is that the JOBS Act also included a provision relating to Regulation A of the Securities and Exchange Act of 1933.  According to the JOBS Act the SEC is required to expand Regulation A to permit private offerings of up to $50 million without registration.

What is Regulation A?

Regulation A is not as well known as Regulation D but it does provide an exemption from registration with the SEC.  Currently Reg A is set up as follows:

  • Companies can raise up to $5 million within a 12 month period.
  • An offering statement must be filed with the SEC on Form 1-A that includes the notification, offering circular, and exhibits.
  • The SEC reviews the submissions for approval.
  • “Bad Actors” are not allowed to participate.  The will be standard practice as the SEC continues to amend regulations as part of the JOBS Act.
  • Investors receive an offering circular which is very similar to a prospectus that is used in public offerings.
  • The securities are NOT RESTRICTED.  This is a big deal and a huge difference between the Reg D an Reg A exemptions.  Securities sold through Reg D are restricted, which limits an investors option to sell them as they please.
  • Advertising is allowed.
  • Financial statements are simpler than the requirements for going public.  They do not need to be audited.
  • There are no Exchange Act reporting requirements.
  • There are three different offering circular formats a company may use, including a simple Q&A format.
  • Companies can “test the waters” before filing with the SEC.

This is actually a great option for companies.  The “test the waters” provision allows companies to publish advertisements, including television and radio, along with showing information to potential investors prior to filing anything.  This way if there is not enough interest a company can either revise their offering and try again, or simply forgo the process all together.  This could be a viable option for companies that want to advertise but are still concerned about changing SEC regulation surrounding Rule 506c.  It is important to remember, however, that the company cannot accept investment until a staff member of the SEC has reviewed and approved the documents.  Testing the waters lets you gage interest and line up investors, you just can finish the process until the SEC is done.

When debating whether you should issue a private offering, go public, leverage crowdfunding, or do a hybrid with Regulation A – it is important to evaluate your overall strategies and goals.  There are several options available to you.  We provide information here and on our blog,  Keep reading and stay up to date.  We will bring you more legislative updates as they come.

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Reg D Requirements – The SEC Form D Explained

Regulation D of the Securities and Exchange Act of 1933 makes it possible for companies to raise money, without formerly registering with the SEC.  Instead of going through all the steps to issue a public offering, a company can issue a private offering under Reg D. Some of the Reg D requirements including: Rule 504, Rule 505, and Rule 506.  Each one details out the amount of capital that can be raised, how many investors can participate, and the accreditation standards for investors.  Regardless of which rule you use, the SEC requires you to complete and file Form D.

Here is what you need to know about Form D, prior to issuing a private offering:

  • Form D Must Be Filed with the SEC.  If you are raising money under Rule 504, Rule 505, or Rule 506a/b you can file Form D after you sell your security.  If you are raising money under Rule 506c, allowing for general solicitation, you must file fifteen days prior to selling any shares or units.
  • The form is filed electronically.  This is through the EDGAR database. In order to file you need to have access with a secure login.  Start this process at least two weeks in advance, as it can take time.
  • Date of First Sale.  The electronic version was amended to include a disclosure for the first date you sold a unit or share through your private offering.  If you are using Rule 506c this will be filed well in advance of a sale.
  • Business Information.  You need to disclose basic business information, including: name, address, state of incorporation, business type, industry, and annual revenue.
  • Related Persons.  You need to document “related persons”.  These are people that are promoting the offering or acting on behalf of the company in relation to the private offering.
  • Type of Exemption.  You need to decide which rule you are using to raise money and identify it here.
  • Type of Security.  Document the type of security you are issuing.  For example: are you raising debt or selling shares for equity?
  • Minimum Investment.  Is there a minimum investment you are requiring for people to participate?
  • Sales Compensation.  If you are working with a broker dealer, and offering a commission, you will need to document it here.
  • Offering Details.  Disclose how much money you are trying to raise.  You can go back later and amend this at any time.
  • Accredited Investors.  If you have sold any shares or units to non-accredited investors, you must disclose it here. WARNING be very careful of accepting funds from non-accredited investors.  It could open you up to additional regulations.
  • Use of Funds.  Disclose how you intend to use the capital you are raising through your private placement offering.

The information requested in Form D is not too extensive but you should know the answers prior to starting the process.  It is important to understand which rule you want to use for your private placement offering.  For example do you want to be able to market your offering?  If so, you need to issue it under Rule 506c.  For additional clarification, consult a Securities Attorney.

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The Trojan Horse in the SEC’s General Solicitation Changes

The approval of General Solicitation will be the topic of choice for most of 2013. With the Securities and Exchange Commission (SEC) apparently lifting the ban general solicitation, or advertising in lay man’s terms, there is a sense that the investment market may have gotten a windfall. Creating an environment where serial entrepreneurs can go back and capture many different types of investors to raise their companies up, create jobs, and generally have all around success. At least that is how the JOBS act passed by Congress appeared to be positioned. However, many are now calling the move by the SEC, and indeed Congress itself, nothing more than a Trojan horse.

One of the best ways the SEC has achieved this is by failing to, anywhere, define what exactly a general solicitation is. Another, implemented by the specific demand of Congress in passing the JOBS act, is that all investors need to be accredited. These two requirements when combined together create a one way ticket to a very sticky place, one that most investors want to avoid and certainly all start-ups would like to stay as far away from as possible. The place where investors have to turn over sensitive documents to verify their investment status, and where startups are unable to seek investment without taking “due precautions” to verify that the investors they are soliciting are indeed accredited. When viewed as part of the general solicitation rule, this includes things like social media where a simple tweet about the company’s offerings could result in hopping on the train to a verification nightmare.

There can be, and is, little doubt that investor are not about to turn over bank account statements, W2’s, credit reports, or brokerage statements to the companies they want to invest in. The more the hassle, the less likely it is that an investor will, in fact, invest. And with the doing away of a simple “agree by signature” the complications continue to grow. Companies are now required to conduct a level of due diligence to ensure that their investors are, in fact, accredited, taking away from the time and effort needed to grow a small company that is seeking investment in the first place. Or companies can simply avoid general solicitation and go on with business as usual.

The irony in this structuring is that the old methods of raising investment are also now under intense scrutiny by companies as well as by investors. The forums where investors could come, see presentations, and potentially invest in the next Facebook are now asking the question, and having to answer it, does the forum constitute a general solicitation. If the answer is yes then all the rules, and full force of Rule 506 (C) comes into effect. As a result, event sponsors and angel groups are being forced to change their operations to include having investors and attendees sign affirmations attesting to their status as accredited investors. In essence, the whole idea of a large solicitation due to an increased audience potential has effectively, and very neatly one might add, been removed.

It would be remiss to say that there are not some success stories out there. Angel list, a popular online platform, announces on its home page that it has helped thousands of investors to take advantage of Rule 506 (c), and successfully raise funds. While their verification process or that of their entrepreneurs could fall under scrutiny, it is for now a working model. Long term, the old models of public pitch events and angel groups success is going to depend on their ability to modify the environments in which they operate.

Only if companies are able to ease the issues of privacy, something not easily done in today’s climate following the revelations of the NSA spying on American citizens, will investors find a level of comfort in sharing documents attesting to their accredited status. The easing for regulations on general solicitation will continue to raise the heart burn of companies raising money, and the investors who want to make the JOBS act work as planned, until investor privacy can be secured.

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Should You Use Reg D Rule 506b or 506c to Raise Capital?

The majority of capital raised through private offerings, also known as private placement memorandums, is done through Rule 506b or 506c of Reg D. Companies and Issuers like Rule 506b or 506c because it provides the ability to raise an unlimited amount of capital, allows for up to 35 non-accredited investors to participate, and is avoids Blue Sky laws.  The benefits have made this an extremely attractive vehicle for raising capital, over $1 billion per year.

The JOBS Act required the SEC to enact a regulation that would allow businesses to advertise their private offerings to Accredited Investors.  This is designed to level the playing field between large hedge funds and non financial issuers, while exposing opportunity to investors that never would have seen it otherwise.  It is a win-win for the investment and business community.  The SEC passed this in July and on September 23rd Rule 506c was open for business.  The challenge is the SEC has extended the comment period and is working out the final guidelines for Rule 506c.  While technically companies should be able to advertise, there is a risk associated with doing something during this time period.  Businesses who aren’t careful may get caught in the political crossfire.

Some guidelines are clear about Rule 506c…. at least for now.

  • Companies must file a Form D prior to advertising their offering.  This is a huge change, and failure to comply could impose a penalty of not allowing a company to raise capital for a full year.
  • Advertisements must be submitted to the SEC prior to being used.  Make sure that you submit exact copies of your ads.  Examples don’t cut it when your business is acting as an SEC test case.  Do not put out any ads that have not been sent to the SEC first.
  • Advertisements must say for Accredited Investors only.  Do not risk appearing that you are trying to raise capital from non accredited investors.

Many companies want to know if they should skip 506c while the regulators work out the kinks.  If you have a network of people you will be raising capital from, or intend to buy accredited investor leads and cold call, stick with Rule 506b.  You can raise money like you always have and skip the liability that comes from being the first mover.  If you have a SEC attorney that can review all of your material or work with a marketing company that has met with the SEC for clarification, you are okay to go forward with advertising under Rule 506c.  Otherwise, you may want to wait until the dust settles in November.  By then the comment period will be over and hopefully the SEC will have issued its final determination on Rule 506c.

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SEC Analysis of Reg D Offerings – Billions of Dollars Raised

The SEC has been monitoring Reg D offerings to gain a better understanding of who is involved and the types of transactions.  They monitored offerings from 2009 to 2012 and found that the Reg D capital market is large and growing.  In 2011, $863 billion was reportedly raised under the Reg D exemption.  In 2012 that number grew to $903 billion.  When including number from 2009 and 2010 the amount of capital raised under Reg D is staggering.  From 2009 to 2012, Hedge Funds raised $1.3 trillion, private equity funds raised $489 billion, and non-financial issuers raised $354 billion.  The SEC estimates that these numbers only represent 63% of the total capital raised.

These numbers are impressive and show the clear need for capital outside of lending and the IPO market.  Due to a tight credit climate many businesses have turned to private offerings instead of securing the debt they would traditionally get from a bank.  This is excellent news for investors as it provides the opportunity to invest in established companies that would otherwise be unavailable.

What is most impressive is that $354 billion was raised from non financial institutions.  That money went to small and mid-size businesses, entrepreneurs, and deal makers that had a vision and raised capital.  Entrepreneurs should be excited by these numbers as they show a clear path towards opportunity.  With the SEC lifting the ban on general solicitation under Rule 506c, business owners have more opportunity than ever to raise the capital they require.

Here are more statistics on the Reg D market from 2009 to 2012:

  • 99% of private placement offerings were issued under Rule 506 of Reg D
  • The average size of a private offering from a small business (non financial issuer) is $2 million and there have been 40,000 since 2009
  • 234,000 investors participated in private offerings under Reg D during the 2012 calendar year.
  • The average commission is 6% for $1 million or less, going down to 2% for $50 million or higher.
  • The median offer size is $1.5 million.
  • Reg D offerings and the S&P 500 have been growing together since 2010.
  • Rule 504 and Rule 505 offerings are subject to Blue Sky laws, where Rule 506 is not.  The SEC believes this is why so many issuers select Rule 506 since technically the limits raised fall under 504 and 505 guidelines.
  • Public equity has raised significantly less than Reg D offerings from 2009 to 2012, close to only 25% of the total capital raised.
  • Over two thirds of Reg D investments is new capital entering the market.
  • More than 65% of Reg D investments are direct equity plays, 23.5% are pooled investment funds interest, 13.3% are options and 12% are debt.

This data is important to know if you are considering issuing or promoting a private offering.  By following the trends, you may increase your chances of a successful offering and raising the capital you need.

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Reg D Private Offerings: Rule 505 and Rule 506

You can raise money by issuing a private offering under Regulation D of the Securities and Exchange Act of 1933.  Reg D provides a safe harbor from companies needing to formally register their offering, as they would if going public.  There are multiple rules under Reg D so it is important to have a strategy and understand which rule you plan on claiming an exemption under.  Staying in compliance is essential for ensuring that you do not accidentally violate the safe harbor provision.  Doing so can subject you to fines and penalties.

When used correctly, the Regulation D exemption can save you significant time and money while allowing your company to raise the capital it needs.  Here is what you need to know:

Rule 505 of Reg D

With Rule 505 you can raise up to $5 million in a 12 month period.  This works well for smaller businesses or companies looking to raise a smaller amount of funds.  You can raise capital through an unlimited number of Accredited Investors but can only have up to 35 non-accredited investors.  This is a fantastic mechanism for raising capital when you have identified friends or family that want to invest but are not accredited.  A warning is that if you are obtaining capital from non-accredited investors you will need to increase your financial disclosures to make them similar to that of a public offering.  If you are worried about the time or money it would take to provide these disclosures, avoid obtaining capital from non-accredited investors.  Company’s need to weigh whether the investment capital received will be worth the additional time and expense.

Rule 506 of Reg D

Rule 506 of Regulation D is a popular vehicle for raising capital because you can raise as much money as you need.  This is ideal for larger companies or real estate transaction over $5 million.  Similar to Rule 505 you can work with as many Accredited Investors as you like.  Most companies will set a minimum investment requirement to ensure that the number of investors are limited.  This is simply for the benefit of the company as managing investors can be time consuming.  Rule 506 has similar disclosure requirements to that of Rule 505.

Under Regulation D, either rule, companies need to provide company information, financial disclosures, risk disclosures, and company contact information.  Investors and the SEC need to be able to reach a single point of contact at the company for updated information as needed.

Here is a big difference: on Rule 505 companies need to file a Form D with the SEC after they have sold their first security.  This is beneficial for entrepreneurs or companies that are not sure if the offering will be successful.  The SEC has recently lifted the ban on general solicitation through Rule 506c so companies that plan on advertising their offering need to give the SEC advance notice of the sale at least 15 days prior to publishing the advertisements and speaking with investors.  It is important for companies to determine if they will advertise and which rule they want to use prior to getting started.  The difference between Rule 505 and Rule 506 was minimal prior to the implementation of Rule 506c.  Now it is a critical and essential difference as missing the 15 day advance notice could cause a company to be penalized for a full year, preventing them from raising capital.

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Accredited Investors Compliance Rules for 506c of Reg D

Regulation D of the Securities and Exchange Act of 1933 has been used as a safe harbor for raising capital apart from officially registering the offering with the SEC.  By reducing disclosure requirements, paperwork, and time, Reg D has been a popular solution for businesses and entrepreneurs looking to raise investment capital.  It has been so popular that over four times the amount of money has been raised in recent years through private placement offerings as compared to the stock market. The Reg D exemption was always designed for Accredited Investors that presumably have more disposable income than the average citizen.

The rules regulating Reg D have stayed consistent until the JOBS Act was passed and the SEC voted to remove the ban on general solicitation in 2013.  While many thought that this would help to free up capital, time will tell if it actually helps small businesses.  One thing that is sure is that the SEC has used the JOBS Act to further regulate the private offering industry and to gain additional, private information on investors.  In typical government fashion what appeared to be a law to help people actually lets them implement additional controls.

There are specific changes to compliance requirements surrounding the verification of Accredited Investors.

Up until now investors could self certify, meaning they could state their personal net worth and sign a statement to that effect.  With Rule 506c this is no longer satisfactory.  Now Accredited Investors need to provide verification documents from a third party.  This is a drastic shift that removes privacy barriers between investors, companies, and the government.  Now every time an investors puts money into a company through accredited investor compliance Rules for 506c of Reg D, everyone in the transaction will have access to their personal financial information.  This could pose more challenges than not for companies looking to raise funds.  Investors with privacy concerns may only choose to invest in deals that come from their personal network.

Companies, and their representatives, that are raising capital need to be aware of compliance rules for 506c and these new certification requirements so as not to violate the rule.  Investor verification’s can come from their CPA, lawyer or a registered broker dealer.  Otherwise the company needs to review tax records, bank statements, and investment accounts in order to verify the net worth of each investor.  Many investors will run from these deals as who wants to expose their tax returns to a complete stranger?  Just because a company has a good product or opportunity does not mean people want all of their personal information exposed.  As a company raising funds it would be wise to identify an attorney to work with that can provide these verification’s in a confidential fashion for interested investors.  Stay tuned for the final changes to ensure that you are in compliance going forward.  They should be complete by the end of September 2013.

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Reselling Securities

Under the Reg D exemption from registration under the Securities and Exchange Act of 1933 investors that purchase securities through a private offering are purchasing “restricted” securities.  This means that they cannot be sold to the general public without meeting specific criteria.  The SEC has put these rules in place to ensure that “private” offerings are truly private.

Accredited Investors should be aware that they will typically need to hold onto these securities for at least one year.  If investors want to sell their securities they need to use an “effective” registration statement under the Securities Act.  Investors should speak with companies issuing private offerings to discuss what their future registration plans are prior to finalizing their investment.

The SEC does provide an exemption for selling restricted securities.  Accredited Investors that bought securities through a private offering can sell them after meeting the following:

  • Hold the securities for a specific amount of time as set forth by the SEC. If you bought restricted securities from a company that is reporting to the SEC the holding period is only six months.  If they are not reporting to the SEC the holding period is one year.
  • Company information needs to be publically available.  For reporting companies this is easy as they have to submit information to the SEC anyway.  Non reporting companies need to have their business information, officer information, and financial reporting available publically.  This could be through their website.
  • If you are an affiliate of the company you cannot sell any more than 1% of the outstanding shares in that same class within a three month period.
  • Normal brokerage practices can be utilized but only if the broker does not get a higher than normal commission.
  • If you are an affiliate you need to inform the SEC that you are selling the securities if you are selling more than $50,000 worth in shares over a three month period.  This is done using Form 144.  If you don’t sell the shares you have to amend it and let the SEC know.

Accredited Investors that are not affiliates of the company have less restrictions or rules to follow.  You still can’t sell them publically until you get a transfer agent to remove the restricted legend on the certificate.  Find out what the companies long term strategy is prior to investing and incorporate that into your financial plan.

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What You Need to Know About Rule 504 of Reg D

Regulation D is an exemption from the registration requirements in the Securities and Exchange Act of 1933.  It allows companies to raise capital through a private offering without completing a full registration with the SEC and going public.  Private offerings have been an essential component of our economy, enabling companies to raise capital for growth and operations.  It has been so successful that private placement memorandums have raised up to four times the amount of capital raised through IPO’s.

Under Reg D their are several rules: Rule 504, Rule 505, and Rule 506.  Each one has similar requirements with different limits placed on investors and capital raised.  Before issuing a private offering it is important for a company to look at each rule in order to determine which will meet the desired objectives.  We have written a lot on Rule 505 and Rule 506 so people interested in learning more can see our previous posts.  Today we would like to focus specifically on Rule 504.

Rule 504 is more commonly known among the business community, in part because it is the first rule listed and many businesses don’t go further into analyzing if it is the correct rule to be under.

Here is what you need to know about Rule 504 under Reg D:

  • You can sell up to $1,000,000 in securities during a 12 month period.  Make sure that you won’t need more funds if you issue a private offering under Rule 504.  You don’t want to have a successful capital raise, need more money, and be stuck waiting for the clock to expire.
  • You can’t advertise to the general public.  If you want to use general solicitation you can now do so under Rule 506c.
  • These are restricted securities meaning an investor cannot sell them with registration or an applicable exemption.
  • Provide information in order to avoid an anti-fraud laws.  This means giving investors disclosures of risk factors and company data.
  • File a Form D after selling your first security.  If you want to have general solicitation and use Rule 506c you need to file this form before you start advertising the offering.

If you want to sell unrestricted securities their are exemptions under Rule 504 of Reg D that allow you to do so.

  • You can register the private offering exclusively in states that require a publically filed registration statement and giving investors substantial disclosure documents.
  • You can sell to unrestricted securities to additional investors in states that do not require a publically filed registration statement as long as you give those investors the same detailed disclosure documents.
  • You sell only to accredited investors following all other SEC and state laws.

Reg D enables companies to raise money for the things they need.  Whether it is expansion capital, operating funds, real estate etc. – private offerings are the viable solution for raising funds.  With three Reg D rules to choose from make sure you select the correct one and only use Rule 504 if you are certain that you will not need more than $1 million within one year.

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Accredited Investors Defined

Private placement offerings are regulated under Regulation D, under the Securities Act of 1933.  The SEC regulates the sale of securities and takes enforcing its guidelines very seriously. The Act provides companies with a number of exemptions that prevent a company from having to officially register their offering like they would when going public.  In order to take advantage of the Reg D exemption companies must follow the guidelines set forth by the SEC, the primary of which is selling to Accredited Investors.  When raising capital through a private offering it is important to understand how the Securities and Exchange Committee (SEC) defines an accredited investor / Accredited Investors Defined.

Here is the SEC’s posted Accredited Investors Defined:

  • A bank, insurance company, registered investment company, business development company, or small business investment company;
  • An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • A charitable organization, corporation, or partnership with assets exceeding $5 million;
  • A director, executive officer, or general partner of the company selling the securities;
  • A business in which all the equity owners are accredited investors;
  • A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
  • A natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
  • A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

Who qualifies as an accredited investor?

Issuers that are looking to raise money through a private offering need to be able to verify whether or not their investors are accredited in order to stay within the rules and guidelines of the SEC. With the SEC now allowing companies to advertise their private offerings those guidelines are now more detailed.  Previously investors could attest to being accredited.  Now the SEC will require verification through a third party source including financial documents like tax returns or a statement by a CPA.  Any companies advertising a private offering need to understand these regulation changes.

Even more significantly as crowd funding sites get more popular, and as the SEC is examining the way of regulating the sale of shares through these means, due diligence is going to become more and more important for companies. Having access to accredited investors is going to become vital to keeping within the ratios of accredited versus unaccredited investors as set forth in the SEC. How the industry, crowdfunding, will rise to the challenge of meeting the changes to Regulation D is yet to be seen. This sums up how an Accredited Investors Defined.

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