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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