Regulation D Exemptions Ease Hurdles to Raising Capital

Qualifying Businesses Under Rules 504, 505 And 506 Need Not File With The SEC

All businesses wishing to sell securities to raise capital must register those securities with the Securities and Exchange Commission (SEC), or qualify for an exemption. These exemptions include Rules 504, 505 and 506, the "safe harbor" provisions, each of which vary in the amount of money that can be raised and disclosure requirements to potential investors. Commonly known as "Reg. D" exemptions, the SEC created these rules to encourage small businesses to raise capital while also simplifying regulations.

Qualifying businesses save extensive legal and compliance fees while still allowing sophisticated investments from private financiers. In addition, a Reg. D exemption protects the small business from unhappy investors wishing to claim a registration or disclosure violation.

Rule 504

Rule 504 allows a business to raise up to $1 million in capital over 12 months. In order to qualify, the company must have a business plan and purpose and not otherwise be subject to reporting requirements.

Companies exempt under Rule 504 can even offer limited public securities, without regulating who the investors can be (i.e. there is no rule requiring accredited investors, unlike Rule 505 and 506). Rule 504 does not require a prescribed disclosure document, unlike registered offerings. However, companies exempt under Rule 504 are still subject to rules regarding fraud and individual state laws may have stricter rules governing securities offerings.

Rule 505

Rule 505 increases the investment limit to $5 million over a 12-month period. However, investors must be "accredited." Accredited investors generally must be businesses that regularly invest, other sophisticated business organizations or high net worth individuals. Rule 505 does allow up to 35 nonaccredited investors, with the caveat that they must receive disclosure documents such as those given for registered offerings. If the company does not use nonaccredited investors, then it is up to the company to decide what information to give potential investors.

Rule 506

Rule 506 allows a company to raise unlimited amount of capital. However, these offerings must be private, meaning the company cannot "go public" and sell common stocks. Purchasers are also restricted from trading the securities after the offering. In addition, Rule 506 also limits the number of nonaccredited investors to 35, and those investors must be sophisticated, which the SEC defines as someone with "sufficient knowledge and experience in financial and business matters" to understand the investment.

More Information

This article is a very brief overview of Reg. D exemptions. If you are looking for investors for your startup or entrepreneurial business, contact a business formations attorney who can provide capital advisement and other information on complying with Reg. D exemptions.