Which Securities Law Exemption Should I Select? Regulation D – Rule 504, 505 & 506 Explained

by Scott Legal, P.C.
Contact

If you want to raise capital by issuing stock, convertible notes or any other security in the United States you will quickly realize that you fall into a complicated web of securities regulations.  To make matters even worse, you must comply with federal Securities Exchange Commission’s (SEC) requirements as well as the State requirements in every State where an investor resides.

The Government’s requirements have been set up to protect investors and generally require any company who wants to attract investors to “register” the securities.  Registering securities is a complicated process and involves providing the investors with information such as financial statements, offering documents, prospectuses and other information so that an investor can make an informed decision.  For small companies though, the SEC allows companies to file for a number of exemptions from registering the securities and each exemption has requirements that must be met.  Failure to follow these requirements can result in dire consequences.  This article summarizes some of the considerations when deciding on which exemption to select.  This is a brief summary of a complicated area so you should seek out legal counsel if you are issuing securities.

Most start-up business that issue securities file based on federal exemption Regulation D which consists of Rules 504, 505, and 506. For reasons that we will go over, Rule 506 is the most commonly used exemption in private offerings and accounts for more than 90% of offerings.

Rule 504

This Rule was created for companies that do not mind limiting the amount of capital they raise in a 12-month period to one million dollars.  It allows you to get this capital from an unlimited number of investors and the investors can be accredited (a sophisticated investor or one with a great deal of money) or non-accredited.  While not advised, this exemption allows you to sell to all of these investors (even non-accredited) without providing them with any specifically mandated information.

While this exemption may appear appealing, it has a significant draw back. That is, while an offering relying on Rule 504 does not require a federal registration it is still subject to state law and the state’s possible registration requirements.  Moreover, if you are selling to investors in different states, you would have to comply with requirements in every state.  For this reason, this exemption is rarely used.

Rule 505

Rule 505 is similar to Rule 504, in that it limits the amount of capital that can be raised under this exemption.  That is, capital raised cannot exceed five million dollars.  Another restriction of this Rule is that it only permits an issuer to offer securities to 35 non-accredited investors. This rule also prohibits general solicitation or advertising to potential investors.  Rule 505 also requires that strictly prescribed information must be given to the non-accredited investors which is similar to the information that would be provided to an investor if the securities were to be registered.  Like 504, this exemption is rarely used.

Rule 506

Most issuers rely on Rule 506 and for good reason.  This exemption allows a company to offer securities to an unlimited number of accredited investors and up to 35 non-accredited investors.  While sales can be made to non-accredited investors, you must provide them with information that is the same as if the securities were to be registered.  (eg. Private Placement Memo).  Given the potential liability associated with selling to non-accredited investors, most use this exemption and only sell to accredited investors.

The key reason that almost everyone (over 90% of issuers) select Rule 506 is that it preempts any other state requirement.  This is a significant advantage because it means that an issuer will not have to register in the various states (or find any state exemption.)  The preemption means that Congress has mandated that states cannot impose additional requirements on issuers and can only require that the issuers submit a notice filing with the state and impose filing fees.  In New York, this filing fee can be $1,200 for offerings greater than $500,000.  This may be a small price to pay though as if another exemption was used some states would require that the securities be registered or subject issuers to other onerous requirements.  The same “no solicitation” rules apply to this exemption.

Another key advantage of Rule 506 is you will not have to provide investors with any specifically mandated information if you sell only to accredited investors.  Notwithstanding the fact that you do not have to provide specific information to accredited investors, it is always highly recommended that a private placement memorandum (PPM) be prepared by a qualified attorney to protect the company from litigation and SEC or state sanctions.  The private placement memo also serves as excellent marketing material for an offering and provides investors with additional comfort.

Other Exemptions

In addition to the exemptions discussed above, you should ask your lawyer about Rule 147 Intrastate Exemption, Blue Sky Laws – State Exemptions, Regulation S – Sales to Foreign Investors, & Small Corporate Offering Registration (SCOR) Offerings.

Also, click here to obtain a free chart that summarizes a number of things to consider when selecting a business entity in an easy to read and understandable format.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Scott Legal, P.C. | Attorney Advertising

Written by:

Scott Legal, P.C.
Contact
more
less

Scott Legal, P.C. on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.