Regulation D (also referred to as Reg D) includes two important exceptions to the general requirement securities registration with the SEC set forth in the Securities Act of 1933. Through Reg D, you can raise capital from investors without having to register the securities (i.e., the securities you are selling to your investors to fund your deal) with the SEC.
The volume of transactions completed through Reg D far outpace those of the other two common money-raising options: Reg A and IPOs. The Reg D transaction volume in 2017 across 40,000 offerings was $1.7 trillion, compared to $250 million for Reg A.
Reg D states that the issuer (i.e., the person selling securities) is exempt from registering with the SEC if the following requirements are met:
- Must file a notice to the SEC on Form D within 15 days of the date of the first sale of a Reg D security on the SEC’s Edgar System (online database that allows for electronic filing) – Form D asks for basic information about the offering and the issuer
- Must file a notice with the state in which the security is sold within 15 days of the first sale – the majority of states have an online databased to allow for electronic filing through the North American Securities Administrators Association (NASAA).
Work with your securities attorney to make sure you are filing these notices on time and accurately.
The two distinct Reg D registration exceptions are 506(b) and 506(c).
What is 506(b)?
If you sell securities under the 506(b) exception, here are the general guidelines:
- General solicitation or advertising of the securities is prohibited
- Allowed to sell to an unlimited number of accredited investors (current accredited investor requirements are a $200,000 annual income individually ($300,000 jointly) or a $1 million net worth (individually or jointly) and up to 35 non-accredited (but “sophisticated”) investors
- Must provide the non-accredited investors with disclosure documents, including an audit of the fund’s balance sheet
- Issuer may rely on investor self-certification
- Issuer must have a substantive, pre-existing relationship with investors
The SEC defines a pre-existing relationship as “one that the issuer has formed with an offeree prior to the commencement of the securities offering…”. In other words, it is a relationship that began prior to them investing in your deal.
The relationship must also be substantive, which the SEC defines as “a relationship in which the issuer (or person acting on its behalf) has sufficient information to evaluate, and does, in fact evaluate, a prospective offerees financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor…self-certification alone without any knowledge of a person’s financials circumstances or sophistication is not sufficient to form a substantive relationship.”
The SEC has made it clear that the establishment of a substantive, pre-existing relationship results from actual effort on the part of the issuer in getting to know the individual investor, and their current financial situation and wherewithal, rather than just checking a self-certification box, subscribing to your email list, or waiting a set amount of time.
When in doubt about whether your relationship with an individual investor will qualify as a substantive, pre-existing relationship in the eyes of the SEC, speak with your securities attorney.
What is 506(c)?
In 2013, the second exception of Reg D was introduced – 506(c).
If you sell securities under the 506(c) exception, here are the general guidelines:
- Issuer may openly market their offering (i.e., advertising and general solicitation) but may only sell to accredited investors
- Investors must be accredited – current accredited investor requirements are a $200,000 annual income individually ($300,000 jointly) or a $1 million net worth (individually or jointly)
- Issuer must verify that the investors are accredited
For 506(c) offerings, you must take reasonable steps to verify the accredited investors status. To do so, you can have your CPA, attorney, or a registered broker-dealer review the investors financials, such as W-2s, tax returns, brokerage statements, credit reports, and the like. Self-certification is not permissible.
The major differences between the 506(b) and 506(c) are:
- Solicitation is prohibited for 506(b) but permitted for 506(c)
- Non-accredited investors may invest in 506(b) but not 506(c)
- Self-certification of investor status is permitted for 506(b) but not 506(c)
- You must have a substantive, pre-existing relationship for 506(b) but not 506(c)
So, if you are interested in raising capital from non-accredited investors with whom you have a pre-existing relationship, 506(b) may be your best option. If you are interested in mass marketing your deals online to accredited investors you do not know, 506(c) may be your best option.
Other Capital Raising Option
One of the other capital raising options you may identify is Regulation A (also referred to as Reg A). Reg A allows qualifying companies to raise capital from the public without taking on the exorbitant costs and legal requirements needed for filing a traditional IPO.
At its inception in the Securities Act of 1933, the Reg A requirements set forth were:
- Securities sold in a year must be valued at $5 million or less
- The issuer must file an offering statement with the SEC
- An offering memorandum must be prepared for the potential security purchases
- The issuer must register the offering in any state in which they plan to sell securities
For comparison purposes, there were over 100 Reg A filings in 2017 totaling more than $250 million. So a much smaller volume compared to Reg D.
In 2015, there was an update to the JOBS Act which broke the Reg A filings into two tiers. For tier I Reg A, the annual limit is $20 million. For tier II Reg A, the annual limit is $50 million. To find more information about Reg A offerings, click Definitive Guide to Regulation
More Resources on Money-Raising with Reg D
For more information on Regulation D, listen to my following podcast episode:
- 506(b) vs. 506(c): Which Money Raising Structure Should You Do? ([26:28]) – Securities law expert Mark Roderick explains the pros and cons of the 506(b) and 506(c) offerings and which one you should use when raising the unlimited amount of money for your deals.
- Counsel For Real Estate Syndication #SkillSetSunday with Mauricio Rauld ([28:15]) – 506b Syndication lawyer Mauricio Rauld explains a three-step process to determine if you are offering a security, and the steps to take if you are.
- Why You Should Raise BILLIONS in Capital with a 506(c) Offering with Mark Mascia ([29:06]) – Commercial developer Mark Mascia talks about how he has completed over $1 billion in development deals while raising money with 506(c) offerings.
- The 4-Prong Test to Raise Money LEGALLY and Avoid Fines with Jillian Sidoti ([26:26]) – Syndication attorney Jillian Sidoti provides a four-part exercise to help you determine if you are offering securities and, if you are, how to do so legally.
- All You Need to Know About Real Estate Syndications with Gene Trowbridge ([26:43]) – Syndication attorney Gene Trowbridge provides an overview of how to sell securities via syndications
Contributor: Roland Wiederaenders, Wiederaenders Law Firm, firstname.lastname@example.org
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.