STARTUP FUNDRAISING: HOW TO CONDUCT A PRIVATE PLACEMENT OFFERING OF SECURITIES
Conducting a Regulation D (Reg D) offering can be an effective way for companies to raise capital from investors while avoiding the time-consuming and expensive process of registering their securities with the Securities and Exchange Commission (SEC). However, conducting a Reg D offering can be complex, and companies must carefully follow the rules and regulations outlined in Regulation D to ensure that their offerings comply with federal securities laws. In this blog post, we will provide an overview of the key steps involved in conducting a Reg D offering.
I have been advising startups and investors in private placement transactions under Reg D and other provisions of securities laws for over 20 years, guiding and counseling clients through the process, negotiating on their behalf, protecting their rights, and ensuring clarity and understanding of an otherwise confusing and complex process. Read more about my Corporate Finance practice here.
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What is a Reg D Offering?
Regulation D (Reg D) is a set of rules established by the U.S. Securities and Exchange Commission (SEC) that governs private placements of securities. Reg D offerings are a type of private placement that allow companies to raise capital from accredited investors without having to register the securities with the SEC.
Reg D offerings are generally restricted to accredited investors, who are defined as individuals with a net worth of at least $1 million, or an annual income of $200,000 or more (or $300,000 for joint income). This restriction is in place to protect less sophisticated investors who may not be able to fully understand the risks involved in these types of investments. However, sales to non-accredited investors are permitted in some cases, as discussed below. But, additional rules (that can be complex and expensive) generally apply.
Reg D offerings typically involve the sale of stocks, bonds, or other securities to a limited number of investors. The companies that offer these securities are not required to file a registration statement with the SEC, which can be a more time-consuming and expensive process than a Reg D offering. Instead, they are required to file a Form D with the SEC, which provides basic information about the offering, the company, and the securities being offered.
Overall, Reg D offerings are an attractive option for companies looking to raise capital quickly and efficiently, while also avoiding the time and expense associated with SEC registration. However, they are generally only suitable for experienced and accredited investors who are familiar with the risks involved in private placements and are comfortable with the limited information that is available about the company and its financials.
What Are the Different Types of Reg D Offerings?
Under Regulation D, there are several "safe harbors" (that is, if you follow the rules, you will be deemed to be in compliance with Rule 4(a)(2) of the Securities Act of 1933 which exempts securities offerings from normal registration requirements). These safe harbors provide companies with certainty that their offerings will be deemed to be exempt from registration under the Securities Act of 1933. These safe harbors are designed to provide clarity and certainty to companies seeking to raise capital from investors, while also protecting investors from fraud and other abuses.
The safe harbors under Regulation D include:
Rule 506(b). This safe harbor allows companies to sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors. The company must provide investors with disclosure documents, and must take reasonable steps to verify the accredited status of investors. Other rules apply. Offerings under Section 506(b) preempt some state-level securities laws.
Rule 506(c). This safe harbor allows companies to engage in general solicitation and advertising to offer securities to accredited investors only. The company must take reasonable steps to verify the accredited status of investors, and must file a Form D with the SEC. Other rules apply. Offerings under Section 506(c) preempt some state-level securities laws.
Rule 504. This safe harbor allows companies to raise up to $10 million in a 12-month period by selling securities to an unlimited number of accredited and non-accredited investors. Companies must comply with state securities laws and provide investors with disclosure documents. NOTE: Offerings under Section 504 might not exempt the offering company from state securities laws.
By relying on these safe harbors, companies can reduce the risk of non-compliance with federal securities laws (and in some cases, state securities laws) in making offers and sales of securities to qualified investors in the United States. Compliance with an available safe harbor can also help a company avoid the very high costs, complexities, and common delays associated with registering their securities with the SEC (i.e., a "public offering"). However, it is important to note that each safe harbor has its own specific requirements and limitations, and companies should consult with experienced legal, accounting, and financial professionals to determine which safe harbor is best suited to their needs.
What About A "Regulation S" Offering?
As its name suggests, this is not a safe harbor under Reg D. However, Regulation S (Reg S) provides for another safe harbor allowing companies to sell securities without compliance with normal registration requirements, and deserves to be mentioned in this context, also. Reg S allows a company to offer and sell securities to investors outside of the United States without registration under the Securities Act. The offering must comply with the securities laws of the foreign jurisdiction, and the company must take reasonable steps to ensure that the securities are not resold to US investors.
What are the Steps to Conduct a Reg D Private Placement Offering?
Step 1 — Determine Type of Reg D Offering
The first step in conducting a Reg D offering is to determine the type of offering that is best suited to your company's needs. There are three types of Reg D offerings: Rule 504, Rule 506(b), and Rule 506(c). Each of these offerings has different requirements and limitations, and companies must choose the type of offering that best meets their fundraising needs and goals.
Step 2 — Draft Offering Documents
Once the type of Reg D offering has been selected, companies must draft offering documents, including a private placement memorandum (PPM) or other disclosure document. The PPM must contain detailed information about the offering, including the terms of the investment, risks associated with the investment, and financial information about the company.
Step 3 — Determine Accredited Investor Status of Investors
One of the key requirements of a Reg D offering is that companies must limit their offerings to accredited investors. Companies must take reasonable steps to verify the accredited status of investors, which typically involves reviewing financial statements, tax returns, and other documentation to confirm that investors meet the SEC's definition of an accredited investor.
Step 4 — File Form D
Companies must file Form D with the SEC within 15 days of the first sale of securities in the Reg D offering. Form D is a notice of exempt offering that provides the SEC with basic information about the offering, including the type of offering, the amount of securities sold, and the number of investors.
Step 5 — Comply with State Securities Laws
In addition to federal securities laws, companies must comply with state securities laws, also known as "blue sky laws." These laws vary from state to state and may require companies to file additional paperwork or pay additional fees to sell securities in a particular state.
Step 6 — Conduct Offering
After completing the necessary paperwork and complying with federal and state securities laws, companies can begin to market and sell their securities to investors. Depending on the type of offering, companies may be allowed to engage in general solicitation and advertising, or they may be limited to selling securities to a select group of investors.
Step 7 — Provide Ongoing Disclosure
Companies that have sold securities in a Reg D offering may be required to provide ongoing disclosure to their investors. This may include providing regular financial statements, business updates, or other relevant information about the company.
In conclusion, conducting a Reg D private placement offering can be a complex process that requires careful attention to federal and state securities laws. By following the steps outlined above and working with experienced legal and financial professionals, companies can successfully raise capital through a Reg D offering while complying with all relevant regulations and requirements.
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