Many businesses receive funding during the start-up phase of their company. Usually, this is from friends and family but even in these situations there are legal requirements that you must abide by. The Securities and Exchange Commission (SEC) regulates how funds are raised for companies. Additionally, each state has specific laws that govern this situation. Failure to take funding pursuant to the specific rules, even for just one person, can result in great consequences, jail time, your business being shut down, expensive lawsuits, and much more.
If you are new to the entreprenuer and business world you might want to understand more about starting a business. To learn more about the types of entities that you could choose you will want to understand the types of businesses that are available. Now, let’s get into raising capital for your business and taking other people money…
What is Regulation D?
Regulation D (Reg D) is a SEC regulation that governs private placement exemptions. Reg D allows smaller companies to raise funding through the sale of equity or debt securities in the business without having to register their securities with the SEC. This allows private companies and entrepreneurs to get funding faster and cheaper because they don’t have the costs involved with a public offering.
What is Rule 504 of Regulation D?
Rule 4 of Reg D provides an exemption to the registration requirements for companies when they are selling or offering up to $1,000,000 of their securities in any 12 month period. As long as the business is not a blank check company they can use this exemption. This generally does not allow companies to advertise or solicit their securities to the public but there are exceptions to this part of Rule 504.
What is Rule 506 of Regulation D?
Often referred to as a “safe harbor”, Rule 506 is a private offering exemption of Section 4(a)(2) of the Securities Act which allows businesses relying on the Rule 506 exemption to raise unlimited amounts of money. Purchases of Rule 506 securities receive restricted securities which means that the securities can’t be sold within the first year without registering them. Under Rule 506 there are actually two distinct exemptions.
(1) The Rule 506(b) exemption can be satisfied pursuant to section 4(a)(2) by abiding by the following regulations:
- The company cannot use advertising or solicitation to market the securities;
- The company is allowed to sell the securities to an unlimited amount of “accredited investors” and up to 35 other purchasers. These investors must be sophisticated which means they need to have a good amount of knowledge and experience in financial and business matters which allows them to evaluate the risks of the potential investment;
- Companies must decide the information given to accredited investors so long as it does not violate the antifraud prohibitions of federal securities law. If the investors are non-accredited, the company needs to disclose information that is generally the same as that found in the registered offerings. Also, if a company provides information to accredited investors, the same must be made available to the non-accredited investors;
- The business needs to be available to answer questions by prospective investors; and
- Financial statement requirements must be met similar to Rule 505.
(2) Under Rule 506(c), a business can solicit and advertise the offering, but will still be viewed as a private offering within Section 4(a)(2) if:
- The investors in the offering are all accredited; and
- The business has taken reasonable steps to make sure the investors are actually accredited which includes measures such as reviewing w-2’s, bank statements, tax returns, credit reports and more.
Under Rule 506, investors don’t have to register with the SEC their offering of securities, but they do need to file a Form D (explained below).
Private Sales of Equity:
If a company makes a private sale of equity and no there are no disclosure delivery requirements, a company should take the time to provide the investor(s) with relevant information to avoid violating any anti-fraud provisions of the securities law. Any information provided should be free from false or misleading statements. The company should not exclude any information if such an omission will make what is provided false or misleading.
This form must be filed within 15 days after the first sale of the securities. Form D gives notice of a company’s executive officers and stock promoters as well as providing relevant information to the SEC. Additionally, the forms allow the investors to receive information regarding their securities rights and helps to prevent fraud during such exchanges. If you are thinking about investing in a company, you can check the EDGAR database to check if the business has filed Form D.
Additionally, you should check with your specific state. Both the investor and company need to abide, not only by federal regulations but also by state laws. In Florida, Statute 517.061 governs the sale of securities for small businesses and companies.