What New York and New Jersey Small Business Owners and Entrepreneurs Should Know About Regulation D

By Kevin Hutchinson (Flickr) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia CommonsRaising capital is a critical step in the early stages of starting a business, but federal and state laws set several important limits on this process. Ownership in a business, when given in exchange for a monetary contribution, is generally considered a “security” for the purpose of federal financial law. Federal law requires companies that are offering stock for sale to the public to register the offer with the Securities and Exchange Commission (SEC). An exception to this rule, known as “Regulation D” or “Reg D,” allows companies to offer stock to certain investors without the lengthy and expensive SEC registration process. This allows small businesses and startups to approach angel investors, venture capital firms, and others.

Public vs. Private Offerings

The process of raising capital for a small business or startup is commonly known as “private equity,” since funding comes from a limited pool of potential investors. A company that registers with the SEC and meets all of the requirements of the Securities Act of 1933, 15 U.S.C. § 77a et seq., can offer their stock for sale to the general public on exchanges like the New York Stock Exchange. It then becomes known as a “publicly-traded” company.

When a company offers its stock for sale to the public for the first time, it is known as an initial public offering (IPO). Obtaining SEC approval for an IPO is complicated, expensive, and out of reach for startups and many small businesses. These businesses need to raise capital, but they must do so in a way that does not inadvertently become an unauthorized public offering of securities.

Regulation D

Regulation D, found at 17 C.F.R. § 230.501 et seq., establishes a series of qualifications that a company’s offer of securities must meet in order to be exempt from registration with the SEC. In general, a company may not advertise that it is offering securities for sale. It must provide various financial disclosures, and the securities must have certain restrictions on resale. The company must file Form D with the SEC to declare the exemption.

The “accredited investor” is a critically important concept. Reg D defines this term to include banks and certain other financial institutions, certain private development companies, and certain business trusts. 17 C.F.R. § 230.501(a). An “accredited investor” can also be an individual who meets any of the following criteria:

– They are a director, officer, or general partner of the company issuing the securities;
– They have a net worth, individually or jointly with a spouse, in excess of $1 million at the time of the securities purchase; or
– Their individual income exceeded $200,000, or their joint income with a spouse exceeded $300,000, for each of the two years immediately prior to the purchase, and they reasonably expect to maintain or exceed that income level during the current year.

Regulation D allows three exemptions to SEC registration. The first two, Rules 504 and 505, 17 C.F.R. §§ 230.504, 230.505, apply to companies that register their offerings, or that are exempt from registration under state law, and that limit the sale of securities to $1 million or $5 million, respectively, during a 12-month period.

Rule 506, 17 C.F.R. § 230.506, is most likely to apply to New York and New Jersey small businesses. A company offering securities under Rule 506 can raise an unlimited amount of capital from an unlimited number of accredited investors, and a maximum of 35 unaccredited investors, provided it meets the requirements for financial disclosures and restrictions on resale. Since 2013, companies are permitted to advertise the offer of securities under Rule 506 if all purchasers are accredited investors, and the company takes “reasonable steps” to verify this.

Business law attorney Samuel C. Berger offers fixed-fee legal-service packages to New York and New Jersey entrepreneurs and businesses, which cover a wide range of legal issues and needs. Contact us today online or at (212) 380-8117 to schedule a confidential consultation with a knowledgeable and experienced business advisor.

More Blog Posts:

A Brief Guide to the Stages of Venture Capital Financing for New York and New Jersey Business Owners, New York & New Jersey Business Lawyer Blog, July 16, 2015

Types of Funding for New York and New Jersey Startups and Small Businesses, New York & New Jersey Business Lawyer Blog, July 2, 2015

Initial Public Offerings by Small Businesses Are Surging, Possibly Due to JOBS Act, New York & New Jersey Business Lawyer Blog, November 6, 2014

Photo credit: By Kevin Hutchinson (Flickr) [CC BY 2.0], via Wikimedia Commons.