Private equity, the process by which companies can raise funding from investors, comes with numerous rules and regulations enforced by the Securities and Exchange Commission (SEC). One of the most important rules that small businesses must understand is Regulation D, or “Reg D,” 17 C.F.R. § 230.500 et seq., which sets forth the procedures for offering securities for sale without going through the full process of registering with the SEC under the Securities Act of 1933, 15 U.S.C. § 77a et seq. Reg D prohibits advertising any sale of securities to the general public, and it states that a business may only issue securities to “accredited investors.” In August 2015, the SEC approved a venture capital firm’s plan to use an online platform to match investors with businesses, finding that it does not conflict with Reg D’s ban on public advertising. This could be good news for other businesses hoping to leverage the internet and social media to raise private equity funds.
Under Reg D, securities may only be issued to “accredited investors,” defined to include banks, nonprofit business trusts, directors, or officers of the issuing company, and individuals with a net worth of more than $1 million or annual income in excess of $200,000. 17 C.F.R. § 230.501(a). With some exceptions, an issuer under Reg D cannot advertise the sale of securities or solicit purchasers from the general public. 17 C.F.R. § 230.502(c). Issuers must file Form D with the SEC to indicate compliance with Reg D.
Rule 506 of Reg D, codified at 17 C.F.R. § 230.506, establishes procedures for communicating with potential investors. Most Reg D offerings follow Rule 506(b), which provides that issuers can approach potential investors if they have a pre-existing relationship, but they cannot advertise or solicit investors from the general public. Offerings under Rule 506(b) may also include up to 35 non-accredited, sophisticated investors who are “capable of evaluating the merits and risks of the prospective investment.” Id. at § 230.506(b)(2)(ii).
In 2013, the SEC amended Rule 506 to add subsection (c), which allows the general advertising of securities, provided that issuers take “reasonable steps to verify that purchasers…are accredited investors.” Id. at § 230.506(c)(2)(ii), 78 Fed. Reg. 44771 (Jul. 24, 2013). The rule provides a list of “non-exclusive and non-mandatory methods” issuers can use to make this verification, including examining tax records or financial statements, or obtaining confirmation of an investor’s accredited status in writing from a financial professional.
Despite the potential avenues opened by Rule 506(c) for new methods of raising capital, few businesses have taken advantage of it, reportedly because of the difficulty of verifying investors’ accreditation. The SEC’s recent decision with regard to a venture capital firm’s online platform, however, may make online fundraising more appealing. The firm’s service matches pre-screened prospective investors with businesses seeking capital. The SEC determined that this does not violate Rule 502(c)’s advertising ban.
Business transactions attorney Samuel C. Berger represents entrepreneurs, business owners, and businesses in New York City and Northern New Jersey. We offer fixed-fee legal-service packages covering a wide range of legal issues, which allow our clients to understand their rights and obligations, and to run their businesses efficiently and effectively. Contact us online or at (212) 380-8117 today to schedule a confidential consultation with a member of our team.
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
New York and New Jersey Entrepreneurs May Be Able to “Crowdfund” Their Businesses Soon Under New Federal Rules, New York & New Jersey Business Lawyer Blog, October 24, 2013