A Deeper Dive into Securities Exemptions for Private Placements

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A securities offering exempt from registration with the SEC is sometimes referred to as a private placement or an unregistered offering.  Under the federal securities laws, a company may not offer or sell securities unless the offering has registered with the SEC or an exemption from registration is available.

Capital may be raised in private placement offerings by relying on exemptions under Regulation D and Regulation A of the Securities Act of 1933. These exemptions are helpful tools if you want to (1) raise capital from investors, (2) be in control of the fund, business, or asset (as opposed to having the investors all sharing control), and (3) not go through the time and expense of registering with the SEC. However, understanding the differences between these exemptions is vital for fund raising and operations. Each of these exemptions are discussed in more detail below:

Accredited Investors

The definition of “Accredited Investor” is integral to the applicability of these exemptions. Investors are accredited by the SEC if they meet at least one of the following requirements:

  • The Investor has a net worth of at least $1 million, which they can share jointly with a spouse or spousal equivalent. This net worth figure cannot include the value of the investor’s primary home.
  • The investor has an income of at least $200,000 per year ($300,000 with spouse) for the previous two years and a reasonable expectation to make the same amount or higher in the coming year.
  • An investor must also be a “knowledgeable employee” of the fund or hold a relevant license demonstrating their financial expertise, such as the Series 7, 65, and 82 licenses.
  • Certain entities with over $5M in assets.

Rule 506(b)

Rule 506b allows you to raise an unlimited amount of capital from Accredited Investors and up to 35 (financially sophisticated) non-Accredited Investors. However, under Rule 506b, any securities are restricted from transfer for a least 1 year, and you cannot engage in general solicitation, advertising, or marketing for your offering.

Non-Accredited Investors and Investor Self-Certification Allowed

Under 506b, you may allow an unlimited number of Accredited Investors to invest in your fund and up to 35 Non-Accredited Investors, each of whom are financially sophisticated. However, if you wish to bring non-accredited investors into the offering, further disclosure rules apply, such as audited financials once the fund reaches $20M in AUM.

No Marketing or Solicitation; Substantive Pre-Existing Relationship Required

You are not allowed to market (via TV, radio, or social media) and generally solicit to the public under Rule 506b.  You may discuss your business generally, but if you want to provide specific terms or details of the offering, the potential investor must be someone with whom you already have a “substantive pre-existing relationship.”  This means you gathered enough information about your investor (professional background, risk tolerance, etc.) that you understand their financial position and know whether they are able to take on the investment, and that a sufficient “cooling-off period” has passed.

Rule 506(c)

Rule 506c allows you to market and advertise your offering and allows you to solicit investors. However, under Rule 506c, all investors in the fund must be Accredited Investors.

Advertising And Soliciting

Under Rule 506c, you may use any marketing channel you wish to advertise your fund. Any advert put out to the public falls under the SEC’s definition of general advertising.

Accredited Investors Only; Verification Required

Only verified Accredited Investors are allowed to invest in a 506c offering, and you must show that you have taken reasonable steps to ensure all your investors are accredited. Verification is completed by confirming the investor’s bank statements, tax returns, or other financial documents. You are also allowed to have a third party, such as an attorney, CPA, Broker Dealer/Registered Investment Advisor, or a verification service, provide you with verification of the investor’s accreditation status. 

Regulation A+

For those who seek to raise capital from a larger contingent of Non-Accredited Investors or seek to pursue a crowdfunding strategy, we typically recommend Regulation A as the best option. Generally, Regulation A is no different than a public offering as it requires SEC approval and frequent reporting.

The below discussion focuses on requirements for Reg A Tier 2 offerings. (Tier 1 has a $20M limit on total capital raised per year.)  Like Rule 506c, Reg A-Tier 2 offerings permit general solicitation and advertising but has a few other limitations and requirements.

Capital Limits and Limitation on Investors

Reg A-Tier 2 funds are limited to raising $75M each year from Accredited Investors and Non-Accredited Investors. However, Non-Accredited Investors will be limited in the amount they can invest.

SEC Review and Registration Required

A Form 1-A must be filed with the SEC for their review and comments.  The offering must be declared “Qualified” before investors are allowed into the fund. 

Audited Financials and Related Financial Statements

Reg A-Tier 2 requires you to include audited financials in you offering documents. The required Form 1-A requires you to provide financial statements such as balance sheets and related financial statements for the two previous fiscal year ends.

Ongoing Reporting Required

Reg A-Tier 2 funds are subject to ongoing reporting and are required to file annual, semi-annual, and current event reports with the SEC. These include: (1) annual reports on Form 1-K; (2) Semi-annual reports on Form 1-SA; (3) Current reports on Form 1-U; (4) Special financial reports on Form 1-K;  and (5) Form 1-SA Exit reports on Form 1-Z.

Do I need a Prospectus / Private Placement Memorandum?

YES! Whether you are selling securities using Rule 506(B), 506(C), state law, or Regulation A, it is considered standard and best practice to offer and sell securities using an offering memorandum like a prospectus. These documents disclose the key features of the offering, risks associated with the investment, and outlines the investor qualifications.

Quick Recap: Rule 506b vs. Rule 506c vs. Reg A – Tier 2:

We have condensed this information into a comprehensive table below.

 Reg D – 506b                       Reg D – 506cReg A – Tier 2
Capital LimitsNone on amount raised; None on each investor amountNone on amount raised; None on each investor amount$75M every 12 months
Investor Eligibility35 Non-AccreditedAccredited Investors onlyNon-accredited investors are subject to an investment limit
Investor Suitability VerificationSelf-certification okVerification required; (Can be by CPA, attorney, financial planner)Self-certification ok  
Limit on Investment AmountNo limitNo limitNo limit for Accredited Investors; Limited to 10% of income/net worth for Non-Accredited
General Advertising/ General SolicitationNot allowed; brand marketing onlyNo limitations  No limitations
Financial StatementsRequired only if non-accredited investors and 20M+ AUMNot requiredAudited financials in accordance with GAAP
SEC ReviewNo reviewNo reviewSEC must review, comment, and declare “qualified” before sale
Filing RequirementForm DForm DForm 1-A
Ongoing DisclosureNoneNoneAnnual, semi-annual, and current reports required

Bottom Line

Whether you are a developer, family office, mortgage lender, or investor, it is important to consider these fundamental securities considerations. Please contact us if you would like to learn more!

Questions about this article? Reach out to our team below.
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