Regulation D Stock Sales
Regulation D (or Reg D) refers to a set of rules established by the U.S. Securities and Exchange Commission (SEC) that provides exemptions from the registration requirements of the federal securities laws. This allows companies to raise capital through the sale of equity or debt securities without having to register the securities with the SEC.
Regulation D consists of various “Rules,” primarily Rules 504, 505, and 506, each with its own conditions and limitations. However, as of my last update in 2021, Rule 505 was no longer in effect, having been eliminated by the SEC. The most frequently used exemptions under Reg D are Rule 504 and Rule 506.
- Rule 504: Allows companies to raise up to $5 million in a 12-month period. The securities can be sold to any type of investor, and there are no specific disclosure requirements. However, general solicitation (advertising the offering to the public) is allowed only in certain circumstances.
- Rule 506: This is the most popular of the Reg D exemptions and is broken down into two distinct exemptions:
- Rule 506(b): Allows companies to raise an unlimited amount of capital. Companies can sell to an unlimited number of accredited investors and up to 35 non-accredited investors. However, if selling to non-accredited investors, certain disclosure requirements must be met. General solicitation is not permitted under 506(b).
- Rule 506(c): Introduced by the JOBS Act, this rule also allows companies to raise an unlimited amount of capital, but with the notable difference that general solicitation is allowed. However, all investors must be accredited, and the company must take reasonable steps to verify their accredited status.
Key features of Regulation D stock sales:
- No SEC Registration: Securities sold under Reg D are not registered with the SEC, which reduces the cost and time associated with the fundraising.
- Accredited Investors: An accredited investor is generally an individual with a net worth (excluding their primary residence) of over $1 million or with an annual income of over $200,000 (or $300,000 with a spouse) in the last two years.
- State Blue Sky Laws: While Reg D provides an exemption from federal registration, companies must still comply with state securities laws (often referred to as “blue sky” laws). However, Rule 506 offerings preempt state review, simplifying the process in multi-state offerings.
- Form D: After securities are sold under Reg D, the company must file a “Form D” with the SEC. This is a brief notice that includes essential details about the company and the offering, such as the names and addresses of the company’s executive officers, the size of the offering, and the date of the first sale.
Regulation D offerings are a popular means for startups and other private companies to raise capital from investors without the complexities and expenses of a public offering or full SEC registration.
Example of Regulation D Stock Sales
Let’s walk through a hypothetical scenario involving a company’s decision to utilize Regulation D to raise capital.
NanoMed, a biotechnology startup focusing on nanotechnology solutions for targeted drug delivery, is in the early stages of research and development. The company has reached a point where additional capital is needed to fund clinical trials. They estimate they need to raise $10 million for this phase. After discussing with their advisors, NanoMed decides to pursue a private offering under Regulation D, Rule 506(b).
- Planning: NanoMed decides to limit the offering to accredited investors, to simplify the process and avoid having to provide detailed disclosure documents to non-accredited investors.
- Engage Legal Counsel: They engage a law firm with expertise in securities offerings to guide them through the Reg D compliance process.
- Preparation of Offering Documents: NanoMed prepares a Private Placement Memorandum (PPM), which outlines the terms of the investment, details about the company, its technology, the intended use of funds, and the potential risks associated with the investment.
- No General Solicitation: Given they are using Rule 506(b), NanoMed refrains from advertising the offering to the general public. Instead, they reach out to potential investors with whom they have pre-existing relationships or who are introduced through their network.
- Verification: While NanoMed is only targeting accredited investors, they don’t need to take extra steps to verify their status under Rule 506(b) since they’re not engaging in general solicitation.
- Investment Agreements: As investors express interest and commit to investing, they enter into subscription agreements with NanoMed, formalizing their investment.
- Raising Capital: Over several months, NanoMed successfully secures commitments from various investors, including angel investors, venture capitalists, and other financial professionals, eventually reaching their target of $10 million.
- Filing Form D: After completing the offering, NanoMed files Form D with the SEC, notifying them of the securities sale. They also ensure they are in compliance with any state-specific regulations where their investors are located.
Thanks to the Regulation D, Rule 506(b) exemption, NanoMed successfully raises the capital it needs without the extensive time and financial costs of a public offering or full SEC registration. Investors in the offering have the opportunity to participate in the early stages of a promising biotech venture. The company can now focus on advancing its clinical trials and making strides in its R&D efforts.
This example highlights how Regulation D provides a more efficient pathway for startups and private companies to secure funding, allowing them to grow and pursue their business objectives.