Regulation D is a SEC regulation created under the Securities Act of 1933, indoctrinated in 1982. It allows companies the ability to raise capital by selling equity or debt securities. This allows small businesses to raise capital from private investors, while avoiding the hefty financial costs of registering the securities with the SEC. This is called an ‘exemption from registration.’
Regulation D Rules
There are 3 basic rules used to get the exemption. These rules allow for different amounts of capital, different types of investors, and different methods for conducting an offering. Before determining which of these rules to use you will need to read each rule and figure out which rule works best for your offering.
- Rule 504 – Old rule, for raising up to $1M. Not recognized by some states.
- Rule 506(b) – Old Rule, unlimited capital amount. Recognized by ALL states.
- Rule 506(c) – The NEW General Solicitation Rule! Recognized by ALL states.
Types of Offerings
The 2 basic types of Regulation D Offerings are:
An “equity” offering – whereby the company sells partial ownership in the company via a security (e.g., stock shares or LLC membership units) to raise capital. Equity offerings are preferred by early stage companies because there is no structured repayment schedule or debt payments. The investors usually receive a return when the company starts to generate profits.
A “debt” offering – whereby the company raises debt financing by selling a promissory note to investors with a set annual rate of return, and a maturity date for when funds will be paid back to investors. A debt offering is much like a business loan, but instead of a bank providing the financing, a group of investors lends funds to the company.
* These offering types can be combined, e.g., debt that converts into equity at some point in the future.
Seven steps to preparing an offering:
- A Great Business Idea.
- A Great Business Plan: A full copy of the business plan should be included in the PPM.
- Investment Layout & Disclosure Documents: Most entrepreneurs are not experts at raising capital, thus typically have poorly structured investments. An improper investment structure will portray an unprofessional image to potential investors. The first step in an offering is properly developing the structure. Structuring usually includes, setting stock price or note amounts, determining how much of the company to sell (in equity transactions), which Reg D program to use, setting the maturity date and rate of return for promissory notes (in debt situations), share allocations to principals (so they maintain a set amount of control in the company), minimum and maximum offering amounts which set the effective range of the offering, minimum amount of investment per investor, etc.
- Document Creation: Preparing an offering involves the creation of the Regulation D Offering documents. These documents include:
- Private Placement Memorandum: The Private Placement Memorandum, or “PPM”, is the document that discloses all required information to the investors about the company, proposed operations, the transaction structure (whether you are selling equity ownership or raising debt financing from the investors), the terms of the investment (share price, note amounts, maturity dates, etc.), risks involved, etc. Note: This document typically contains much of the information found in a business plan and also includes an extensive “return on investment” structure, along with an investment contract or “Subscription Agreement” (see next bullet point).
- Investor Suitability Questionnaire: This questionnaire must be completed by each investor and attached to the Subscription Agreement. This document qualifies the investor as an Accredited Investor.
- Subscription Agreement: The Subscription Agreement explains the terms and conditions of the offering. It is the “investment contract” for purchasing the securities. Typically an investor will complete this document and then attach a check for the investment.
- Promissory Note: In debt offerings you need to have a Promissory Note outlining the terms of the loan arrangement with the investors. The note is the actual “loan document” between the company and the investor.
- Form D SEC Filing: The Form D is the form filing that is sent to the SEC in Washington, DC. It notifies the SEC that you are using the Regulation D program and provides them basic information on the company and the offering. Note: It is not an approval document or registration, rather it is a filing that notifies the SEC that you have a Regulation D Offering in place.
- State Form D Filing: Also called “Blue Sky” Filings, most states require a specific form to be filed along with a copy of the SEC Form D and some require a copy of the PPM. Nearly all states charge a fee ranging from $50 to $1,500. In most states the form does not need to be filed until capital has been received from an investor in that state. After receiving the capital you typically have 15 days to file the appropriate documentation, with a few exceptions like New York, who requires filing prior to raising capital; and
- Marketing and Capital Acceptance: The offering is now ready for marketing to investors. The JOBS Act of 2012 has reversed a 80 year old rule whereby solicitation or advertising to accredited investors was strictly prohibited. Investors can now advertise their offerings to accredited investors provided they file Form D and notify the SEC that they intend to use general solicitation.
The Regulation D Programs can be used by domestic as well as foreign corporations. While the programs can be used by any corporation type – the preferred structure is a “C” Corporation or Limited Liability Corporation “LLC“.