Reg D: Raising Capital

Entrepreneurs wishing to sell securities to raise capital must register those securities with the Securities and Exchange Commission (SEC), or qualify for an exemption. These exemptions, commonly known as the Reg D exemptions, include Rules 504, 505 and 506, each of which vary in the amount of money that can be raised and disclosure requirements to potential investors.

Businesses save money in terms of legal and compliance fees while still creating a market for securities. In addition, a Reg D exemption offers protection to the entrepreneur from unhappy investors wishing to claim a registration or disclosure violation.

Rule 504

Rule 504 allows a business to raise up to $1,000,000 in capital over 12 months. In order to qualify, the company must have a business plan and purpose and not otherwise be subject to reporting requirements.

Companies exempt under Rule 504 can even offer limited public securities, without regulating who the investors can be (i.e. there is no rule requiring accredited investors, unlike Rule 505 and 506). Rule 504 does not require a prescribed disclosure document, unlike registered offerings. However, companies exempt under Rule 504 are still subject to rules regarding fraud and individual state laws may have stricter rules governing securities offerings.

Rule 505

Rule 505 increases the investment limit to $5,000,000 over a 12-month period. However, investors must be accredited investors.  Currently, an accredited investor can be one whose net income before taxes exceeds $200,000.00 in each of the two most recent years whereby such person reasonably expects to reach the same income level or exceed the income level in the current year.  An accredited investor can also be one whose net income before taxes combined with that of his or her spouse exceeds $300,000.00 in each of the two most recent years and reasonably expects that they will reach the same level of income or exceed that income level in the current year.  In terms of assets, an accredited investor, either alone or with his or her spouse, beneficially owns, directly or indirectly, financial assets (cash and securities) having an aggregate realizable value that, before taxes, but net of any related liabilities (liabilities incurred to finance the purchase of, or secured by, the financial assets), exceeds $1,000,000.00. Rule 505 does allow up to 35 non-accredited investors, with the caveat that they must receive disclosure documents such as those given for registered offerings.

Rule 506

Rule 506 allows a company to raise unlimited amount of capital.  However, these offerings must be private, meaning the company cannot "go public" and sell common stocks.  Purchasers are also restricted from trading the securities after the offering.  In addition, Rule 506 also limits the number of non-accredited investors to 35, and those investors must be sophisticated, which the SEC defines as someone with "sufficient knowledge and experience in financial and business matters" to understand the investment.