Guide to Fundraising. Exemptions from SEC Registration
Raising capital is a critical step for many businesses, particularly for startups and growing companies. When seeking to raise funds, companies must be mindful of the U.S. Securities and Exchange Commission (SEC) regulations to avoid costly penalties. The SEC requires companies to register most securities offerings, but there are several exemptions available to streamline the process, especially for private companies.
This guide will explain and compare four popular exemptions: Regulation D Rule 506(b), Regulation D Rule 506(c), Regulation A Tier 1, and Regulation A Tier 2. Each of these exemptions allows companies to raise capital while avoiding the lengthy and expensive process of full SEC registration. However, each has specific requirements and limitations that make them suitable for different situations.
1. Regulation D, Rule 506(b)
Key Features:
Unlimited Capital Raising: Companies can raise an unlimited amount of capital.
Types of Investors: Companies can sell to an unlimited number of accredited investors (wealthy individuals or entities) and up to 35 non-accredited investors, provided they have sufficient knowledge and experience in financial matters to evaluate the investment.
No General Solicitation: Companies cannot advertise or solicit investments publicly. They must rely on pre-existing relationships or private networks to find investors.
Disclosure Requirements: Minimal disclosure is required if all investors are accredited, but if non-accredited investors are involved, issuers must provide detailed information similar to what would be required in a registered offering.
Form D Filing: The company must file a Form D with the SEC within 15 days after the first sale of securities.
Best for:
Companies looking to raise capital privately without public advertising, especially when they already have a network of potential accredited investors.
Potential Pitfalls:
The restriction on public solicitation can limit the reach of your offering. Additionally, the inclusion of non-accredited investors adds a layer of complexity and requires enhanced disclosure.
2. Regulation D, Rule 506(c)
Key Features:
Unlimited Capital Raising: Like Rule 506(b), there is no limit on the amount of capital that can be raised.
Types of Investors: Companies can sell securities only to accredited investors. Non-accredited investors are not allowed.
General Solicitation Allowed: Companies can use public advertising and solicitation (e.g., social media, websites, or email campaigns) to attract investors, but all purchasers must be accredited investors.
Verification of Accredited Status: Issuers must take reasonable steps to verify that each investor is accredited. This could include reviewing tax returns, bank statements, or obtaining written confirmations from financial professionals.
Form D Filing: Similar to Rule 506(b), a Form D must be filed within 15 days of the first sale.
Best for:
Companies that need to reach a broader audience and use public advertising to find investors, but only want to deal with accredited investors.
Potential Pitfalls:
The requirement to verify accredited investor status can be more burdensome than Rule 506(b), especially for companies with limited administrative resources. This additional verification is crucial to remain compliant.
3. Regulation A, Tier 1
Key Features:
Capital Limit: Companies can raise up to $20 million within a 12-month period.
Types of Investors: Anyone, including non-accredited investors, can invest.
General Solicitation Allowed: Companies can advertise publicly and solicit investments from the general public.
State Review Required: Offerings under Tier 1 are subject to state securities regulations (also known as Blue Sky Laws). This means companies must seek approval from each state in which they plan to sell securities.
Disclosure Requirements: Issuers must file an offering statement with the SEC, but the disclosure requirements are less burdensome than a full registration.
Ongoing Reporting: There are no ongoing SEC reporting requirements once the offering is completed.
Best for:
Companies that want to raise up to $20 million from a broad pool of investors, including non-accredited individuals, and are prepared to deal with state-level regulations.
Potential Pitfalls:
The need to comply with state-level securities laws can make the process more time-consuming and costly. Additionally, the $20 million cap may be too limiting for larger companies.
4. Regulation A, Tier 2
Key Features:
Capital Limit: Companies can raise up to $75 million in a 12-month period.
Types of Investors: Available to both accredited and non-accredited investors. However, non-accredited investors are subject to investment limits (no more than 10% of their annual income or net worth).
General Solicitation Allowed: Public advertising is permitted.
State Preemption: Unlike Tier 1, Tier 2 offerings are exempt from state securities laws, meaning companies do not need to seek state-by-state approval. This can save time and costs.
Disclosure Requirements: Issuers must file an offering statement with the SEC, which is more comprehensive than Tier 1.
Ongoing Reporting: Companies must file annual, semi-annual, and current reports with the SEC, similar to public companies but with less stringent requirements.
Best for:
Companies looking to raise a larger amount of capital (up to $75 million) from a wide range of investors and who prefer to avoid state securities law complications.
Potential Pitfalls:
The ongoing reporting requirements can be burdensome, particularly for smaller companies. Additionally, the investment limits on non-accredited investors could reduce the pool of potential contributors.
Comparing the Exemptions
Choosing the Right Exemption
Rule 506(b) is ideal for investment funds or companies with pre-existing relationships with accredited investors and who do not wish to engage in public advertising.
Rule 506(c) is suited for investment funds or businesses that need to reach a larger audience through public solicitation but want to limit investors to accredited individuals.
Regulation A, Tier 1 is best for smaller investments or companies looking to raise up to $20 million from both accredited and non-accredited investors, although state-by-state compliance can add complexity.
Regulation A, Tier 2 is beneficial for investments or companies seeking to raise up to $75 million and wishing to avoid state securities laws, though they must be prepared for ongoing reporting requirements.
Consulting with a knowledgeable attorney before choosing an exemption is critical to ensure compliance and avoid unnecessary regulatory complications. Each exemption has different advantages and limitations depending on your company’s goals, investor base, and capital needs. Schedule a free consult here with our attorney or call at 435 612-0422