As always, make sure you get the advice of a securities attorney with private placement experience.   There are lots of complicated regulatory requirements to comply with, both on the state and federal level.   A private placement attorney can help you navigate the regulations and to draft your private placement memorandum.

Related posts:

1. Private Placement – A Brief Overview of Rule 506
2. Private Placements – A Brief Overview of Rule 504
3. Private Placements – A Brief Overview of Raising Capital with a PPM

a bank, insurance company, registered investment company, business development company, or small business investment company;

an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;

a charitable organization, corporation, or partnership with assets exceeding $5 million;

a director, executive officer, or general partner of the company selling the securities;

a business in which all the equity owners are accredited investors;

a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase [08/05/2010 - See this link for a recent change to this portion of the definition];

a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or

a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

In addition to understanding what it means to be an accredited investor, it is also important to understand how accredited investor status relates to the most common exemptions from the registration requirements of federal securities law. In a nutshell:

• Rule 504 permits allows a business to sell up to $1 Million in securities during a 12 month period to an unlimited number of non-accredited investors. Additionally, Rule 504 does not require the issuer to provide any specific disclosure to the offerees, regardless of whether they are accredited (but keep in mind the anti-fraud requirements).
• Rule 505 allows a business to sell up to $5 million in securities during a 12 month period to an unlimited number of accredited investors, and up to 35 non-accredited investors.  The big problem with selling to non-accredited investors is that the disclosure requirements are significantly more difficult to meet – very similar to the disclosures required in a public offering.
• Rule 506 allows a business to raise an unlimited amount of capital via the sale of securities to an unlimited number of accredited investors, and up to 35 non-accredited investors.  In addition to the substantial disclosure requirements discussed above for Rule 505, any non-accredited investors must also meet a “sophistication” standard, either themselves or via a qualified purchaser’s representative.  The status of an investor as “sophisticated” is a fairly high standard; investors who are merely knowledgeable about the particular industry are not necessarily sophisticated.

As you can see, raising capital from non-accredited investors puts a start-up in a much more tenuous position in terms of disclosure – which means substantially more legal and accounting fees.  Non-accredited investors also tend to be more difficult to deal with in the long term.  Consider carefully the decision to raise capital using non-accredited investors – and of course consult with a securities attorney.

One other thing to keep in mind is that the burden of establishing whether an investor is an accredited investor falls on the issuing company.  At a minimum, the issuing company must reasonably believe that the investor falls into one of the 8 categories in the definition of “accredited investor.”  This is typically accomplished using a carefully drafted investor questionnaire – make sure you use one and that you consult a securities attorney.

Related posts:

1. Private Placements – A Brief Overview of Rule 505
2. Private Placement – A Brief Overview of Rule 506
3. Private Placements – A Brief Overview of Raising Capital with a PPM

As always, make sure you get the advice of a securities attorney with private placement experience.  There are lots of complicated regulatory requirements to comply with, both on the state and federal level.  A private placement attorney can help you navigate the regulations and to draft your private placement memorandum.

Related posts:

1. Private Placements – A Brief Overview of Rule 505
2. Private Placement – A Brief Overview of Rule 506
3. Private Placements – A Brief Overview of Raising Capital with a PPM

The SEC created Regulation D, which creates certain rules for private offerings. By following these rules, an issuer (i.e. a company selling stock or other form of security to raise capital) generally may raise up to $5,000,000 without a public offering.

Generally, a private offering may have no more than 35 investors. On the federal level, though, certain high-net-worth investors defined as “accredited investors” may be excluded when calculating the number of investors. There must also be NO general solicitation of investors by the issuer – no advertising. Just this weekend I came across someone soliciting the “private” sale of securities on Twitter – definitely not a good idea if you are trying to comply with the registration exemptions under Regulation D.

The federal securities laws for both public and private offerings are based on the premise that investors in securities are best protected by the disclosure of all relevant information regarding the securities and the issuer. The underlying guideline in this respect is Rule 10b-5, which requires the issuer to disclose to investors anything material that a reasonable investor would want to know prior to making a decision to invest. This is why PPMs are stocked to the brim full of material facts, disclaimers, and lots and lots of risk factors. Failure to properly include these and other items may subject the issuer to serious liability, including being forced to buy back the securities from the investor, as well as damages. If you want to avoid liability, overdisclose, do not hide anything, and do not mislead (among other things of course).

Keep in mind that there are also state “blue sky” laws to comply with – and they will need to be complied with in every state that a security is offered and/or sold.

Make sure to consult a private placement attorney / securities law attorney before you raise capital for your business.

Related posts:

1. Private Placements – A Brief Overview of Rule 505
2. Private Placements – A Brief Overview of Rule 504
3. Private Placement – A Brief Overview of Rule 506