Navigating the Labyrinth: Regulation D

In the aftermath of the Great Depression, the United States Congress passed a law called the Securities Act of 1933. (“That’s very nice,” you say; “Did I accidentally sign up for a history lesson?” Not at all, my impatient friend, but if we’re going to get through this labyrinth of regulations and red tape safely, a little historical context goes a long way.)

The Securities Act of 1933 was the first major federal legislation to regulate the offering and sale of securities. Before it, regulation was conducted on a state-by-state basis under what were—and still are—known as Blue Sky laws. The Securities Act was an attempt to centralize and standardize regulation, stipulating that any offer to sell securities had to be registered with the SEC unless it fell under an exemption. Those exemptions are extremely important for private companies and entrepreneurs, who can use them to obtain funding more quickly and with fewer costs than a traditional public offering.

Regulation D, adopted in 1982, defines several of those exemptions, defined by Rules 504, 505, and 506 (no points are given for creative naming over at the SEC). Rule 506 is by far the most commonly used, so we will dispense with the first two quickly. Rule 504 provides an exemption for the offer and sale of securities up to $1 million in a 12 month period; Rule 505 allows a company to raise $5 million over a 12 month period. There are additional details, but what both rules share in common is that they are subject to state Blue Sky regulations. This generally adds a lot of annoyance and expense, and with that $1-5 million cap, most people opt to use Rule 506 instead.

Rule 506 is popular because, unlike 504 and 505, it has no cap on the amount of money you are allowed to raise. Additionally, you’re not subject to state Blue Sky regulations, which makes it doubly appealing.

“Sounds good,” you say. “Tell me more.”

As you wish.

Rule 506 offers an exemption to two different situations. The first, 506(b), allows you to raise money from an unlimited number of accredited investors plus 35 non-accredited investors, but prohibits the use of “general solicitation and advertising” to find those investors. This means you can’t buy ads in your local investment journal or run an online campaign for the raise. The second rule, 506(c), does not allow you to raise money from unaccredited investors, but it does allow you to use general solicitation and advertising to find as many accredited investors as you like.

506(c) is a newcomer to the game, having been put in place as part of the JOBS Act of 2012. Therefore, 506(b) is still more commonly used currently, but expect to see 506(c) gaining traction in the coming months and years.

According to numbers from a 2012 SEC report, Regulation D raises comprise an enormous chunk of the capital raised by companies, far surpassing public equity offerings and even rivaling public debt offerings. If you’re a company looking for an infusion of cash, chances are, you’re going to at least consider a Regulation D raise.

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And there you have it—we’ve made it through the first ring of the labyrinth! Ready to wade further in?


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