Regulation D — The Ultimate Guide on Raising Private Capital
Last Updated: 12/17/2023
What’s Regulation D
Regulation D, also known as Reg D, is a set of federal securities laws imposed by the Securities and Exchange Commission (SEC) to regulate private security offerings, also known as a private placement offering. Small companies, entrepreneurs, and startups can benefit from the exemptions granted by Reg D, which allows them to skip the lengthy paperwork and regulations associated with a public offering.
In this sense, Reg D and its applicable laws provides an expedite route through which a company can offer securities to third parties to raise money for its operational needs.
A business can either raise money through equity instruments (such as common shares) or debt instruments (such as bonds or convertible issues) and the offering will not have to be registered with the SEC. Instead, the company will only inform the SEC about the proceeding but it will not require its authorization to complete the placement.
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Regulation D Advantages
For a company that’s looking to raise money quickly to fund its operations, Regulation D provides the most favorable legal framework to expand its network of potential investors outside the tight circle of family, friends, and close acquaintances, as Reg D, provided certain criteria is met, permits the possibility of soliciting and advertising the private offering to ‘accredited investors.
How much money can I raise through Regulation D offerings
There are two rules that disclose the details of how large a Regulation D offering:
· Reg D: Rule 504
A rule that allows a business to offer up to $5,000,000 in securities privately in a 12-month period without the need of registering the offering with the SEC (such registration is mandatory).
Under most circumstances, these securities should be “restricted” which means that the holder cannot be sold for a period of 6 to 12 months without registering them formally with the SEC. Reg D is not applicable to investment companies or companies at a development stage that doesn’t have a clear business plan.
· Reg D: Rule 506
This rule permits two different scenarios under which a company can raise an unlimited amount of money through Regulation D:
Scenario 1 — RegD Rule 506(b):
Under paragraph ‘b’, a Reg D company can’t solicit or advertise the offering but it can sell the offering to an unlimited number of ‘accredited investors and up to 35 non-accredited investors, as long as they proved to be sufficiently knowledgeable of business matters to the extent that they understand the risks associated with investing in the business.
The company must disclose sufficient information to portrait the financial situation of the business and it must be available to potential investors to answer any questions they may have, so they can make an informed decision on whether to invest in the offering or not.
This information commonly involves audited financial statements and business reports that disclose the key operating aspects of the business including details on their manufacturing processes, products, services, marketing information, and future projects.
Scenario 2 — Rule 506(c):
Paragraph ‘c’ allows a Reg D business to solicit and advertise its offering, as long as all the parties investing in it are considered ‘accredited investors’. The company must ensure that the parties involved meeting the criteria to qualify as such and they must also disclose all relevant information associated with the business financial and operational situation.
Under both scenarios, a company must file an electronic Form D through the EDGAR Database to inform the SEC that the offering has been placed. The form requires information about the business, its officers, the nature of the offering, the minimum investment required, and any commissions associated with the offering.
Additionally, even though Reg D companies may be exempt from formally registering the offering with the Securities and Exchange Commission in, some states, may impose certain rules related to private placements. In this sense, the issuer must look for advice from a local securities attorney to make sure the company complies with local regulations.
What’s an accredited investor
According to federal securities laws, an accredited investor is an individual that is capable of understanding the risks associated to do business and investing in securities, to the extent that they can make an informed decision based on factual information.
The criteria to qualify as an accredited investor, especially applicable to a Reg D offering is:
· An annual income of at least $200,000 for an individual or a combined annual income of $300,000.
· A net worth of least $1,000,000 either for a single individual or combined with its spouse, excluding the value of its primary residency, but including savings accounts, savings deposits, and money market accounts.
· A trust that manages at least $5,000,000 in total assets, that is operated by a sophisticated individual (business-savvy) and that wasn’t formed with the specific purpose of purchasing the offering.
· A legal entity whose shareholders are all accredited investors.
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Raising money through a Regulation D private placement requires certain skills that are crucial to a successful result. A founder must be capable of transmitting through the documentation, and potentially through personal presentations, the business idea, his qualifications, the soundness of the business model, the key relationships he has that will ensure his success, the qualifications of his teams, and many other elements that will communicate persuasively that this is a business an investor shouldn’t pass on.
Some information is often presented in the form of a pitch deck, for more information read this guide on its creation, which contains marketing information on the business.
Given that both offerings are similar in nature, some of these tips are applicable to Regulation D offerings also.
Here are a few that you may find useful regarding Reg D offerings:
Make sure consumers love your product
If you can’t prove there’s a market eager to buy what you are selling, you’ll find difficulties in pitching your idea to those with enough money to know better than a business with no customers is no business at all.
Set a low goal for your initial round
Some companies go too far when they do their first round of funding. If there are still a few details of your business model that need further A/B testing or, if the product still has details that need to be fixed, you should consider setting a low goal for your initial Reg D offering, this way you’ll seize the momentum but you’ll also protect yourself from unaccomplished high goals that may trigger refunds or cancellation.
You need money to raise money
Raising capital through Reg D is not cheap, especially if you go the 506(c) route and you want to advertise your offering. The funds to cover the legal fees and a decent marketing budget are a must. Failing to adequately market the offering can end in disastrous results. So, if you are considering raising capital on a low budget, think twice.
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How much does it cost to raise money through Regulation D?
· Filing Form D to comply with the SEC requirements for a Reg D offering costs between $300 and $500, depending on the state.
· The legal fees associated with a Regulation D offering may range from $12,000 to $30,000 or more depending on the complexity of the case. For this reason, many entrepreneurs use Regulation D to raise millions of dollars, as these expenses can be diluted in a large offering.
· Marketing costs associated with a Regulation D, Rule 506(c) offering can range from 1% to 8% depending on the marketer. The agency in charge of helping the business in advertising the offering will collect this fee once the offering is allocated and in some cases, the issuer can negotiate a fee structure based on the percentage of the offering that was successfully allocated.
· There are also some fees associated with certify or qualify accredited investors and Reg D companies usually hire financial advisors to help them draft business plans, pitch decks and, financial projections. Establishing a business valuation is key to raise capital.
Commonly Asked Reg D Questions
Can I use AI to create my Reg D documents?
While you are able to use many things for AI including creating your investor marketing materials (E.g. business plan, pitch deck, financial model) with tools like ProAI, it is not advisable to rely on securities or other legal documents with AI and is best to work with a securities attorney.
What type of assets qualify for an accredited investor?
Net Worth = Assets — Liabilities
Example Assets:
- Savings accounts
- Money market accounts
- Real estate (excluding primary residence)
- Other assets
Example Liabilities:
- Personal loans
- Tuition loans
- Other assets
What are the stages of capital for a business?
The stage of capital depends on the type of business in question. Technology startups that qualify for venture capital are different than more traditional a businesses such as a natural resource company or manufacturer. In general:
- Seed Stage (Friends & Family): The first round of capital typically below $3 but averaging as low as $250,0000–$1,000,000. For a complete guide on seed stage funding, read more here.
- Series A: The first institutional round of capital typically, generally when company has demonstrated revenue or some serious traction, raises can be $3,000,000 — $20,000,000 or more in some cases but average $10,000,000 — $15,000,000 in many cases. For a complete guide on Series A funding, read more here.
- Series B: Generally raised by companies that have already demonstrated traction and financial viability and are on a clear path to scale. Larger funds tend to dominate this round and the capital infusion can in some cases be as high as several hundred million. For a complete guide on Series B funding, read more here.
- Private Equity and Late Stage Venture Capital: For companies beyond Series B or those in non-tech related industries, late stage VC and Private Equity may get involved. For these raises, there is no limit and in some cases, investors may take a controlling interest in the case of private equity.
What are the risks associated with Regulation D?
Whenever private securities are offered, including or excluding Reg D, the seller is subject to civil liability. There are not exceptions to avoiding civil liability. In many cases, however, when fraud is present the company and its management may be subject to criminal liability, fines, or other penalties by regulators.
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