There are three primary SEC Regulation D Programs that offer support for; the Regulation D 504 Offering, Regulation D 506 Offering, and the Small Corporate Offering Registration (“SCOR”) Offering.

Determining which program best suits your company is based primarily on transaction size. We normally recommend the standard 504 or 506 offering programs (not SCOR) for most companies.

Regulation D 504 Offerings are typically used for transactions under $1,000,000 in size.

Regulation D 506 Offerings are used for offering over $1,000,000.

504 Program

Regulation D 504 Offering: allows companies to raise up to a maximum of $1,000,000 in a 12 month period – the exemption is renewable meaning the company can use the 504 program again 6 months from their last securities sale under 504.

The 504 is the least restrictive of the Regulation D programs regarding structure, financials, disclosure, and investor suitability. A 504 offering allows a company to sell securities to an unlimited number of purchasers without regard to their sophistication or experience – although some States may limit the company to 35 non-accredited investors while still allowing an unlimited number of accredited investors.

The 504 is the most popular and widely used of the Regulation D programs. Many companies use 504 for an initial round and then float a 506 for a larger second round – both offerings can be done in a 1 year period because they are separate exemption programs.

The 504 program is available for private corporations only. Public reporting companies cannot use the 504 program.

The 504 program is regulated at the Federal level and State level (the State the investor resides). Companies using the 504 program must file a Form D notification filing with the SEC (included in our service) and may be subject to informational filings at the State level depending on the residency of the investor. We have streamlined the State filing process – most companies only need to file in 1-5 States to sell out a 504 offering.

506 Program

Regulation D 506 Offering: allows companies to raise capital through the sale of securities with no principal amount cap per 12 months. The 506 program provides an exemption for limited offers and sales of securities without regard to the dollar amount of the offering. Most companies use the 506 program to raise amounts from $1,000,000 up to $50,000,000 – although there is no cap on how much capital can be raised via a 506.

506 offerings have basic disclosure requirements regarding transaction and company details – our PPM documents exceed the Federal minimum disclosure level. Only financial statements for the most recent fiscal year need to be certified by an independent public accountant. If an issuer cannot obtain audited financial statements without unreasonable effort or expense, or if the company is a start-up with no operating history, only the issuer’s balance sheet (to be dated within 120 days of the start of the offering) must be audited. An issuer can forgo providing audited financial information if the offering is made solely to accredited investors or if the information on the balance sheet is not material to the investment decision.

A 506 offering allows up to 35 non-accredited investors and an unlimited number of accredited investors. 506’s are exempt from State securities laws – the Federal regulations supersedes the State rules, however most States will want a copy of the Form D submitted if you are selling securities to investors that reside in their State. As with the 504 program a company must file Form D in conjunction with a 506 offering to notify the SEC of the offering.

SCOR Program

Small Corporate Offering Registration (”SCOR”) Offering: The SCOR is a more complex version of the 504 offering. The SCOR offering provides a standardized disclosure format that is accepted by 43 States and allows increased freedom of solicitation and advertising over the standard Regulation D 504 exempt program. The standardized disclosure format (the U-7 form) also allows the company to comply with a large number of individual States securities laws utilizing one regional review instead of filing the offering with each individual State the company sells securities in.

The SCOR does require audited financial statements for the past 2 fiscal years for offerings exceeding $500,000 and has a maximum 12 month cap of $1,000,000. You must also have 10% equity relative to the amount of capital you are raising through the offering. We typically recommend the standard 504 over SCOR due to its lack of restrictions, its ease of implementation, and its use of the more sophisticated and professional PPM disclosure document. The SCOR U-7 disclosure document is a question and answer document that we do not feel is very professional in its appearance to investors.

If you have any questions about whether a SCOR or 504 would be best for your transaction please feel free to call us directly to discuss specifics.

There are 2 basic types of Regulation D Offerings that can be structured; an “equity” offering where the company is selling partial ownership in the company (via the sale of stock or a membership unit) to raise capital – or a “debt” offering where the company raises debt financing by selling a note instrument to investors with a set annual rate of return and a maturity date that dictates when the funds will be paid back to investors in full.

Offering Types – Debt or Equity

An equity offering is where the subject company sells an ownership stake in the company to investors. Equity is usually preferred by early stage companies that need flexibility regarding capitalization. In an equity situation investors profit as the company profits since they are partial owners. This provides the advantage of not having a debt service payment draining revenue from the company in its early stages of growth. Most companies sell 10-30% of their company for a first round funding – obviously there are exceptions but this is the average. We recommend using either a “C” Corporation (where you would sell stock to investors) or a Limited Liability Corporation LLC (where you sell a membership unit to investors). Investors typically profit in two ways from an equity deal; via their proportionate “per share” percentage of company profit (called a dividend) and via the final sale of the security through an exit strategy (example: the company buying the securities back from the investors, the company and its issued and outstanding securities being bought out by another company, going public and selling on the open market, etc.)

A debt offering functions much like a private business loan where the company sells a promissory note to investors. The note sets forth the terms and conditions of the loan arrangement between the company and the investor. Thus a note would provide a certain interest rate typically paid annually to investors with a maturity date that dictates when the principal is paid back in full to investors. The notes are sold in fractional amounts providing flexibility for accommodating investors – thus a typical debt offering for $100,000 would be the sale of 20 notes at $5,000 per note. An investor investing $10,000 would get two notes. If the interest rate was 12% then he would get $1,200 paid to him annually based on the $10,000 investment. If the maturity date was 36 months then at the end of the 36 months the company would pay back the $10,000 to the investor. Many early stage companies that lack the required equity or operating history for conventional bank financing will use private debt from investors for a short period of time (12-36 months) to establish a credit and operating history. They then have the capability to take out the private debt loan from the investors with a standard bank business loan at a lower interest rate.

Even if your transaction will only involve one or two investors – you still need to provide the proper transaction framework, disclosure documentation and investment agreements necessary for raising capital. Raising capital from investors, debt or equity, of any amount requires very specific documentation that far surpasses what a business plan provides. It is imperative that a company seeking capital from investors have in place a Private Placement Memorandum, a Subscription Agreement, and in debt offerings a Promissory Note Agreement. Raising capital without these documents is nearly impossible – they are a necessity.

You also need to use an SEC program, like Regulation D, to properly sell your company’s securities to the investors. The SEC and States have specific rules concerning how a private company solicits capital from investors – even if very few investors are involved. The Regulation D Offering program is the exemption program designed by the SEC for private business. It is the most widely used program the SEC offers and provides the proper exemption needed to raise capital from investors. Not raising capital properly can provide investors with a “right of rescission” in the future – meaning they can get their investment back regardless of the circumstances. You could also face fines and other penalties resulting from an improper sale of securities to investors.

The Regulation D Offering Programs are typically utilized to raise from $25,000 to $50,000,000 in capital. Regulation D Offerings are used for a wide variety of transaction and industry types: corporate seed capital, corporate expansion capital, film production capital, real estate equity funding (acquisitions, development projects, golf courses, rehab), capitalization for early to pre-IPO stage Internet and technology companies, expansion funding for retail companies, and product development and distribution funding.

A Regulation D Offering provides the fundamentals for raising capital from investors – regardless of your industry type, age of your company, or the size of your organization.

The very first step that most companies take when seeking private capital is the creation of an executive summary and a business plan. While executive summaries and business plans are an important facet of raising capital they are not designed to be investment documents.

Executive Summaries and Business plans typically just provide general information about the company, its business model, goals, etc. While this information is important to investors, it does not provide a basis or structure for accepting capital investment.

A business plan does not allow a company to accommodate multiple individual investors. Most business plans state an aggregate amount of funding needed, “$500,000″ for example, but provide no structure to allow for fractional investment. This means the company must find one single investor with $500,000 to invest – and the patience to develop the transaction structure and documents to process that investment. This limitation is probably the single biggest reason why so many companies fail at raising investor capital. Raising capital effectively and properly from investors requires very specific documentation that far surpasses what a business plan provides.

Public companies don’t raise capital from investors by putting a business plan in front of them. If you wanted to invest into Dell Computer – do you think Dell would send you a business plan to process your investment? Of course not – you would invest into Dell Computer through a securities offering. The same holds true for private companies seeking capital from investors. Don’t expect an investor to invest unless you have presented them with a securities offering. Business plans serve a purpose (especially for start-up companies) – but they should not be relied upon as investment documents.

The Fundamentals of Raising Investor Capital

There are certain fundamentals that you must have in place in order to raise any amount of capital from investors properly (whether it be one investor or one hundred):

First, you must have proper transaction structure in place before you interact with investors. The overwhelming majority of companies that are just using a business plan to raise capital (whether for $50,000 or $15,000,000) typically have very little transaction structure beyond “we’re selling 20% of the company for $2,000,000″. This is wholly inadequate.

How many shares or units are being sold? Preferred return or common ownership? What is the share/unit price? What is the total authorized share/unit pool and how will it affect future dilution of the investment? What is the exit strategy? How is the investor return modeled? Are the securities convertible?

Not addressing this information places the responsibility for creating proper transaction structure on the investor – which is very unprofessional and reflects poorly on the subject company. To raise private capital successfully you need to go well beyond simply stating to investors an aggregate amount of capital needed and providing information on the business. Do not expect investors to have any interest in your opportunity without providing them concise terms and conditions regarding their capital investment in your company. If you were an investor – would you not want the same information and structure provided for your investment?

Second, proper documentation for raising capital from investors is of critical importance. A business plan is not even the bare minimum needed for raising private funding – of any amount. The specific documents needed for raising private capital are:

• Private Placement Memorandum: The Private Placement Memorandum, or “PPM”, is the document that discloses all pertinent information to the investors about the company, proposed company operations, the transaction structure (whether you are selling equity ownership or raising debt financing from the investors), the terms of the investment (share price, note amounts, maturity dates, etc.), risks the investors may face, etc. Do not confuse the detailed corporate disclosures, SEC disclosures, and transaction structure in a PPM with the general information a business plan provides – they are not the same.

• ·    Subscription Agreement: Business plans do not even provide the documentation necessary to allow the investor to actually invest. Don’t expect investors to provide you funding based on a handshake. Would you invest funds into a company without signing a document that sets forth the terms and conditions of the investment? The Subscription Agreement sets forth these terms and conditions – this is the document the investor signs and returns to you with their investment check. You will have a very hard time raising debt or equity capital without this basic document.

• ·    Promissory Note: In debt offerings you need to have a Promissory Note outlining the terms of the loan arrangement with the investors. The note is the actual “loan document” between the company and the investor. It is impossible to have a “loan” without a “loan agreement” that sets forth the terms and conditions of the loan.

Third, in order to sell securities to investors you must follow the rules and regulations that govern these sales as set forth by the Securities and Exchange Commission and State securities regulators. The SEC has specific rules concerning how a private company solicits capital from investors – even if very few investors are involved. The Regulation D Offering program is the exemption program designed by the SEC for private business. It is the most widely used program the SEC offers and provides the proper exemption needed to raise capital from investors. Not raising capital properly can provide investors with a “right of rescission” in the future – meaning they can get their investment back regardless of the circumstances.

Don’t rely on your business plan to perform a function it was not designed to accomplish. Let us structure a Regulation D securities offering for your transaction and begin raising capital the right way.

Those are common statements from individuals unprepared to discuss with investors their opportunity and deal. The biggest mistake a person makes is when they approach a potential investor with only a business plan. A business plan is important and has its place among the tools of the business owner but to use the business plan solely for the raising of money is usually disastrous. Business plan should never be used solely for raising funds because they are not designed for such use.

Business plans provide basic and general information about the company and concept of the businesses. Investors appreciate business plans but it does not provide the structure for the raising of money. Neither does the business plan address the need for multiple investors. Merely stating the amount required or needed does not provide the structure for the raising of the money.

The business plan and this weakness is probably the one reason why so many companies fall short in their attempts to raise capital from investors. Raising capital effectively and properly from investors requires very specific documentation that far surpasses what a business plan provides. Public companies don’t raise capital from investors by putting a business plan in front of potential investors. The same holds true for private companies seeking capital from investors. Don’t expect an investor to invest unless you have presented them with a securities offering such as a REG D 504 or 506 Private Placement Memorandum. Business plans serve a purpose (especially for start-up companies) – but they should not be relied upon as investment documents.

How to Properly Raise Capital for your Business

There are certain fundamentals that you must have in place in order to raise any amount of capital from investors properly (whether it be one investor or one hundred):

First, you must have proper transaction structure in place before you interact with investors. The overwhelming majority of companies that are just using a business plan to raise capital (whether for $50,000 or $1,000,000) typically have very little transaction structure beyond “we’re selling 20% of the company for $1,000,000″. This is wholly inadequate.

How many shares or units are being sold? Preferred return or common ownership? What is the share/unit price? What is the total authorized share/unit pool and how will it affect future dilution of the investment? What is the exit strategy? How is the investor return modeled? Are the securities convertible?

Not addressing this information places the responsibility for creating proper transaction structure on the investor – which is very unprofessional and reflects poorly on the subject company. To raise private capital successfully you need to go well beyond simply stating to investors an aggregate amount of capital needed and providing information on the business. Do not expect investors to have any interest in your opportunity without providing them concise terms and conditions regarding their capital investment in your company. If you were an investor – would you not want the same information and structure provided for your investment?

Second, proper documentation for raising capital from investors is of critical importance. A business plan is not even the bare minimum needed for raising private funding – of any amount. The specific documents needed for raising private capital are:

Private Placement Memorandum: The Private Placement Memorandum, or “PPM”, is the document that discloses all pertinent information to the investors about the company, proposed company operations, the transaction structure (whether you are selling equity ownership or raising debt financing from the investors), the terms of the investment (share price, note amounts, maturity dates, etc.), risks the investors may face, etc. Do not confuse the detailed corporate disclosures, SEC disclosures, and transaction structure in a PPM with the general information a business plan provides – they are not the same.

Subscription Agreement: Business plans do not even provide the documentation necessary to allow the investor to actually invest. Don’t expect investors to provide you funding based on a handshake. Would you invest funds into a company without signing a document that sets forth the terms and conditions of the investment? The Subscription Agreement sets forth these terms and conditions – this is the document the investor signs and returns to you with their investment check. You will have a very hard time raising debt or equity capital without this basic document.

Third, in order to sell securities to investors you must follow the rules and regulations that govern these sales as set forth by the Securities and Exchange Commission and State securities regulators. The SEC has specific rules concerning how a private company solicits capital from investors – even if very few investors are involved. The Regulation D Offering program is the exemption program designed by the SEC for private business. It is the most widely used program the SEC offers and provides the proper exemption needed to raise capital from investors. Not raising capital properly can provide investors with a “right of rescission” in the future – meaning they can get their investment back regardless of the circumstances. Don’t rely on your business plan to perform a function it was not designed to accomplish. Structure a Regulation D securities offering for your transaction and begin raising capital the right way.

Every day I am speaking with individuals who intend to raise money with their existing corporation or Limited Liability Company (LLC) who are completely convinced they can raise any amount of money they want using a business plan through private sources.

If you are one of these people, I strongly recommend that you research and read this information immediately.

There are many web sites and self proclaimed “GURUS” that are leading people to believe that YOU can LEGALLY raise money from private individuals (or “angle”) investors without having to comply with or “worry about” SEC (Security and Exchange Commission) regulations.

Those web sites and gurus are wrong. And following their advice puts you in jeopardy of losing your business, house and bank account as well as possible fines and sanctions from the SEC and other serious legal consequences. There are specific rules that must be followed.

For 23 years I’ve been helping business owners fund their companies and projects legally and within the regulations of the SEC.

I use a method that I consider one of the BEST KEPT SECRET IN BUSINESS FUNDING. If a company is either a corporation or LLC and intend to use their STOCK or UNITS to fund their company, I prepare the necessary documentation that exempts the company from violating the Security & Exchange Commissions laws and regulations. The Reg D Series is how it’s done. I specifically recommend the Regulation D 504 due to the fact that no filings or reviews are required. It is a cost effective method to raise up to $1 million. If your requirements exceeds $1 million, then most likely a Reg D 506 will be required that has more restrictions and requirements associated with it but again, is very effective. My role is to prepare all the necessary documents and tools used in the offering. I am YOUR coach through the entire process. Most of my clients raise their funding within 90 days.

This is nontraditional funding and does not require financial’s, credit reports or other burdensome disclosure. The private investor is simple purchasing your privately held stock or a unit position in exchange for his/her money. Each investor takes a minority position in the company. You never loose
control of management or majority position in your company.

Each investor will want to know how they benefit from their investment whether through declared dividends or an established percentage of the profits from the company.

Once the Private Placement Memorandum is prepared, one of my associates who is a host for a radio investment talk show will send out a newsletter explaining your offering to 12,000 private investors.

The commencement date of private offerings is fixed generally at the date of the availability of the approved offering documents, for distribution to sales personnel.

The termination date for a private offering is dependent on the type of offering being made. An “all or nothing” offering contains, by its terms, a fixed or defined date for the termination of the offering. A “best efforts” offering may have an indeterminate termination period meaning that the offering continues until the full number of Securities is placed and the subscribers are formally accepted by both the issuer (or a duly authorized representative) and by a Principal of the brokerage firm.

The sales objectives in a best efforts offering, of course, is that all securities will be placed with suitable investors. However, short of all securities being placed, it is required that a minimum amount of money need be raised which shall be sufficient, after the funding of all of the organizational and offering expenses, and giving consideration to the fixed contractual obligations of the issuer, without changing the nature of the investment called for by the general terms of the offering. The issuer may be given the option of funding required issuer obligations by the making of loans or deferral of fees. In such a case where
the issuer funds financial requirements prior to the placement of all of the securities, it is the obligation of the brokerage firm to assure itself that appropriate disclosure to all offerees (and subscribers) be made and to assure itself that the basic nature and character of the transaction called for by the terms of the offering are maintained. If it appears that they cannot be maintained, then the transaction must be rescinded and monies paid by subscribers must be refunded.

Possible Need for a Purchaser Representative

A judgment must be made as to the business sophistication of a purchaser. If it is determined that a particular purchaser is not sufficiently sophisticated in business matters to effectively evaluate the investment opportunity, then he or she must be assisted by a “purchaser representative,” i.e., a person possessing the requisite sophistication (chosen by the purchaser) who is able to and does assist in evaluating the investment opportunity and who is not an affiliate of the issuer, not the brokerage firm. Also, State Blue Sky laws impose additional requirements for their investors. Only customers known to registered representative personally should be sent only brokerage firm approved offering materials. If there is doubt about the individual’s need for a purchaser representative, the subscriber should be required to obtain one.

No General Solicitation

1. Cold Calling is not permitted.
2. Advertisements, articles, notices or any other communication cannot be published in any newspaper, magazine, newsletter or similar media or broadcast on TV, radio or cable.
3. No seminars or meetings may be held with regard to any current offering unless each invitee is known and qualified in advance.
4. No mention of any specific offering or past performance may be made at generic seminars (i.e. seminars to discuss the general concept of such investments).

No Fee Sharing

Fees may not be split with non-registered persons such as lawyers, accountants or investment advisers.

Investment Intent

Purchasers of private placement securities must purchase for investment purposes and not for the purpose of resale. The typical subscription documents used in private placements contains what is called “investment letter language.” This representation should be personally verified. Consideration should be given as to whether the investment representation makes sense in view of the surrounding circumstances of the proposed purchaser.

Oral Representations

Offerees, having received private placement offering documents, frequently request oral explanations or supplements to the information presented. Great care should be taken in making oral disclosures regarding a private placement. Deviation from the printed material is prohibited. Written notes of conversations with offerees (and their representatives) should be made, dated and placed in the client’s file.

Acceptance of Offerees as Purchasers

In all private placement offerings, the subscribers must be formally accepted by the issuer. The acceptance of subscribers is based upon a subscriber questionnaire and, possibly, the customer’s account information (a document signed by the client). A review of the contents of this form by a representative of the firm who is qualified to make such determinations is imperative.

Following the acceptance of the subscribers in an offering by both the issuer and the principal, the offering shall be terminated by notification to all involved sales persons or entities.

Mechanics of Offering Process

The offering documents should be numbered. Unnumbered copies should be marked “For
Information Only”, “File Copy” and other appropriate notation.

1. A distribution control sheet will be created, and monitored. As offering documents are assigned to particular registered representatives, the number of the offering documents, together with the registered representative’s name, should be placed on the control sheet.
2. A sales control sheet will be maintained reflecting current sales.
3. Incoming checks, subscription agreements, and executed suitability documents will be logged on the Sales Blotter on a daily basis.
4. Checks should be reviewed for acceptability by the firm, recorded on the brokerage firm’s receipts blotter, and forwarded to the individual bank escrow agent, and where appropriate to the Issuer, together with the purchaser’s name, address, social security number, and number of shares/units.
5. Incoming subscription agreements should be approved by the firm, recorded on the sales blotter and forwarded to the Issuer for acceptance. A copy must be maintained for the brokerage firm files.
6. Confirmations should be sent immediately to the subscriber upon acceptance, to the registered representatives, and a file copy should be retained (e.g. a copy of the Subscription Documents.)
7. Form D will be filed, on a timely basis, by counsel to the Issuer, with the SEC and with those states that require it.
8. Care should be taken that any other forms necessary to comply with the state Blue Sky authorities will be timely filed. Counsel to the issuer or brokerage firm counsel should generally be consulted as to the required forms in the states where the securities have been sold. Generally, this is accomplished by counsel to the issuer. (Some states require no forms.)
9. A complete file containing the above-described documents for each private placement should be maintained as part of the brokerage firm’s records.

Escrow Account – Private Placements Only

The federal securities law (the Exchange Act) is very specific with respect to the required treatment of an escrow account maintained in an “all or none” or “part or none” offering.

The rules applicable to “all or none” or “part or none” offerings relating to the maintenance of an escrow account for a given offering are Rules 10b-9 and 15c2-4 of the Securities Exchange Act of 1934. Rule 10b-9 requires, in general, that in an “all or none” or “part or none” offering (as opposed to a “best efforts” offering) monies paid for the purchase of securities must be returned to the investors if the specified number/dollar amount of securities is not sold within a specified time. In other words, the “all or none” or “part or none” offering requires specification of the number of securities and the time of the selling
period. Both terms must be adhered to.

Rule 15c2-4 requires, in general, that the monies received from investors be deposited into a separate segregated bank account (Independent Bank as Escrow Agent) and held for the investors’ benefit until the “all or none” or “part or none” terms have been complied with. If the terms of the offering are met, the money is to be transmitted to the issuer. If not, the monies are to be returned to subscribers.

The specific procedures to be followed in the handling of escrow accounts for “all or none” or “part or none” transactions are as follows:

1. When an “all or none” or “part or none” offering is commenced, an escrow agreement shall be created. This document should be executed by the brokerage firm and the bank. The brokerage firm is required to keep a copy of all escrow agreements on file to demonstrate compliance with Rule 15c2-4.
2. An escrow account should be opened by the bank. The escrow account is governed by the escrow agreement. The account typically requires signatures of representatives of both the brokerage firm and the Issuer before any checks can be issued from the account.
3. Incoming monies should be deposited immediately into the escrow account, along with the purchaser’s name, address, social security number and number of shares/units.
4. Upon the completion of the “all or none” or “part or none” terms of the agreement or upon the expiration of the specified time period, the escrow agent verifies that the terms of the escrow agreement have been or have not been met by the designated date and that the funds should be released from escrow.
5. The issuer then transmits written confirmation stating that a determination has been made that the conditions of the escrow have or have not been complied with and request a release of the funds.
6. Upon receipt of the written confirmation described above, the funds are transmitted to the proper entity or persons.
7. The documentation created by these procedures above, the funds are transmitted to the proper entity or persons.
8. In a “best efforts” offering, the brokerage firm is contractually bound to use its “best efforts” to place the securities with suitable investors. The brokerage firm will follow the procedures as outlined above regarding placement of subscriber’s funds in an independent bank escrow account.

This document is not legal advice, and is intended solely for information and educational purposes. If you are contemplating a private placement, or any legal transaction, you should consult someone who can provide you with the advice that you need, for your specific circumstances. Securities law, and corporate finance, is not the area for novices to play. Incorrect documentation can have serious ramifications for all involved parties. The term “private placement” as used in this text refers to the offer and sale of any security by a brokerage firm not involving a public offering. Private offerings are not the subject of a registration statement filed with the SEC under the 1933 Act. Private placements are done in reliance upon Sections 3(b) or 4(2) of the 1933 Act as construed or under Regulation D as promulgated by the SEC, or both. Regulation D, promulgated in 1982, sets forth certain guidelines for compliance with the Private Offering Exemption. Any registered representatives who are involved in the private placement process are expected to have a working familiarity with Regulation D.

To qualify as a private placement, an offering by an issuer must meet either the requirement of Sections 3(b) or 4(2) of the 1933 Act as developed through SEC
interpretation and court decisions or must follow the conditions set out under Regulation D of the 1933 Act. Persons claiming the exemption from the 1933 Act carry the burden of proving that its activities came within that exemption.

Regulation D

Overview

Regulation D is a series of six rules, Rules 501-506, establishing three transactional exemptions from the registration requirements of the 1933 Act.

Rules 501-503 set forth definitions, terms and conditions that apply generally throughout the Regulation. Specific exemptions are set out in Rules 504-506. Rule 504 applies to transactions in which no more than $1,000,000 of securities are sold in any consecutive twelve-month period. Rule 504 imposes no ceiling on the number of investors, permits the payment of commissions, and imposes no restrictions on the manner of offering or resale of securities.

Further, Rule 504 does not prescribe specific disclosure requirements. Generally, the intent of Rule 504 is to shift the obligation of regulating very small offerings to state “Blue Sky” administrators, though the offerings continue to be subject to federal anti-fraud provisions
and civil liability provisions of the Exchange Act.

Rule 505 applies to transactions in which not more than $5,000,000 of securities is sold in any consecutive twelve-month period. Sales to thirty-five “non-accredited” investors and to an unlimited number of accredited investors are permitted. An issuer under Rule 505 may not use any general solicitation or general advertising to sell its securities.

Rule 506 has no dollar limitation of the offering. Rule 506 is available to all issuers for offerings sold to not more than thirty-five non-accredited purchasers and an unlimited number of accredited investors. Rule 506, however, unlike 504 and 505, requires an issuer to make a subjective determination that at the time of acquisition of the investment each non-accredited purchaser meets a certain sophistication standard, either individually or in
conjunction with a “Purchaser Representative.” Like Rule 505, Rule 506 prohibits any general solicitation or general advertising. “Accredited Investor” is defined in Rule 501(a). The principal categories of accredited investors are as follows:

1. Directors, executive officers, and general partners of the issuer, including general partners of general partners in two-tier syndicating. (The term “executive officers” is more fully defined in the Regulation.)
2. Purchasers whose net worth either individually or jointly with their spouse equals or exceeds $1 million. It is important to note that while there is no definition of “net worth” in Regulation D, there similarly is no requirement of liquidity in the calculation of net worth for this accreditation standard. Thus, a purchaser’s home, furnishings, etc. are includable in the determination of net worth.
3. Natural person purchasers who have “income” in excess of $200,000 in each of the two most recent years and who reasonably expect an income in excess of $200,000 in current year (or $300,000, jointly with their spouse).
4. A business entity will be treated as a single accredited investor unless it was organized for the specific purpose of acquiring the securities offered, in which case each beneficial owner of the security is counted separately.

Additional Compliance Considerations under Regulation D

The SEC has pointed out the following regarding Regulation D:

1. Regulation D does not exempt offerings from the anti-fraud and civil liability provisions of the various federal securities laws.
2. Further, Regulation D in no way relieves issuers of their obligation to furnish to investors whatever material information may be needed to make any required disclosures not misleading.
3. Similarly, notwithstanding exemption from registration at the federal level, Regulation D in no way obviates an issuer’s obligation to comply with applicable state law.
4. Regulation D is interpreted as providing “transactional” exemptions to issuers only. An investor whose purchase was exempt from registration cannot resell his or her interest without establishing an independent basis of exemption.

The three exemptions are not intended to be mutually exclusive, that a reliance on one exemption is not deemed to be an election to the exclusion of any other applicable exemption.

Finally, the exemptions of Regulation D may not be claimed with respect to any plan or scheme to evade the registration provisions of the act. Existing state securities regulations at times impose substantially more onerous limitations on issuers than Regulation D. Issuer’s counsel must be consulted regarding the
requirements of the securities law of each state in which an offering is going to be sold.

Form D

Notices, on Form D, are due within fifteen days after the first sale of securities in an offering under Regulation D. It will be prepared by Issuer’s counsel.

Private Placement of Restricted Securities Outside Regulation D

The specific requirements to be satisfied in establishing an exemption under Section 4(2) for a private placement are not stated in that section of the Securities Act of 1933. By studying SEC interpretations and court decisions dealing with Section 4(2), the basic requirements which a private placement must meet can be determined. They are summarized below:

• All the offerees and purchasers must have access to the same kind of information concerning the issuer which would appear in an SEC registration statement, and these persons must be able to comprehend and evaluate such information. It must be kept in mind that any offer to an offeree who would not qualify, as well as a sale to a purchaser who would not qualify, may destroy the private placement exemption and result in a violation of Section 5 of the 1933 Act.

• The issuer and any parties acting for the issuer, including the broker-dealer, must take all reasonable steps to insure that the information given to the offerees and purchasers is complete and accurate. This is “due diligence.” All information passed on in the course of the private placement, either orally or by memorandum (or offering circular), is subject to the anti-fraud provisions of the federal securities laws. The fact that the offering memorandum is not reviewed by the SEC does not lower the standards for accuracy which would be applicable to any registered offering.

• All of the offerees must have access to meaningful current information concerning the issuer. The fact than an offeree has considerable financial resources or is a lawyer, accountant or businessperson, and thus may be considered sophisticated, does not eliminate the need for appropriate information to be made available.

• While there is no specific limitation on the number of offerees, the greater the number of offerees, the greater the likelihood that the offering will not qualify for the exemption. In this connection, a private placement cannot be the subject of advertising, general promotional seminars or public meetings in connection with the offering. This limitation does not preclude meeting with offerees to discuss the terms of the offer or to present information concerning the issuer or the offer. After the private placement has been completed, a general announcement (such as a tombstone ad) concerning it may be made if this is desired.

• Purchasers in a private placement must acquire the securities for investment and not for the purpose of further distribution. If the purchaser acts in such a manner so as to participate in distribution of the securities to the public, either directly or indirectly as a link between the issuer and the public, he or she will be deemed to be an underwriter and the selling brokerdealer and other participants in the distribution, including the issuer, will be in violation of Section 5 of the 1933 Act. Each of the purchasers must intend to acquire for investment at the time the securities are purchased. Whether or not investment intent was present will be determined from all the circumstances surrounding the acquisition. Such circumstances would include the financial capability of the purchaser to hold the securities for the long term and whether the purchaser signed a letter of investment intent. The amount of time the securities have been held (the holding period) is one of the factors in a hindsight determination that an investment intent existed at the time of purchase. A two-year holding period is deemed to be the bare minimum.

What is readily apparent from the foregoing is that current and accurate information about the offerees in a private placement transaction is absolutely essential for the making of judgments as to suitability, ability to evaluate an offering, and investment intent.

Private Placement Offering Memorandum

To meet the requirement of Regulation D or the requirements of Section 4(2) of the 1933 Act (the private placement exemption), the issuer is almost always required to make extensive disclosures regarding the nature, character and risk factors relating to an offering. The disclosure document often is labeled “Offering Memorandum” or given a similar title, which, in the normal course, is based upon information provided to counsel to the issuer. While a properly executed private placement is exempt from the registration provisions (i.e. Section 5 of the 1933 Act) of the federal securities laws, the transaction (and the
disclosures made or a lack thereof) is subject to the anti-fraud provisions. If the offering memorandum is a particular private placement turns out to be materially misleading in terms of disclosures which have been made (or which should have been made), the brokerdealer and its principals may be deemed to have violated or aided or abetted violations of the anti-fraud provisions of the federal securities laws.

Unfortunately, because of the nature of a private offering, those looking to review an offering memorandum for educational purposes will have a very difficult time finding one.

Supplementary or Corrective Material

During the course of private placement activities on a particular issue, or prior to the closing, it may become necessary to update or correct information supplied in the private placement memorandum as originally prepared. The corrected information must be brought to the attention of the offerees by means of a cover or transmittal letter which describes the changes or additions. Depending upon the information transmitted, reconfirmation of an investors desire to invest may be required. The files maintained with respect to a particular offering must contain a record of what has been done. Prior to closing an offering, meaning the acceptance of investors in a transaction, a brokerage firm Principal must verify that all such amendments have been sent to all subscribing offerees and that the files are accurate and complete.

Offeree Access to Information

In most private placement offering memoranda, it is stated that the memorandum has been prepared by counsel to the issuer (i.e., the corporation) from documents which have been provided by representatives of the issuer. Offerees are invited to meet with representatives of the issuer to make an independent investigation and verification of the matters disclosed in the offering memorandum. Courts, reviewing private placements when challenged, weigh investor access to underlying information about the transaction very heavily in the determination of whether there has been compliance with the private placement exemption. The brokerage firm’s designated Principal should obtain a commitment from the Issuer that potential purchasers and their representatives shall be given access to underlying information about the transaction if they desire to pursue such information. The fact that information is available to offerees should be specifically disclosed to the offerees at a conspicuous point in the offering documents.