At the ISIN Network, the term “private placement” is used in reference to raising capital and creating a private placement memorandum in order to procure financing. ‘Private placement’ thus refers to the offer and sale of any security by a brokerage firm (or by the company seeking capital). A private placement offering stands out precisely because it does not involve a public offering, hence it’s a ‘private offering,’ or a private placement offering (PPO). Private placements are unique in that the private placement offering is not subject to a registration statement filed with the SEC under the 1933 Securities Act.
Private placements – usually conducted via a private placement memorandum – are conducted in reliance upon Sections 3(b) or 4(2) of the 1933 Act as construed, under Regulation D as promulgated by the SEC, or both. Regulation D sets forth various guidelines for compliance with the Private Offering Exemption. Any registered representative who is involved in the private placement offering process is expected to have a working familiarity with Regulation D or other Regulations like 144A. Regulation D acts as the backbone of the entrepreneurial world in the American regulatory landscape. Both start-ups and later-stage growth companies seeking investment capital and funding for their businesses typically make use of Regulation D.
For companies conducting a private offering to qualify for a private placement, the issuer (the one selling the securities) must meet either the requirement of Sections 3(b) or 4(2) of the 1933 Act as developed through SEC interpretation and court decisions. Otherwise, the issuer 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. Often, this exemption is spelled out in the offering documents, commonly known as the private placement memorandum (PPM).
Regulation D (or “Reg D”) is a series of six rules, Rules 501-506, and 506b and 506c, that establish three transactional exemptions from the registration requirements of the 1933 Act. When reading the information below, keep in mind our statement from above: that Regulation D is the backbone of American entrepreneurial world. This will help shed light upon the rules and their details below. These rules can be read in full at the SEC’s website, www.sec.gov.
Regulation D Rules 501-503 set forth definitions, terms, and conditions that apply generally throughout Regulation D. Specific exemptions are set out in Reg D Rules 504-506.
Regulation D Rule 504 applies to transactions in which no more than $1,000,000 of securities (such as stocks, bonds, debentures, notes, etc.) are sold in any consecutive 12-month period. Rule 504 imposes no ceiling on the number of investors (in theory you can have as many investors as you want), 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, unlike Rule 505 and Rule 506, below. Generally, the intent of Reg D 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. Blue Sky rules typically refer to each individual state or jurisdictional rules for private placement offerings.
Regulation D Rule 505 applies to transactions in which not more than $5,000,000 of securities is sold in any consecutive 12-month period. Sales to 35 (thirty-five) “non-accredited investors” (see below for a definition, and visit the SEC’s website for a full definition) and to an unlimited number of accredited investors are allowed under Rule 505 of Reg D. An issuer under Rule 505 may not use any general solicitation or general advertising to sell its securities, meaning no public advertisements, e.g. television, radio, etc. Rule 505 of Regulation D is a popular avenue for raising capital, although Regulation D Rule 506, outlined below, surpasses Rule 505 in popularity.
In Regulation D Rule 506 there is no limit to the dollar amount that can be raised in this private offering, i.e., an unlimited amount of capital can be procured. Rule 506 of Reg D is available to all issuers for offerings sold up to, but not beyond 35 (thirty-five) non-accredited investors or purchasers and an unlimited number of accredited investors. Reg D Rule 506, however, unlike Reg D Rule 504 and Reg D Rule 505, does require the issuer of the securities to ensure that a subjective determination – which happens at the time of acquisition of the investment – that each non-accredited investor or purchaser meets a certain “sophistication” standard. These sophistication standards, individually or in conjunction with a “Purchaser Representative,” must be made. Like Rule 505, Rule 506 prohibits any general solicitation or general advertising, such as on television or the radio, etc.
“Accredited Investor,” defined fully at the SEC’s website, www.sec.gov, 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). In addition, rules change frequently (check with the SEC).
(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. Its important to only include the proper investors in your private placement
(5) There are more requirements to be considered an Accredited Investor. Contact ISIN.net for more information.
Additional Compliance Considerations Under Regulation D
The SEC has pointed out the following regarding Regulation D:
Existing state securities regulations at times impose substantially more onerous limitations on issuers than Regulation D. Issuer’s counsel or consultants must be consulted regarding the requirements of the securities rules of each state in which an offering is going to be sold. This basically translates to the fact that each individual state, and depending on one’s location and where capital is being sought (one’s country as well), must comply with local rules and regulations.
Form D has two components, federal and state. The Federal Form D notices are due within fifteen days after the first sale of securities in an offering under Regulation D. The Federal Form D for Regulation D is a free application. Additionally, each state has their own criteria for the filing of the state Form D, and each state has a fee of some sorts for this filling. The federal and state Form D can be prepared by Issuer’s consultants or counsel, or by oneself. The ISIN Network’s staff can help your company prepare and submit the Form D.
The specific requirements that need to met or satisfied in order to establish an exemption under Section 4(2) for a private placement are not stated in that section of the Securities Act of 1933. After reviewing SEC interpretations and court decisions dealing with Section 4(2), the basic requirements which a private placement offering must achieve can be determined. Although not extensive and not exhaustive, they are summarized below:
What is apparent from the aforementioned discussion is that up-to-date and accurate information about the offerees in a private placement transaction is absolutely essential. This is essential for the making of judgments as to the suitability of the investor at hand, and his or her ability to evaluate an offering, and investment intent.