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Raising Capital? Don’t Forget about SEC Filings (It’s Not as Difficult as It Sounds)

October 6, 2015
Startup Blog Post

The mention of "securities law and regulations" is a common, but daunting phrase that many entrepreneurs hear when they are attempting to raise money from investors for their companies. Under federal securities laws, any sale of equity, or even the mere offer to sell equity in a company (whether it is stock in a corporation or a membership interest in a limited liability company) must be registered with the U.S. Securities and Exchange Commission ("SEC"), unless the company can show that the offer and/or sale of equity meets specific requirements allowing the company to be exempt from registration with the SEC. Such exemptions are essential for early-stage companies, as the registration of an offer and sale of equity can take up a lot of time and money.

One of the most common methods used to demonstrate that a company is not required to register its offer and sale of equity with the SEC is to show that the offer and sale is not a "public offering" but rather, a private placement. While the difference between a public offering and a private placement may seem obvious, the line between the two is actually quite hazy. For this reason, companies will often rely on a particular safe harbor rule within the securities regulations – Rule 506 – which provides a company with objective standards that it can rely on to show that its offer and sale of equity is a private placement, rather than a public offering. 

Rule 506

Under Rule 506, if the company decides to use general solicitation and advertising to market its sale of equity, then the company may raise an unlimited amount of money from an unlimited number of accredited investors, but it must take reasonable steps to confirm that each of the investors is actually accredited. Such reasonable steps may include the review of the investor's tax returns, bank statements, brokerage statements and/or consumer reports. If the company does not choose to use general solicitation and advertising to market its sale of equity, it may still raise an unlimited amount of money from an unlimited number of accredited investors, but it may also raise money from up to 35 non-accredited investors. 

However, if the company chooses to sell equity to non-accredited investors, they must be considered "sophisticated" and the company will be required to provide to all accredited and non-accredited investors much of the same information and disclosures that would be required of the company if it had registered its sale of equity with the SEC in the first place. For this reason, a company will often limit its capital raise to accredited investors to avoid the added cost of providing such information to investors.

Finally, regardless of the way the company chooses to market its sale of equity, once the sale is made, the equity may not be re-sold to third parties by the investors. Such a resale by any single investor will (except under certain circumstances) eliminate the company's ability to rely on the safe harbor rule and it will be required to go through the timely and expensive registration process that it was trying to avoid in the first place.

If the company's capital raise can meet the above requirements, it will not have to register its sale of equity with the SEC, but upon completion of the sale of equity, the company must immediately file a "Form D" with the SEC. Form D is a simple form that notifies the SEC of the company's capital raise, the types of investors involved and includes limited information about the company. In addition to filing Form D with the SEC, the states in which the company sold its equity will also require that the company provide notice of such Form D filing (together with a fee), but no other state securities laws will be triggered if the company has relied on Rule 506 in its capital raise.

Compliance with federal and state securities laws can be very simple and inexpensive for a company that is looking to raise capital from investors, so long as it can demonstrate that its capital raise meets the requirements of the Rule 506 safe harbor. Ultimately, the company should consult with its attorneys to determine the best course of action to ensure such compliance.

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