SEC Regulation D – Private Offerings: NY Startup Law

Start-ups in New York looking for investment capital should consider the classification of investors that can and cannot partake in private offerings.  Under the Securities and Exchange Commission’s Regulation D, an organization may issue a private offering of stock to raise funds without officially registering to “go public.” We discussed the nature of Regulation D offerings, which are also called “private placements” in an earlier blog post.

Only certain types of investors may participate in a Regulation D offering.  To understand why the SEC encourages certain kinds of investors over others, it is important to understand the different types of investors in the market:

Accredited Investor: This is defined as an individual that has earned US$200,000 or more on an annual basis for the past two out of the three years and is likely to make that same amount this year.

Alternatively, an accredited investor can fail to meet the income threshold, but qualify if s/he has a net worth of over $1 million, excluding any primary residence.  The investor can “self-certify” that they are accredited in most circumstances, but in the case of a private offering using Rule 506(c), the investor must be certified by the issuing company or a qualified third party.

Non-Accredited Investor: A non-accredited investor is simply everyone else that is not an accredited investor. In many cases, start-up companies wish to accept investor dollars from friends and family that are interested in supporting the owners who are, often, non-accredited but still want to participate. Rule 506 (c) forbids such investment outright, but another Regulation D rule, Rule 506(b), allows non-accredited investment as long as the investors are “sophisticated” and the start-up raising the money has no more than 35 of them investing in the offering.

Sophisticated Investor: A sophisticated investor is a non-accredited investor that has superior knowledge of business and financial matters.  For example, it could be a CFO, CPA, accountant, business owner, banker or some other financial professional.

This definition leaves room for interpretation by the offering company, so it is important to define what “sophisticated” means under law and to be able to back this up in case the SEC were to ask why you thought a certain investor was “sophisticated.”  Many attorneys setup compliance programs to allow for companies to not run afoul of the SEC rules.

The reason why New York start-up businesses need to understand these definitions is because, under Regulation D, there are several rules under which your private offering can be issued. The SEC encourages or, in some cases, requires companies to work with accredited investors when raising capital through a private offering.  However, the rules also give room for a certain number of non-accredited investors to participate so long as disclosure requirements are met.  As noted above, not to run afoul of the law, any non-accredited investor must be a sophisticated investor.

Private offerings are  an excellent source of capital, but make sure you are following the guidelines carefully.

Sean Hayes

Known for his street-smart advice & proactive advocacy. Sean works with senior retired judges, senior officials and leading attorneys in contentious and transactional matters. First non-Korean lawyer (NY) to work at Korean Courts and one of the first non-Korean law professors. Rated a top lawyer by major rating agencies.

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