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What Are Private Placement Securities?

In a private placement, the shares of stock or debt instrument are considered securities under both federal and state securities laws. Consequently, any transaction involving the shares or debt must be registered under such securities laws or be exempt from registration. Typically, the offeror is an emerging growth company that has few capital alternatives, although more mature companies tend to be more successful in this process. Securities laws generally require that offers are made mainly to accredited investors.

There are two basic types of private placement offerings:
• Private Placement Equity Offering: The company sells partial ownership via the sale of stock or a membership unit in order to raise capital. Equity offerings are preferred by early-stage companies, because there is no set repayment schedule with this offering.
• Private Placement Debt Offering: 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. A debt offering is similar to a business loan, except the financing is provided by investors instead of an institution.
Although private placements are exempt from full SEC registration requirements, they still must comply with federal and state regulations. The most important private placement rules fall under Regulation D, promulgated by the SEC.

Regulation D: Private Placement Rules and Exemptions

Reg 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

Rule 504 is the most popular of the Reg D rules. Raising capital for a small business can be expensive and time consuming, but a private placement under Rule 504 of Reg D can minimize costs and delays while giving the issuer access to debt or equity capital. In a Rule 504 offering, a business can raise a maximum of $1 million in any year. Rule 504 has no prescribed disclosure requirements, no limit on the number of purchasers, and no investor sophistication standards. Offerings that are exempt under Rule 504 are relatively simple to prepare and can generally be undertaken by the offeror without substantial outside professional expenses. The JOBS Act of 2012 allows offerings to be made through any form of general solicitation or advertising. Rule 504 does not mandate that specified disclosure be provided to purchasers. However, the offeror must provide enough information to meet the full disclosure obligations under the anti-fraud provisions of the securities laws.

Rule 505

A Rule 505 offering may not exceed $5 million in any given 12-month period. This exemption limits the number of non-accredited investors to 35, but has no investor sophistication standards and no limit on the number of accredited investors. Rule 505 was adopted by the SEC to provide small businesses more flexibility in raising capital than under Rule 504. If only accredited investors are involved in the offering, there is no specific information the issuer must furnish to investors. However, if the offering involves one or more non-accredited persons, the issuer must furnish all purchasers with the same kind of information specified by Regulation D. As with a 504 offering, prior to the JOBS Act of 2012, this offering could not be made by means of general solicitation or general advertising.
For Rule 505 offerings over $2 million, financial statement conditions include the following:
• Only financial statements for the most recent fiscal year need be certified by an independent public accountant.
• If an issuer other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the issuer’s balance sheet (to be dated within 120 days of the start of the offering) must be audited.
• Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish financial statements prepared on the basis of federal income tax requirements and examined and reported on by an independent public or certified accountant in accordance with generally accepted auditing standards.
• The issuer must also be available to answer questions by prospective purchasers about the issuer or the offering.

Rule 506

Rule 506 provides an exemption for limited offers and sales without regard to the dollar amount of the offering. There is no ceiling on the amount of money which may be raised. The JOBS Act of 2012 permits general solicitation and advertising. There is no limit to the number of accredited investors, but the number of non-accredited investors may not exceed 35. If only accredited investors are involved in the offering, the issuer is under no obligation to furnish specific information to investors. If the offering involves one or more non-accredited persons, however, the issuer must furnish all purchasers with the same information required by Reg D. Rule 506 requires detailed disclosure of relevant information to potential investors; the extent of disclosure depends on the dollar size of the offering. For offerings over $2 million, the issuer must provide audited financial statements. Offerings under $2 million follow Reg A as a guide, with an additional requirement for a certified balance sheet. The securities sold are “restricted” under the same stipulations in Rules 504 and 505. A company is required to file a notice of the offering on Form D at SEC headquarters within 15 days after the first sale in the offering. There is no requirement to file the offering memorandum with the SEC.
From an investor’s perspective, here are some important compliance features of Regulation D:

• No offerings are exempt from the anti-fraud and civil liability provisions of the various federal securities laws.
• Issuers are not relieved of their obligation to provide investors with information needed to make any required disclosures not misleading.
• Regulation D provides transactional exemptions to issuers only. An investor whose purchase was exempt from registration cannot resell their interest without establishing an independent basis of exemption.
Documents to Support a Private Placement
The following documents are needed to raise private financing from investors.

Private Placement Memorandum

A Private Placement Memorandum (PPM) provides critical details about the offering. This differs from a business plan, which does not provide information about the technical structure of an offering. A PPM is used to raise capital from a number of investors instead of trying to find one with the entire amount of required capital.
The PPM outlines information such as:
• Purchase price per note
• Number of shares or notes being sold
• Maturity date
• Rate of return
• Risk factors
Additional Private Placement Documents
• Subscription Agreement sets forth the terms and conditions of the investment. This is the document that the investor executes, and to which he or she attaches a check.
• Promissory Note Agreement (for debt only) is the actual loan agreement between the investor and the company.
• Form D SEC Filing is the notification filing that is sent to the SEC in Washington, DC. It notifies the SEC that the issuer is using the Regulation D program and provides basic information on the company and the offering. It is not an approval document. It is merely a filing that notifies the SEC that the offeror has a Reg D offering in place.
Types of Private Placement Offerings

Regulation D Equity Offering

An equity offering lists the securities authorized and offered by the issuer, as well as the use of proceeds. Purchasers of these securities are almost always minority investors. This alone creates a liquidity risk and minority rights issues that should be strongly considered. Offerees should seek legal assistance before making such an investment.

Regulation D Debt Offering

A debt offering involves the sale of a promissory note to investors. The note sets forth the terms and conditions of the loan arrangement between the company and the investor. For instance, the interest rate, payment periods, and maturity date are described in the note. Notes are sold in fractional amounts providing flexibility for accommodating investors. For example, in a typical debt offering the company raises $1,000,000, which might involve the sale of 20 notes at $50,000 per note.

Jumpstart Our Business Startups (JOBS) Act

Securities regulators have bemoaned the lack of oversight for years as investments offered under Reg D have exposed investors to far more risk than originally anticipated. This is because unlike public offerings, Reg D offerings are subject to minimal regulatory screening. But despite the continuing abuses, politicians have further loosened regulations with the passage of the JOBS Act, which amends or exempts certain issuers from the requirements of the regulation.


The stated purpose of the JOBS Act is to stimulate investment in startup and emerging companies. By having more capital, it is thought that these businesses will hire more employees. Many experts, however, have questioned the premise that more capital will lead to greater growth, even survival, of startup or entrepreneurial companies. Rather, they believe that failure is more due to unrealistic expectations, poor management, and bad execution than the lack of capital. They worry that more capital will instead lead to bigger failures, boondoggles, and frauds. Whatever the consequence of the Act, investors should be prepared to handle a flood of solicitations that will likely appear over the Internet and via the phone from salesmen with the latest and greatest investment. JOBS drastically changes the investment environment for the private placement of securities by introducing a new fundraising process called “crowdfunding,” and allowing wide solicitation (and advertising) of potential investors with minimal regulatory oversight of the process.

Implications of JOBS

• The $1 million annual limit will restrict issuers to small, start-up, or first stage companies, historically the highest risk category of companies in which to invest. The odds are that investors in these companies will lose a portion or all of their investment.
• The annual individual limit on investments in crowdfunded securities will be impossible to police. As a consequence, unethical and fraudulent brokers are unlikely to seek this information from prospective investors, or may encourage the investor to provide false information.
• The lower financial limits required to purchase crowdfunded securities virtually assure that many, if not the majority of, investors will buy a non-traded security for the first time. In other words, they are not likely to be familiar with the lack of liquidity, financial information, and investor rights which are typically present in privately held companies.
• Crowdfunded securities and intermediaries – funding portals – are specifically exempt from state securities laws and the oversight of state securities commissioners and their staffs, the most active component of the regulatory bodies. As a consequence, enforcement of security protection laws is likely to be uncertain, delayed, or nonexistent, leaving purchasers of crowdfunded securities in a regulatory no man’s land.
Issuers of securities will continue to be subject to Regulation D unless exempted by the crowdfunding provision. Under this regulation, the protections for investors are more robust, with greater penalties for issuers and broker-dealers who ignore or intentionally fail to comply with any of its provisions.

How to Protect Yourself

Astute investors have always recognized that their greatest protection from frauds and other thefts is personal vigilance, a willingness to investigate, and the confidence to say no. These traits are particularly important in the world of private placements. There are predators in the Reg D market quick to seize upon unwary investors who do not possess these traits. The following tips will help you identify the real opportunities and avoid costly mistakes if you consider a private placement investment.

Limit Your Investment to Low-Risk Funds

Many investors become so blinded by the promise of future riches that they forget the reality of the business or the long-term success rate of new companies. As a result, they plunder their savings and retirement accounts expecting to become millionaires overnight. The fact is, less than one-quarter of new businesses survive through the fifth year, and the majority of the ones that do survive are rarely market successes with huge returns to their shareholders. Exploratory oil and gas wells are notoriously risky; wells that return the costs of drilling after payment of attached royalties and overrides are rarer still. Unless you or the group in which you are co-investing have millions of dollars to purchase the best prospects and use the latest drilling technology and techniques, the odds of finding a new field are extremely low. Private placement opportunities are generally high risk or scams. As a consequence, the likelihood of losing your total investment is very high. Limiting your investment to funds in which you can lose without affecting your present or future lifestyle is the only sensible strategy when purchasing Reg D securities.

Stick to Offerings That Meet Reg D Requirements

A Regulation D-exempt offering, while not approved by the SEC or state securities commissioners, must still be registered to take advantage of the exemption. Investors are required to make minimum investments either as a dollar amount or as a percentage of their net worth. And no more than $1 million per year of securities can be sold by a specific issuer, or $2 million if you are provided with audited financial statements.
Even though regulatory oversight has been decreased, these regulations do apply. Be sure that the investment you are considering fully complies with federal and state securities laws by taking the following steps:
• Contact the SEC and your state securities commissioner to verify that the issuer has registered the offering.
• Confirm that the issuer has not issued offerings for more than the maximum allowed under Reg D.
• If the promoters offer to take less than the minimum required by law, or to couple your investment with another investor to meet the minimum amount required, immediately cease communications with this promoter.

A favorite ploy of unscrupulous promoters is to tell their prospective mark that the investment opportunity is quickly being sold out, sometimes as an explanation as to why there isn’t enough time for the investor to properly investigate the offering. Promoters are adept at making prospective investors feel that the investment is a “once in a lifetime” opportunity which will go away, never to return. They appeal to the emotions with promised riches and the trappings those riches will bring. Entranced by the sizzle of success, the investor often overlooks the more likely pitfalls and probability of failure. An inviolate rule of professional capitalists is “Never react to an issuer-imposed deadline.” They understand that nothing is forever, and that 10 more offerings will be presented to them before the end of the month – each with the same assurance of profitability. They also know the odds of picking a winner. As a consequence, their first reaction when pressured to make a premature decision is to halt their due diligence, turn down the investment, and move on to the next deal. Their actions should be copied by every prospective investor.

Securities Lawyer

When you need legal help with a REG D offering or a PPM, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.

Michael R. Anderson, JD

Ascent Law LLC
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506
Ascent Law LLC

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