Regulation of Investment by Friends and Relatives
In the world of securities, Rule 505 of Regulation D under the Securities Act of 1933 offers a path for companies to raise capital from a limited number of investors, including certain non-accredited investors, without registering the securities with the Securities and Exchange Commission (SEC).
To qualify for this exemption, companies must adhere to specific requirements. The offering size limit is set at $5 million within a 12-month period. The number of non-accredited investors is also limited, typically to no more than 35.
Companies relying on Rule 505 must provide detailed disclosure documents similar to those used in registered offerings to non-accredited investors. This includes financial statements and other material information necessary for investors to make informed decisions. To verify the investor’s status, companies selling to non-accredited investors must take reasonable steps to ensure they understand the risks.
Securities sold under Rule 505 are restricted and cannot be freely resold without registration or another exemption. Rule 505 also does not permit general advertising or broad solicitation of investors.
While Rule 505 has historically been popular for smaller raises involving a mix of accredited and non-accredited investors, it has been partially superseded by other rules like Rule 506 which provide more flexibility, especially with respect to accredited investors.
A securities offering exempt from registration is sometimes referred to as a private placement or an unregistered offering. Entities such as banks, partnerships, corporations, nonprofits, and trusts may also be accredited investors if they meet certain conditions.
In California, Rule 25102(f) allows a company to sell securities to an unlimited number of accredited investors and company executives, and up to 35 non-accredited investors, as long as they meet certain conditions, like having a preexisting personal or business relationship with the seller or having the capacity to protect their own interests.
In summary, to raise capital from non-accredited investors under Rule 505, issuers must limit offering size to $5 million, provide meaningful disclosure, limit the number of non-accredited investors to 35, and comply with restrictions on solicitation and resale. While Rule 505 offers a path for companies to raise capital from non-accredited investors, Rule 506 remains the most attractive option due to state law preemption, but Rule 504 can be a good alternative for states like California without rich uncles.
Companies utilizing Rule 505 for fundraising must abide by various stipulations to qualify for the exemption from SEC registration. This includes supplying detailed disclosure documents, such as financial statements and essential information, to non-accredited investors. Furthermore, companies relying on Rule 505 for investing in business should be mindful of the offering size limit of $5 million within a 12-month period and the restriction on the number of non-accredited investors, typically not exceeding 35.
