For Israeli startups and growth-stage companies that seek to raise capital from investors in the United States, it is imperative that they understand the various securities issues that can arise in a capital raise. Under the Securities Act of 1933, any offering of securities in a company must either be registered with the SEC or qualify for an exemption to the registration requirement. As most companies that are solely seeking capital are not ready to file their securities with the SEC (and effectively go public), an exemption to the registration requirement is often sought out. A common exemption for issuers is Section 4(a)(2) (the private placement exemption) which states that a registration is not needed in a nonpublic offering. The regulations implementing this statute are called Regulation D, which includes Rule 504, Rule 505, or Rule 506 (all described in detail below). In addition, Section 4(a)(5) provides an exemption for offers and sales to accredited investors. In connection with the reliance on these Rules, issuers file a Form D online, which is a form that is used to file a notice of an exempt offering of securities with the SEC.
The Form D filing itself requires stating whether the SEC exemption that is being used is Rule 504, Rule 505, or Rule 506 of Regulation D, or Section 4(a)(5) of the 1933 act. A short summary of these exemptions is as follows:
- Rule 504 provides an exemption from the registration requirements of the federal securities laws for some companies when they offer and sell up to $1 million of their securities in any 12-month period. Unless the securities are registered in one or more states requiring a substantive disclosure document, or are sold under state law permitting general solicitation to accredited investors, the exemption does not allow companies to solicit or advertise their securities to the public and purchasers receive restricted securities, meaning that they may not sell the securities without registration or an applicable exemption.
- Rule 505 provides an exemption from the registration requirements of the federal securities laws for companies when they offer and sell securities. To qualify for this exemption, a company:
- Can only offer and sell up to $5 million of its securities in any 12-month period;
- May sell to an unlimited number of “accredited investors” and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions;
- Must inform purchasers that they receive “restricted” securities, meaning that the securities cannot be sold for six months or longer without registering them; and
- Cannot use general solicitation or advertising to sell the securities.
- Rule 505 allows companies to decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. However, companies are required to give nonaccredited investors disclosure documents that generally are equivalent to those used in registered offerings, including scaled financial statement information. If a company provides information to accredited investors, it must make this information available to nonaccredited investors as well. The company must also be available to answer questions by prospective purchasers.
- Rule 506 allows for the raise of an unlimited amount of money. The Rule was recently amended and for a general summary of the changes please see the article “Navigating the Recent Changes to Regulation D Rule 506,” written by Greenberg Traurig Shareholders Rebecca Distefano and Bruce Rosetto. Rule 506 currently contains two distinct exemptions:
- Under Rule 506(b), a company can be assured it is within the exemption by satisfying the following standards:
- The company cannot use general solicitation or advertising to market the securities;
- The company may sell its securities to an unlimited number of “accredited investors” and up to 35 other purchases. Unlike Rule 505, all nonaccredited investors, either alone or with a purchaser representative, must be sophisticated—they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;
- Companies must decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws. However, companies must give nonaccredited investors disclosure documents that are generally the same as those used in registered offerings. If a company provides information to accredited investors, it must make this information available to nonaccredited investors as well;
- The company must be available to answer questions by prospective purchasers; and
- Financial statement requirements are the same as for Rule 505.
- Under Rule 506(c), a company can broadly solicit and generally advertise the offering, but still be deemed to be undertaking a private offering if:
- The investors in the offering are all accredited investors; and
- The company has taken reasonable steps to verify that its investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports, and the like, or obtaining third-party verification of the investor’s status.
Section 4(a)(5) exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million and no public solicitation or advertising is made. Note, however, that this section is not commonly used as a stand-alone exemption, as much of this statutory exemption generally fits under the exemptions of Regulation D that are described above.
In addition, the Form D requires listing certain detailed information with respect to the issuer and the offering, and the filed forms are then available for public viewing on the SEC’s website. The form must be filed within 15 days after the first sale of securities in the offering, which is the date on which the first investor is irrevocably contractually committed to invest. Since the form is a filing with respect to federal law, counsel should be consulted regarding state law requirements (so called blue sky laws). Securities sold under Rule 506 are “covered securities” under the Securities Act of 1933, and under federal preemption standards, the states may not perform a substantive review of an offering and are limited to obtaining a copy of the Form D filed federally together with a fee and a consent to service. Rule 504 and Rule 505, and Section 4(a)(5), are not covered securities and compliance with state securities law is required.
As discussed in this summary, there are very specific restrictions involved in the exemptions that permit a company to file a Form D and thereby sell exempt securities. With an international consisting of attorneys around the globe, Greenberg Traurig is uniquely situated to advise our clients on matters relating to raising capital raises and the issuance of securities.