If you plan to approach potential investors for your new business, you may want to discuss your plans with a startup lawyer. A startup lawyer can discuss compliance with Securities and Exchange Commission (SEC) regulations that cover who you may approach and how you may approach them.

The Securities Act of 1933 requires any startup company that wants to sell shares of the business to register with the SEC if the principles want to sell the securities in a private offering. This requirement also applies to you if you have an established firm and want to expand by selling additional shares. If you believe that registering your startup with the SEC is not in the best interests of your new company or your investors, a business attorney can explain to you the exemptions to this requirement under Rule 506 of the Securities Act. 

A business lawyer can assist you in meeting the exemptions under Rule 506 by helping you demonstrate that your investors are either “accredited” or “sophisticated” investors. Sophisticated investors are those who have shown through their experience in investing that they understand the risks involved in investing in securities. Accredited investors are the people with certain level of income and/or assets. A business lawyer can discuss with you in greater detail what makes an investor an accredited investor or a sophisticated one.

A business attorney will discuss with you whether it is best to seek exemptions under 506(b) or 506(c). There are some subtle but important differences between 506(b) and 506(c). The differences are mainly in the number and type of investors.

506(b)

This exemption to Rule D allows you to have an unlimited number of accredited investors, and as many as 35 other investors. You will need to demonstrate that the non-accredited investors are sophisticated investors, either through their own experience or that of an investor representative. You may not use general advertising or solicitation for investment in a private offering and still claim the 506(b) exemption.

Under 506(b), you must provide the same information to non-accredited investors as you do to accredited investors. You must also provide non-accredited investors information that you would if you were to register your offering with the SEC. You must be available to answer questions that potential investors may want to ask.

506(c)

If you use the 506(c) exemption to Rule D of the Securities Act, all your investors must be accredited investors. You must also be able to show that you took reasonable steps to verify that all the investors in your offering are accredited investors. You can do this by obtaining documentation, such as bank or brokerage statements, W-2s, credit reports or tax returns. You do not necessarily have to produce such documents, but you need to be able to demonstrate that you reviewed them to verify that your investors are accredited investors.

If you meet the above criteria for the 506(c) exemption, you can broadly advertise and solicit for investment and still have your offering considered a private offering.

Both 506(b) and 506(c) require investors to hold their new shares for at least one year before selling them. After you have sold the shares to your new investors, you must file a Form D, which lists the principles and promoters of the company, and gives basic information about the offering.

Attracting investors is an important step and can be a formidable challenge. Please contact us for a comprehensive consultation about securities law and regulations.