Private Placement and Regulation D

Looking for Investors in Your Company? Get to Know “Regulation D”

Private Placement and Regulation D

The Sale of Stock as a Private Placement.  Private Placement and Regulation D. These are concepts that apply to the sale of what are known as securities. Sometimes securities transactions are involved in M&A transactions.  But for many companies, these concepts are most commonly implicated when looking for investors. When you are looking to sell an interest in your company to a person or entity, you may well be selling securities. Securities can take various forms, but one of the most common is stock in a corporation. And when a company, be it a startup or a more established corporation, is looking to sell stock to a private investor, that company is likely partaking in a private placement of securities.

A private placement of securities, as the name suggests, involves a private transaction between a business entity and an investor. Private placements, like all sales of securities, are subject to securities laws, both federal and state. Generally speaking, securities laws require, among other things, that all sales of stock be registered with the US Securities and Exchange Commission (SEC). There may also be registration requirements at the State level. Private placements may be exempt from that registration requirement if a federal or state exemption applies.

Regulation D. There are various exemptions at both the federal and state levels, but some of the most common federal securities registration exemptions fall under what is known as “Regulation D.” Regulation D of the Securities Act of 1933 contains various exemptions allowing for some private placements to be made without the need for registering the sale of securities with the SEC – Rules 504 and 506 of Regulation D being the most commonly utilized.

Private Placement and Regulation D are incredibly important for corporations looking to raise funds through equity. Registration with SEC is a time-consuming process, with ongoing duties and obligations that carry on well-past the registration date. It is typically considered advisable to try to find an applicable Regulation D exemption to avoid this registration requirement. But this will come down to the individual facts and circumstances of your potential stock offering.

The exact rules of Regulation D are too long and complex to discuss in great depth in this post, but some important things to remember when considering a private placement:

  • The number and type of investors: accredited vs. non-accredited. If a would-be investor meets the definition of “accredited” under applicable law, this opens up additional exemptions than would apply to non-accredited investor transactions and it potentially reduces a corporation’s disclosure requirements, i.e., what info it must provide the investor. There are also caps on the number of investors allowed under certain exemptions.
  • Determining what disclosures are required and making timely disclosures. The general principle for any information provided to potential owners is that it must be free from false or misleading statements, and should not exclude any information if the omission would make what is provided to investors false or misleading. As noted above, there are also specific rules applicable to disclosures to accredited vs. non-accredited investors.
  • The intended amount of money to be raised. This can also impact whether and what exemption applies, with some exemptions placing caps on the amount to be raised.
  • Restricted securities. Generally speaking, most securities acquired in a private placement are “restricted securities,” meaning that there are restrictions on transferability of the stock after acquisition.
  • Form D. Even though registration of the sale of securities is not required in an exempt private placement, every “issuer” of offered securities (i.e., the selling corporation) must file a document known as Form D with the SEC within a set time period. Form D is not the same as registration with the SEC, but does involve some notice of the pending securities offerings and are searchable on the records of the SEC. Failure to timely file Form D can lead to negative consequences for the corporation, namely potential loss of the future ability to use Regulation D for exempt securities offerings.

LLC Interests and Regulation D. Above I noted that one of the most common forms of securities is corporate stock. You may be wondering how limited liability companies come into play with private placement and Regulation D: do the ownership interests held in LLCs constitute securities, and thus fall under applicable securities laws (like the obligation to register the sale of securities or find an exemption)? The answer to that question, like that to any good question asked of an attorney, is that it depends.

When the Securities Act of 1933 and, its less often cited younger sibling, the Securities Act of 1934 were enacted, LLCs didn’t even exist. The limited liability company is a creation of statute and didn’t really come into being in the US until well after these securities laws had already been on the books.  Accordingly, the definition of “securities” under those Acts did not expressly include LLC ownership interests. But common sense suggests that LLC interests would also be securities, right?

While State statutes may well expressly resolve the question, there is an absence of determinative federal statutes on point. We, therefore, must look to the Supreme Court for the answer to this question. SCOTUS did not disappoint. They gave us the Howey Test, the first iteration of which was published in S.E.C. v. W.J. Howey Co., 328 U.S. 293 (1946). This test, as honed and refined by subsequent court decisions, states that if an LLC interest constitutes an “investment contract”, as defined in the Securities Act, then it is a security. Essentially this means that if an individual is making an investment of money in a common enterprise (i.e. the LLC) with a reasonable expectation of profits, which profits are to be derived from the entrepreneurial or management efforts of others, then the ownership interests in the LLC will be considered securities and, therefore, an exemption under Regulation D must apply to avoid the registration requirement. Among other things, this test differentiates between passive and active owners. But with LLCs, the difference can sometimes be hard to spot.

Why Does It Matter? You may be wondering, “Private Placement and Regulation D? So, what?” Or perhaps your buddy owns a corporation and told you about a recent round of capital investment, making no mention of Regulation D, Form D or registration with the SEC. Beware your buddy and the failure to comply with Regulation D or find an otherwise applicable exemption to federal and state law requiring registration. That failure can lead to substantial consequences for a company and its key personnel, including civil liability (such as rescission, under which the sale must be undone and money returned to the investor, or breach of contract claims) and potentially criminal liability, as well. For instance, officers or directors of the corporation convicted of fraud in the transaction could face hefty fines and even jail time.

Private placement and Regulation D are very important concepts, with important rules and applications.  It is incredibly important to conduct the transaction properly, including in regard to the SEC and registration or exemption requirements. It is highly advisable to seek a competent securities lawyer to help you or your corporation through the process. What is the registration requirement? Does an exemption apply? Will the sale of LLC interests constitute a securities transaction? What type of disclosures are required? What does the law in my State require? These, and many other questions like them, should be addressed with your attorney. Don’t go it alone. The potential consequences are too great. Private Placement and Regulation D go hand in hand. Make sure you discuss how to properly utilize this combination with your attorney.



The information herein is not legal advice and does not create an attorney/client relationship. The information is in the form of legal education and is intended to provide general information about the matter.  The above is not, nor is it intended to be, legal advice.  Consult your attorney with questions.