Feds Make Change to Help Entrepreneurs Raise More Money

May 9, 2017 Business planning, Real Estate, Small Business Comments Off on Feds Make Change to Help Entrepreneurs Raise More Money

Your federal government has modified rules making it easier to raise more money from so-called “unaccredited investors”. Under the updated rule, known as Rule 504, you can raise up to $5 million from unaccredited investors in a 12-month period. Prior to the 2017 update, you could only raise $1 million from unaccredited investors. The updated $5 million cap is available under Rule 504 offerings and should only be used when the offering is a private placement memorandum offering (“PPM”), where you aren’t marketing the offering to the general public but privately to know persons and contacts. The new $5 million cap will make it easier to raise larger amounts of money from unaccredited persons and we expect to see an increase in persons using Rule 504 to raise money for operating businesses and real estate investments.

Background to Securities Offering Exemptions

At some point in its lifespan, just about every business needs an infusion of capital, whether to buy equipment or inventory, hire more employees, make additional investments or something else.  Obtaining that capital can be accomplished in several ways – maxing out credit cards, getting a business line of credit, tracking down private money loans, bringing on partners who invest money but also participate in the decision-making process of the business, or maybe even having a bake sale!

However, sometimes it makes sense to raise cash by bringing on investors – silent partners who have funds to contribute, but who would rather not (and maybe who you would rather not) participate in the business.  These are the type of folks who want to invest their money, step away, and then have you make the hard decisions and put in the blood, sweat and tears to produce a return on their investment.  When you bring on an investor of this type, whether you know it or not, you have sold that investor a “security” and you are now under the purview of the Securities and Exchange Commission (the “SEC”) – perhaps the only federal agency with a less developed sense of humor than the IRS.

Created by FDR and Congress while the country was in the throes of the Great Depression in 1934, the SEC exists to make sure the excesses and outright frauds that created the 1929 Stock Market Crash do not repeat themselves.  The intervening decades have seen the number and complexity of SEC regulations wax and wane, but in 2017 we are left with a multi-layered, multi-faceted system that those seeking to raise capital should not attempt to navigate without expert guidance.

Regulation D and the 2017 Federal Securities Exemption Options

One of the most popular tools for small businesses looking to raise money is something called “Regulation D.”  In a nutshell, under Regulation D, the SEC allows businesses to raise capital through the sale of securities without requiring those businesses to register said securities with the Commission (an extremely expensive and time-consuming process).  For the past 35 years or so, there have been three separate and distinct sets of hoops to jump through to comply with Regulation D, called Rule 504, Rule 505 and Rule 506.

Rule 506 has been the most popular of the three.  For all intents and purposes, Rule 506 only allows businesses to offer and sell securities to “Accredited Investors” – people with a net worth over $1 million, or whose annual income exceeds $200,000 (individually) or $300,000 (jointly with a spouse).  In exchange for only dealing with Accredited Investors, issuers of Rule 506 offerings get to raise an unlimited amount of money from an unlimited amount of investors over an unlimited amount of time.  In some situations, they may also be eligible to solicit their offerings to the general public (think email blasts and radio and TV ads).  Rule 506 offerings are also simple at the state level – where only the same short document filed with the SEC (the “Form D”) has to be filed (and a fee paid) in each state where Rule 506 securities are sold.

2017 Update

The recent SEC change that will help entrepreneurs raise money comes in Rule 504 of Regulation D.  The nice part about Rule 504 has always been that it allows the company raising the funds to accept money from both accredited and non-accredited investors – a huge advantage if you don’t have contact info for a bunch of super-rich folks in your phone.

The main problem with Rule 504 has always been that you can’t raise more than $1 million in any 12-month period, and $1 million doesn’t go quite as far today as it did in 1988 (which is when the $1 million cap was instituted).  Well, apparently late last year the powers that be at the SEC woke up one morning and realized that 1988 was almost 30 years ago, so they decided to increase the cap from $1 million to $5 million in any 12 month period.  This increase became effective January 20, 2017.  The increase is a potentially significant change, so let’s recap the parameters of the new Rule 504 Offering:

1)   You may offer up to $5 million in securities in any 12 month period.

2)   You may offer securities to an unlimited number of both accredited and non-accredited investors.

3)   Unless you jump through some pretty onerous hoops, you may not “generally solicit” your offering.  You will still need to rely on “word of mouth” marketing.

4)   You can’t play in the Rule 504 sandbox if you have run afoul of the SEC previously and have been branded a “Bad Actor” under their rules.

5)   You still have to comply with state-by-state “Blue Sky” laws.  This can be tricky.  Unlike with a Rule 506 offering, state law compliance is not always as simple as filing the SEC Form D and paying a fee.  In some blessed states (let’s give a shout out to Colorado and South Dakota) the process is exactly the same as a Rule 506 offering.  In others (I’m looking at you California and Texas) the rules are restrictive and complex, and you will be very limited on the number of folks you can accept money from (or even solicit) without “qualifying” the offering in that state.

The bottom line is that if you want to bring on investors and raise up to $5 million in capital, but you are worried about only being able to take money from “accredited investors” then the Rule 504 Offering absolutely needs to be on your radar.  It’s going to take a bit of heavy lifting on the state compliance side of the coin, but depending on the states involved, it could be a very attractive option.  Please speak with an experienced securities attorney to see if a Rule 504 Offering could make sense in your specific situation.

About the author

Jarom brings a wealth of experience in several diverse areas of law, but focuses his practice primarily on business formation and transactions, real estate, trademarks, estate planning, self directed IRA law, and civil litigation. Jarom has spent much of his practice helping entrepreneurs and small business owners across the country navigate the trials and tribulations of starting and operating a business. He has helped clients set up hundreds of business entities, drafted multifaceted business and real estate agreements, and represented companies large and small in complex contract, intellectual property and real estate litigation. He also routinely helps clients obtain and protect trademarks and other intellectual property.