Friday, August 17, 2012
An important part of the JOBS Act that was adopted into law on April 8, 2012 is the revisions to Rule 506. Transactions pursuant to Rule 506 of the Regulation D are often referred to as the “Reg D private placements.” The Rule allows startups to issue unlimited amount of securities to an unlimited number of accredited investors and up to 35 sophisticated non-accredited investors. Accredited investors’ definition includes individuals who have (i) a net worth (or joint net worth with his/her spouse) that exceeds $1 million at the time of the purchase (not including the value of the primary residence); or (ii) income exceeding $200,000 in each of the two most recent years (or joint income with spouse exceeding $300,000 for those years) and a reasonable expectation of such income level in the current year. Currently, one of the conditions of a Rule 506 offering is that there cannot be general solicitation or advertising. Compliance with the Rule is simple as long as the offering is made only to accredited investors. If, however, an offering involves investors who are not accredited, the company is required to provide more disclosure, which increases the offering's legal costs.
The JOBS Act lifted the ban on general solicitation and advertising in Rule 506 offerings so long as all investors are accredited, and asked the SEC to adopt rules relating to the verification of the investors’ accredited status. Changes to Rule 506 will not become effective until the SEC develops the rules. The SEC had 90 days from April 8th to accomplish this task. The 90-day period expired on July 7th but no rules came about.
Once effective, changes to Rule 506 will radically change the private placement process. Companies looking for funding will no longer be limited to contacting their wealthy friends, family members and people with whom they have a pre-existing relationship. Startups will be able to solicit and advertise openly, as long as all investors who end up investing in the company are accredited. Hopefully, the SEC is not delayed much longer in its rule-making that would enable more companies to raise the much-needed capital.
This article is not a legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga. Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.