Going Public With Rule 506(b) – The Friends and Family Round

Seed Capital and the Friends and Family Round

Many small companies seeking to raise funds for their business raise initial seed capital from friends and family. Even when raising funds in a friends and family round, federal securities laws are applicable.

Do the Securities Laws Apply to the Friends and Family Round?

Generally, under federal securities laws in order to raise capital from investors even in a friends and family round, you must register the securities with the U.S. Securities & Exchange Commission (“SEC”).  There are several forms of SEC registration statements available to public or private companies, with the most common being Form S-1 for domestic issuers and Form F-1 for foreign private issuers. Because the SEC registration statement can be time consuming and burdensome, many companies seek to rely upon an exemption from SEC registration to raise their seed capital.

Rule 506 of Regulation D

The most common exemption from SEC Registration is Rule 506 of Regulation D which provides for two unique exemptions from SEC registration that allow the issuer to raise unlimited amounts of capital if it complies with the specific requirements of each rule. As discussed in more detail below, Rule 506(b) permits sales to up to 35 non-accredited investors and an unlimited number of accredited investors while Rule 506(c) allows sales to be using general solicitation and advertising so long as the issuer verifies that all investors are accredited purchasers. Both can be used for a friends and family round but if any investors are non-accredited then Rule 506(c) is not available.

The Rule 506(c) Safe Harbor

Under Rule 506(c), a company can broadly solicit and generally advertise the offering and still be deemed to be in compliance with the exemption’s requirements if:

• The investors in the offering are all accredited investors; and
• The company takes reasonable steps to verify that the investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.

Purchasers of securities offered pursuant to Rule 506 offerings  receive “restricted” securities, meaning that the securities cannot be sold for at least six months or a year without registering them.

Companies that comply with the requirements of Rule 506(b) or (c) do not have to register their offering of securities with the SEC, but they must file what is known as a “Form D” electronically with the SEC.

The Rule 506(b) Safe Harbor

Under Rule 506(b), a “safe harbor” under Section 4(a)(2) of the Securities Act, a company can be assured it is within the Section 4(a)(2) exemption by satisfying certain requirements, including the following:

• The company cannot use general solicitation or advertising to market the securities.
• Unlike Rule 506(c) discussed below, no accredited investor verification is required.
• The company may sell its securities to an unlimited number of “accredited investors” and up to 35 other purchasers. All non-accredited investors, either alone or with a purchaser representative, must be sophisticated—that is, 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. This means that any information a company provides to investors must not contain false or misleading statements.  Similarly, a company should not exclude any information if the omission makes what is provided to investors false or misleading.  Companies must give non-accredited investors disclosure documents that are generally the same as those used in Regulation A or SEC registered offerings, including financial statements, which in some cases may need to be certified or audited by an accountant.  If a company provides information to accredited investors, it must make this information available to non-accredited investors as well.
• The company must be available to answer questions by prospective purchasers.

Rule 506(b) might be a good be a better option than Rule 506(c) for a friends and family round because:

• The issuer can raise an unlimited amount of money from accredited investors and up to 35 non-accredited investors.
• Rule 506(b) does not impose on-going reporting obligations on the Company.
• A Form D must be filed only after you receive funds.
• Rule 506(b) pre-empts state law even though the states can require a copy of the Form D and filing fee.
• Rule 506(b) can be used to raise going public costs prior to the filing of an SEC Registration Statement.
• The issuer can conduct a Rule 506(c) offering as it completes its Rule 506(b) offering. 

  For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com.   This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.

  Hamilton & Associates | Securities Lawyers
  Brenda Hamilton, Securities Attorney
  101 Plaza Real South, Suite 202 North
  Boca Raton, Florida 33432
  Telephone: (561) 416-8956
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