Private Placements of Securities: Rule 504, 505, and 506
Private placements offer privately held companies a means
of obtaining financing from investors through the sale
of stock without the regulatory burdens, delay, and expense
of a public offering - and without regard to the prevailing
conditions in the public securities market.
U.S. securities laws generally prohibit the offer and
sale of securities unless they have been registered under
the Securities Act of 1933 and the securities ("blue
sky") laws of the states in which they are offered.
Nevertheless, these laws permit the offer and sale of
securities without registration upon compliance with one
of the currently available express exemptions from registration.
Private placement exemptions are among the most commonly
used exemptions from registration. They allow a company
to raise money privately without publicly soliciting investors.
In preparing for a private placement, the company prepares
offering materials containing information about the company
and the securities being offered. The company then approaches
a limited number of investors who satisfy certain suitability
standards, so-called accredited investors - without general
solicitation or advertising. Last, filings are made with
the SEC and with the appropriate state securities commissions.
The company selling the securities does not become a
public company by reason of the private placement and
does not become subject to the periodic reporting and
ongoing disclosure requirements under the securities laws.
Resales of the securities sold in a private placement
are restricted, and typically no trading market in these
shares develops. Shares acquired in such transactions
are stamped with a legend stating that such shares have
not been registered in a public offering.
Private placements can be structured in various ways,
but most are designed to comply with one of the three
alternative provisions of Regulation D of the Securities
Act of 1933, depending on the amount of financing sought
and the type of investors to be solicited.
Rule 504 allows a privately held company to raise up
to $1 million within a 12-month period. The securities
may be offered to an unlimited number of investors, and
no specific type of disclosure material is required to
satisfy the exemption. In some instances, Rule 504 offerings
may be made through public solicitations and the securities
sold are not subject to resale restrictions and investor
accreditation standards. While no federal registration
is required, state governments also regulate offerings.
In Alaska and Montana, for example, companies may raise
up to only $500,000 by the sale of securities to investors
residing in those states because they have no disclosure
laws applicable to the offering. And while a private placement
memorandum is not required, it is probably a good idea
to create one to minimize legal liability.
Rule 505 allows a company to raise up to $5 million
within a 12-month period. Rule 505 may not be used by
an investment company or a company that is disqualified
due to prior misconduct relating to the securities laws
by the company or its officers, directors, principal shareholders,
or other affiliates. The securities may be sold to an
unlimited number of "accredited investors" and
up to 35 nonaccredited investors. Specific types of disclosure
must be given to nonaccredited investors, similar to that
which is required for Rule 506 offerings, under $7.5 million.
Rule 506 does not limit the dollar amount of the securities
that may be sold in a private placement. As with Rule
505, the securities may be sold to an unlimited number
of accredited investors. However, each nonaccredited investor
must, either alone or with a purchaser representative,
have such knowledge and experience in financial and business
matters that the investor is capable of evaluating the
merits and risks of the prospective imvestment (or the
company must believe at the time the securities are sold
that each nonaccredited investor satisfies this requirement).
Rule 506 requires detailed disclosure of relevant information
to potential investors; the extent of disclosure depends
on the dollar size of the offering.