Regulation D

Regulation D is the SEC’s exemption from full Securities Act of 1933 registration for private offerings of securities. It allows companies to raise capital from accredited investors (wealthy and sophisticated individuals) and a limited number of sophisticated investors without filing a prospectus or undergoing SEC review. Rule 506 (the largest Reg D exemption) has no dollar limit — companies can raise billions as long as they comply.

The Regulation D structure

Regulation D has three tiers (Rules 504, 505, 506), each with different dollar limits and investor restrictions. The largest and most important is Rule 506, which has no dollar ceiling and allows companies to raise unlimited capital from unlimited accredited investors (and up to 35 non-accredited sophisticated investors, under Rule 506(b), or accredited-only under Rule 506(c)).

A Regulation D offering requires only that the company file a Form D with the SEC — a 4-page form announcing the offering after it has closed. The SEC does not review or approve the offering; it simply collects data. The company avoids the burden and expense of prospectus review that a full registration requires.

Accredited investor: the definition

An accredited investor is defined as:

• An individual with annual income over $200,000 (or $300,000 joint with spouse), in the past two years and reasonably expected to continue, or
• Net worth exceeding $1 million (excluding primary residence), or
• Officers or directors of the company, or
• Certain institutional investors (banks, funds, etc.)

The definition is straightforward but the verification is company’s responsibility. In Rule 506(b), the company “reasonably believes” investors are accredited (subjective). In Rule 506(c), investors self-certify and the company can rely on third-party verification.

Rule 506(c): advertised offerings

Before the JOBS Act, Rule 506 offerings could not be advertised — the company had to solicit investors privately, and investors had to have a pre-existing relationship with the company. This made fundraising difficult for new companies.

The JOBS Act created Rule 506(c), which allows companies to advertise Rule 506 offerings to accredited investors. AngelList, SeedInvest, and other platforms now use Rule 506(c) to connect startups with investor networks. Investors prove accreditation (tax returns, net worth statements) and participate.

Sophisticated investor

For the 35 non-accredited investors allowed in Rule 506(b), the company must also ensure they are “sophisticated” — they must either have relevant business experience or hire an adviser (like an accountant) to evaluate the investment. This is meant to ensure that non-wealthy investors at least understand the risks.

Integration: the trap

One trap in Regulation D is “integration.” If a company does a Reg D offering and then, within six months, does a public offering, the SEC might integrate the offerings and demand that the company repay investors or convert the Reg D to registered shares. Integration is meant to prevent companies from using Reg D to avoid registration, then immediately going public.

Resale restrictions and illiquidity

A major drawback of Regulation D is that securities purchased are restricted — they cannot be resold without registration or another exemption. A person who buys stock in a startup through a Reg D offering typically cannot sell that stock for years (until the company goes public or is acquired). This illiquidity is why investors demand discounts — Reg D shares are cheaper than public shares to compensate for lack of liquidity.

The ecosystem: venture capital and startups

Regulation D, especially Rule 506(c), is the backbone of venture capital fundraising. Nearly every startup raising venture capital uses Reg D. The entrepreneur issues stock, takes money from venture funds (accredited investors), files Form D, and continues building. If the startup succeeds, it either exits (is acquired, for cash) or IPOs (at which point shares become liquid).

See also