Raising Money From Investors Part 4: Regulation D "Safe Harbor" Provisions

This week we continue our series on raising money from investors. In Part 1, we covered why this complex area of law matters, even if you’re just raising money from friends and family. Complying with securities laws requires that you register at both the federal and state level or comply with an exemption (again, at both levels). In Part 2, we explained the common exemptions to registration at the state level. In Part 3, we looked at the common exemptions at the federal level. As we explained there, some of the federal exemptions leave quite a bit of room for interpretation, causing some businesses to rely instead on certain “safe harbor” provisions. 

Just what are the "safe harbor" provisions? Can you ever advertise that you're seeking investors? And is an offering document really necessary?

​What is Regulation D?

​Regulation D is an SEC regulation that sets forth more detailed guidance for private placements. To comply with the Regulation D “Safe Harbor” provisions, you will have to file a notice filing known as Form D with the SEC within 15 days after the first sale of securities. Form D puts the SEC on notice of the amount and nature of the securities being offering and what exemption(s) from registration is being relied upon. The good news is that there is no filing fee associated with Form D, but it does require the creation of an EDGAR account. And as we discuss below, Form D must also be filed with the Ohio Division of Securities, which does charge a filing fee. 

Rule 506(b)

Rule 506(b) is probably the most common of the Regulation D “Safe Harbor” provisions. Put simply, this rule provides specific requirements that, if followed, firmly establish that the transaction falls within the private placement exemption. To qualify for this safe harbor, your business must: 

• Not use general solicitation or advertising to seek out investors;
• Not sell securities to more than 35 non-accredited investors (and any non-accredited investors must have sufficient knowledge and experience in business matters to be capable of evaluating the merits and risks of the prospective investment); 
• Give non-accredited investors specified disclosure documents;
• Be available to answer questions from prospective investors who are non-accredited investors; and
• Provide certain financial statements to investors. (The specific requirements vary depending on the amount of the offering, but generally, you should plan on providing two years’ of financial statements and recent quarterly updates, including an audited balance sheet.)

Unlike other exemptions, Rule 506 does not place any limits on the amount of money that you can raise for your business.  

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​Rule 504 – Seed Capital Exemption

​Rule 504 exempts the offer and sale of up to $5 million in securities in a 12-month period. Like most exemptions, you cannot use general solicitation or advertising to market or sale the securities, and the securities are restricted, meaning that the investors cannot just find a new buyer to get rid of their securities without first registering the securities or complying with an exemption. This exemption also cannot be used by so-called “blank check companies,” i.e. those that have no specific business plan or purpose or simply plan to merge with or acquire unidentified companies.

​Rule 506(c)

Rule 506(c) is a newer exemption created to implement the JOBS Act. Unlike most securities exemptions, this rule does allow general solicitation and advertising if all of your investors qualify as accredited investors. However, the burden falls on the business to take reasonable steps to verify their accredited investor status (unlike Rule 506(b), where your potential investors can simply self-certify that they meet the standards to be considered an accredited investor). Third-party verification services exist, or your company can require investors to prove their accredited status with information from their brokers or accountants.
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Like Rule 504, Rule 506 securities are “restricted.” 

​Why You Should Always Use an Offering Document 

Technically, Rule 506(c) does not require a specific form of offering or disclosure document. In theory, accredited investors responding to a general solicitation nor advertisement know enough to protect themselves and ask the right questions before investing in your business. Similarly, certain state-level exemptions and the federal intrastate exemption do not specify any particular type of disclosure document to provide to potential investors. 

However, not providing a disclosure document is a terrible idea. No matter how you go about seeking investors for your business, you are still subject to anti-fraud provisions. How do you protect both yourself and your business from a claim that you misled or outright lied to an investor? Answer: By putting all of the critical information about the business and an investment in the business in a written document. Anything less is setting yourself and your company up for one of the most expensive types of litigation: he-said, she-said. And remember, a claim of securities fraud means that you, personally, can be held liable for returning the entire investment amount. 

​How does this all tie-in with Ohio law?

In Part 2, we said that Ohio recognizes two private placement exemptions (and each of these “safe harbor” provisions is a type of private placement exemption). If you are relying on Rule 506, Ohio’s 3(X) exemption applies. A copy of Form D (along with Ohio’s $100 filing fee) must be submitted to the state within 15 days of the first sale in Ohio.
 
All other private placements fall under Ohio’s 3(Q) exemption. Ohio has its own form (Form 3-Q, $100 filing fee) that must be submitted to the state within 60 days of each sale (not just the first sale) in Ohio. 

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​This is a complex, difficult topic, especially when you are fortunate enough to know potential investors who want to support your entrepreneurial journey and your business. But we’ve seen time and time again what happens when small businesses get this wrong. Disgruntled investors will use any violation of securities laws, no matter how small or seemingly insignificant, to demand a return of their entire investment. Before you accept an investor’s money, you need to know how an investment your business fits this complex regulatory framework, and you need to get the right disclosure documents and investment agreements in place. 

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