I went right to the source to do research for this article: http://www.sec.gov/answers/rule506.htm
The timing right now in April of 2012 is very good for raising money in this way: with interest rates at an all time artificial low, many conventional investors are looking at non-conventional alternatives in order to create a return. Since these wealthy individuals and companies often live off that investment income return, there is a huge incentive for them to examine new alternatives.
Internet start-ups require less capital than was required in the prior-to-Internet past in order to execute such a fundraising effort: with electronic commerce, social networks, and opt-in email marketing, there are many new and inexpensive ways to approach investors legally and ethically under Regulation D: Rule 506 is the rule best suited for venture capital offerings in my opinion: (IE: the little guys should stick with the mainstream investments: prudent man rule)
Regulation D is considered a “safe harbor” for the private offering exemption of Section 4(2) of the Securities Act. Companies using the Rule 506 exemption can raise an unlimited amount of money. A company can be assured it is within the Section 4(2) exemption by satisfying the following standards:
- The company cannot use general solicitation or advertising to market the securities;
- The company may sell its securities to an unlimited number of “accredited investors” and up to 35 other purchases. Unlike Rule 505, 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 anti-fraud prohibitions of the federal securities laws. But companies must give non-accredited investors disclosure documents that are generally the same as those used in registered offerings. 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;
- Financial statement requirements are the same as for Rule 505; and
- Purchasers receive “restricted” securities, meaning that the securities cannot be sold for at least a year without registering them.
While companies using the Rule 506 exemption do not have to register their securities and usually do not have to file reports with the SEC, they must file what is known as a “Form D” after they first sell their securities. Form D is a brief notice that includes the names and addresses of the company’s owners and stock promoters, but contains little other information about the company.
In February 2008, the SEC adopted amendments to Form D, requiring that electronic filing of Form D be phased in during the period September 15, 2008 to March 16, 2009. Although as amended, the electronic Form D requires much of the same information as the paper Form D, the amended Form D requires disclosure of the date of first sale in the offering. Previously, the closing date of an offering was used as the first date of sale. The Office of Small Business Policy has posted information on its web page about the filing requirement for the new Form D…..>>more here>>
Rule 506 of Regulation D is widely used by venture capitalists and entrepreneurs in the early stages of forming a company: before the company has 10 stockholders (referred to as “the coffee table rule) no forms must be filed to begin such a start up business (sometimes referred to as the organizational period)
An entrepreneur can create a document (you can download all the current documents for filling a Reg. D in any state in template format and fill in the blanks for a small fee at ppmfast.com and a number of other for-profit websites); and simply use that document to begin raising money in several ways:
- “FFR” Money – family friends and relatives my be interested in helping you get started in the earliest stages before you are far enough along to raise money elsewhere
- Industry-related – many businesses will be good customers, and/or good suppliers when they are funded: other businesses who will benefit in this way may be willing to invest, or offer contingent commitments for trade credit and other considerations based on the success of the offering; these commitments enhance the start-up ability to raise serious investment capital by leveraging the potential returns.
- Government incentives – especially in a recession, there are many local, state, and federal programs designed to create jobs and/or attract investment to any area: these include the SBA, BDCs, SBCs. These are good sources of early stage capital, and incentives that reduce labor, rent, and tax costs for an early stage business that can create jobs and tax base. Again, such arrangements, even as contingent commitments, can greatly enhance potential profits and make an early stage investment in a private offering more attractive.
- Private investors: “Angles” – wealthy individuals often invest in this type of offering with a criteria that the upside is so large when a private company goes public, so that they can afford to be wrong nine times out of ten and still see a huge return form the one that hits – the key here is to be able to invest early, and to be able to afford to diversify risk (invest in at least ten of them)
- Professional venture capitalists – I do not recommend that you pursue investment from professionals in this industry unless and until and unless you have exhausted the other alternatives: you can find many of these sources in The Corporate Finance Sourcebook 2011
What has changed with the advent of the Internet since when I was involved heavily in doing this for many clients in the 1980s: is that this type of offering is much less less expensive, sometimes not even requiring any printing or stamps (which were an expensive part of this then). With email and social networks to use, the entrepreneurs’ investment may literally be only his time and minor organizational costs – the early stage money can even be raised prior to incorporation under an “agreement to incorporate” made from the PPM templates. It is truly a “brave new world” for entrepreneurs, and their backers. These changes have spurred so much activity, that some have even proposed more regulation to restrict past abusers from using this type of offering: see:
My company here: UpLog.org, was capitalized and is still not incorporated, funded with under $20,000 thus. We will eventually incorporate, file Form D, and raise at least another 100,000 to expand and eventually go public. I am currently preparing another offering document under Rule 506 of Regulation D for a private investor who plans to go after the huge and coming market for human electronics: IE: integration of technology with the human mind and body – I like that one because the window will not close any time soon, because the client-entrepreneur is so far ahead of the marketplace that I will have time to do my work, and it seems obvious and inevitable that a huge market will eventually exist; and already does exist with aging baby-boomers. Let me know of you want to see the PPM (private placement memorandum) when it is done!
– copyright Israel Rothman 2012 – free consultation 805-827-2450
Original article is here:
101 How to raise money for a startup under SEC Rule 506 of Regulation D
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