Limitations on the Number of Investors in a Reg. D Private Placement

Limiting the number of investors assures that your company is not a "public offering."

In the Securities Act of 1933, the “Selling Stock Act,” the statutory framework for Private Placements is set forth in Section 4(2) of the 1933 Act as “transactions by an issuer not involving a public offering.” In SEC Regulation D, the SEC has said that one way to assure that your offering is not a “public offering” is to limit the number of people who can buy your stock in the Private Placement.

If you are contemplating a Go Public Direct transaction as opposed to a reverse merger with a public shell, this is important because it gets you the necessary number of shareholders to obtain a Ticker Symbol and gives you the opportunity to raise funds prior to filing a registration statement on Form S-1 with the SEC with the certainty you are doing so without violating the law.

Rules 505 and 506 limit the number of investors to 35 investors who are not “Accredited Investors.”  Rule 504 does not have this limitation. However, state “Blue Sky” laws effectively impose the same limitations even if you choose a Rule 504 Private Placement.

What is an Accredited Investor?

To make this count accurately and assure you don’t violate Reg. D by going over the number of allowed investors, you must understand what an Accredited Investor is.  There are many classification of the term Accredited Investor. Those used most often, under current law, are:

  1. Any natural person whose individual net worth, or joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000, excluding the value of the primary residence.
  2. Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.

There are other types of Accredited Investors, primarily non-individuals such as institutions that meet certain standards, and there are also other individuals that are also excluded in the count, most often any relative, spouse or relative of the spouse of a purchaser who has the same principal residence as the purchaser.

Why is an Accredited Investor treated differently under Regulation D? According to the SEC, it is because one purpose of the accredited investor concept is to identify persons who can bear the economic risk of an investment in unregistered securities, including the ability to hold unregistered (and therefore less liquid) securities for an indefinite period and, if necessary, to afford a complete loss of such investment.

Accredited Investors and the Dodd-Frank Act

In 2011, under the Dodd-Frank Act, Congress directed the SEC to adjust the accredited investor net worth standard that applies to natural persons individually, or jointly with their spouse, to “more than $1,000,000 . . . excluding the value of the primary residence.”  So in December 2011 the SEC did this by adopting amendments which provide the following:

  1. The person’s primary residence shall not be included as an asset;
  2. Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (with certain limitations); and
  3. Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability.

What does the future hold for the definition of an accredited investor? Under Dodd-Frank, an increase in the $1,000,000 standard every four years beginning in 2015.

How do you know if an investor in your placement is accredited? You ask. All investors in your Reg. D Private Placement must fill out a Subscription Agreement. In the Subscription Agreement, you ask the Investor to make representations confirm Accredited Investor status.

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