Regulation D, Rule 505
Rule 505 of Regulation D provides an exemption for offerings up to $5,000,000 in a 12-month period.[1] This exemption is not available to investment companies[2] or the so-called “bad actors.”[3] Just like in Rule 504 offerings, a company cannot use general solicitation or advertising to sell the securities in Rule 505 offerings.[4] And just like in other Regulation D offerings, Rule 505 securities are restricted securities[5] and issuers need to file Form D with the SEC.[6] What’s different about Rule 505 is that the issuer can sell to an unlimited number of accredited investors and up to 35 unaccredited investors.[7] Rule 505 allows companies to decide what information to give to accredited investors, so long as it does not violate the antifraud prohibitions of the federal securities laws, but companies must give unaccredited investors disclosure documents that are generally similar to those used in registered offerings and be available to answer questions by prospective purchasers.[8] With respect to the financial statement requirements applicable to this type of offering:
- Financial statements need to be certified by an independent public accountant;
- If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company’s balance sheet must be audited; and
- Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.[9]
If you read our previous posts on exempt offerings and crowdfunding, you may be thinking that this sounds a lot like Rule 506(b). Indeed, other than the offering limit and the enhanced investor sophistication requirement, they seem strikingly similar. But there is a significant difference between Rule 505 and Rule 506(b): Rule 505 does not preempt state law requirements, which is a huge disadvantage. For this reason, this exemption is also rarely used.
This post was a part of a multi-post blog series on other exemptions under Regulation D and the overwhelming popularity of Rule 506. You can find the other posts by searching our blogs at www.mcbrideattorneys.com. In our next post, we will discuss the overwhelming popularity of Rule 506.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C. which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] See generally id. § 230.505.
[2] Id. § 230.505(a).
[3] Id. § 230.505(b).
[4] Id. § 230.505(b). See also id. § 230.502(c).
[5] Id. § 230.502(d).
[6] Id. § 230.503.
[7] Id. § 230.505(a)(ii).
[8] Id. § 230.502(b).
[9] Id.