Crowdfunding Lawyers

Regulations: Understanding Regulations D, CF, A, and S

January 18, 2023
Regulations: Understanding Regulations D, CF, A, and S

Structuring an investment correctly is essential. If you fail to do so, you run afoul of the SEC and could find yourself in some very hot legal water. Several keys exist to achieving that goal, but perhaps the most critical is understanding the various regulations that apply to these deals.

You should know of several, including Regulation D, Regulation CF, Regulation A, and Regulation S. In this post, we’ll discuss these and some of their permutations to help you understand what’s necessary to structure your deals correctly.


A Brief Overview

Before we take a deeper dive, let’s briefly explore each regulation to provide some foundation for the wider discussion.

Regulation D – Usually called Reg D, this provides safe harbor. It essentially says that if you follow the rules spelled out in the regulation, you will not be deemed to have offered your securities publicly. You also have a subset of rules within Reg D that you can choose from, including:

  • 506 B
  • 506 C
  • 504 – Note that we’re not discussing 504 in this post. Simply put, it means that you’re dealing with individual state regulations. Some states will let you raise $10 million, while others won’t. Know the rules that apply based on state regulations.

Regulation CF – This regulation is specifically for raising money online (CF stands for “crowdfunding”).

Regulation A – You most likely will not use Reg A because it involves a quasi-public offering, but we’ll cover it because there are some uses for it.

Regulation S – If you plan to raise money by targeting investors outside the United States (non-US citizens located outside the country), the SEC is not particularly worried about it. This regulation primarily focuses on ensuring you follow the laws in whatever nation(s) you raise funds.

These are the most common regulations you’ll deal with, but they’re not the only ones. You can wade through a veritable alphabet soup of rules when selling securities without registering them. And you do want to avoid that, particularly for smaller deals. Registration is a long, drawn-out process that eats up your resources.

Going public is not the path if you’re just trying to raise $5 or $10 million. That means working with exemptions, which is where most deals end up.


Regulation D. 506 C

This exemption allows you to raise as much money as you want, but you can only do so by targeting “accredited” investors. It requires that you take reasonable steps to ensure that your investors are accredited before working with them. That can include a letter from their attorney or a CPA, or you can work with an online verification service. However you do it, you must be able to demonstrate that you did your due diligence. This verification is good for five years before going through the process again. You can also take advantage of general solicitation. That means you can market your deal through Facebook, email, billboards, radio ads, and other avenues without it being considered a public offering.

Regulation D. 506 B

506 B is very similar to 506 C, but it does differ in a few ways. You can raise unlimited funds from accredited investors, but you do not have to verify that they are accredited. You’re allowed to take their word for it. You’re also allowed up to 35 unaccredited investors in the deal within any 90-day period, as long as they qualify as “sophisticated.” Note that all investment disclosures are required, particularly if you’re working with unaccredited investors. That must come in the form of a PPM, which is a prospectus-like document you might have seen if you’ve ever bought a mutual fund. The PPM provides important information about the deal’s managers, structure, and more.

You should also understand a couple of other key differences. One, you cannot use general solicitation methods. You must work within a private network of investors. The SEC also recommends (although this is not a rule) that you have a pre-existing, substantive relationship with your investors.

A Quick Aside

We’ve covered a couple of terms so far that deserve some definition – accredited and sophisticated. Let’s explore those in greater depth, so you don’t encounter any surprises.


What Does Accredited Mean?

Accredited means that the investor has an income of at least $200,000 for each year within the preceding two years or $300,000 in combined income with their spouse or someone acting as their spouse. You’re no longer required to be married, so any significant other can contribute.

What about people who want to invest but who don’t earn that much per year? If your net worth with your spouse or spousal equivalent is over $1 million, you are considered an accredited investor.

How does someone prove that they are accredited? There are no forms to fill out or anything like that. They simply need to meet the criteria mentioned above, which can be attested with a letter from their attorney or CPA, as mentioned already. Note that your net worth cannot include your primary home as an asset, and positive equity within a house does not count toward your net worth. However, negative equity in a mortgage does count against you.

Finally, people without a high income or a high net worth can also be considered accredited if they hold the right type of license. For instance, someone who holds a series 7 license can be considered accredited. Entities can also be accredited (businesses and other organizations), but the owners must be accredited for that to occur. Entities with assets exceeding $5 million can also be accredited, provided they were not formed for the offering.


What Does Sophisticated Mean?

A sophisticated investor is not the same as an accredited investor. This is more about having the financial knowledge and experience necessary to invest wisely rather than having a specific amount of income or a particular net worth. Sophisticated investors know what they’re getting into and can evaluate the risks and merits of an investment on their own. Sophisticated investors can also be people who lack that experience and knowledge, but who work with a purchaser representative who has it. This person is not involved with or not a major player in the entity making the offering and provides expert guidance so the other person can invest. All unaccredited investors under 506 B must qualify as sophisticated or work with a sophisticated purchaser representative.

What Is a Pre-Existing Substantive Relationship?

As mentioned, 506 B requires that anyone you admit to the deal have a preexisting, substantive relationship with you. What does that mean, though? Simply put, it means that you and the investor must have known one another before the investment offering. Note that this means you must have known them before starting the offering, not just before allowing the investor into the offering. How well must you know them, though? You don’t need a deep personal history with the individual, but you must know their financial situation. You must have enough knowledge to determine whether they are sophisticated enough for the deal.


Regulation CF

Regulation CF (for crowdfunding) is the new kid on the block, so to speak. It was introduced when the Internet began being used to raise funds, but it differs significantly from others out there. For instance, you can raise up to $5 million online, which is an increase from $1.07 million previously. You can also take on as many unaccredited investors as you like, but they are limited to 5% or 10% of their net worth or income to invest in your deal. Your offering must also be sold through a registered crowdfunding portal broker-dealer (FINRA handles approving those portals). You must also deal with restrictions on what you can say about the deal outside of the official crowdfunding portal. Finally, you must submit your offering documents to the SEC, although they do not use them for anything.

The bulk of your marketing must be geared toward getting potential investors to the portal. Once they enter the portal, you can advertise to them, communicate with them, and explain the deal. Only US issuers are allowed, and they must make direct investments. However, crowdfunding vehicles are now allowed that invest in other deals, like a fund of funds. There can also be no SPACs (special-purpose acquisition companies).


Regulation A

For some deals, Regulation A might be the way to go. This is a public offering that somewhat resembles a registered offering. However, it has lesser disclosure documentation and reporting requirements. It lands between private and public offerings and is sometimes called a mini-IPO or a Regulation A+.

Regulation A has two tiers. Tier one is useless and requires you to comply with all 50 states’ laws simultaneously while limiting how much money you can raise (you’re limited to $75 million). It was $50 million previously.

Regulation A has no requirements for accredited or sophisticated investors, either. Anyone and everyone can put their money in if they like. You can also advertise your deal to anyone, anywhere you want.

However, there are some limitations here. For instance, it takes longer to put together your offering than if you were to use Regulation D, and it will require you to complete Form 1A. You’ll also need a securities attorney to draft that for you. Your offering must also be qualified with the SEC, which means you must submit your information to the agency and then act to address any changes they require. Be prepared for a lot of back and forth in this process, too.

Here are a couple of other important limitations to understand:

  • It’s only for US or Canadian issuers.
  • The principal place of business must be in the US or Canada.
  • No SPACs.
  • No funds of funds.
  • No fractional interest in oil and gas.


Who Should Use Reg A?

Regulation A has a lot of benefits but also a lot of drawbacks. So, who’s the best fit for it? This can be a good route if you need a lot of capital. It’s also a good option for anyone with a major social media following or those who are great at online marketing.

If you choose to go this route, you will need to build a bigger team than what is required with Reg D. You’ll need a securities attorney, as mentioned. You’ll need a broker-dealer to handle problem states like Florida. You need someone capable of handling multiple low-value investments and communicating with all those investors. A compliance service will be necessary, as will an offering platform, and a securities escrow.

You’re looking at assembling a large team and incurring substantial costs for their help, as well as for the accounts you’ll need. However, they’re critical to hold your investor money until you raise enough to “break impounds” and meet the threshold to start operating the business you’re funding.

In Conclusion

You have many options when it comes to structuring your deal. The choice of the pathway (Reg D, Reg A, Reg CF, etc.) is particularly important. It will affect everything from how wide a net you can cast to the size of the internal team you must build and even how and when you can advertise your deal. Take the time necessary to make an informed decision here and understand that there is no one-size-fits-all solution.

Are you interested in learning more about the regulations for Crowdfunding? If so, click the Contact button at the top of our page to reach out to one of our leading Crowdfunding Attorneys and schedule a free consultation. Our attorneys are experienced in Regulations D, CF, A, and S and can help you understand the legal requirements for launching a successful crowdfunding campaign. Act now to ensure you’re compliant and secure the best outcome for your venture. Contact us to schedule your free consultation!

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