Raising capital through a private offering, rather than an Initial Public Offering (IPO), offers certain advantages, including lower visibility and reduced regulatory burdens. However, private offerings are still subject to strict legal requirements and carry meaningful risks.

Failure to comply with all applicable restrictions can result in the loss of the private offering exemption, exposing the issuer to significant regulatory and liability consequences.

Regulatory Framework for Private Offerings

The primary exemption from the IPO registration requirement is governed by Regulation D under the Securities Act of 1933. To maintain this exemption, issuers must strictly comply with the following requirements.

Key Requirements Under Regulation D

• Securities may be offered only to accredited investors
• Up to 35 non-accredited but sophisticated investors may participate, provided enhanced disclosures are made
• The issuer must take reasonable steps to verify accredited investor status
• All information provided to investors must be truthful, complete, and not misleading; federal anti-fraud rules apply
• A private placement memorandum (PPM) is typically used instead of a prospectus
• Securities are generally subject to transfer restrictions, often lasting six to twelve months

Common Risks Associated With Private Offerings

Despite their advantages, private offerings involve several risks that issuers must carefully manage.

Risk of Losing the Exemption

• Failure to comply with any Regulation D requirement—including general solicitation rules, investor qualification standards, or disclosure obligations—can invalidate the exemption
• Loss of the exemption may require rescission of the offering and repayment to investors

Investor Rights and Liability Exposure

• Investors may gain the right to demand their investment back if disclosures were misleading or omitted material information
• Both federal and state regulators may limit or prohibit future capital-raising efforts
• Private investors are often more willing than public shareholders to pursue direct legal action

Governance and Control Risks

• Investors with veto rights can exert substantial influence over company operations
• Sophisticated investors frequently demand enhanced protections and oversight
• Board seats and preferred rights are commonly required as a condition of investment

Risks Posed by Sophisticated and Accredited Investors

Accredited investors, particularly when dealing with inexperienced issuers, may leverage their position to secure favorable terms.

Common issues include:

• Company undervaluation or acceptance of unfavorable deal terms
• Early credit or liquidation preferences that deter future investors
• Expectations of ongoing financial reporting beyond legal requirements
• Reputational damage from a poorly structured or unsuccessful offering
• Demands for preferred equity, control provisions, or board representation

The Importance of Professional Guidance

Choosing between a private offering and an IPO requires a comprehensive understanding of the regulatory requirements, costs, risks, and long-term operational consequences of each approach.

The attorneys at Corporate Securities Legal, LLP have extensive experience advising business owners and companies seeking to raise capital and ultimately go public. Our team helps clients:

• Evaluate private offering versus IPO strategies
• Structure offerings to maintain regulatory exemptions
• Minimize liability exposure
• Protect long-term control over company operations

Careful planning and experienced legal guidance can help ensure that a private offering delivers the intended benefits without jeopardizing the company’s future. We invite you to contact our attorneys to discuss your goals and develop a strategy tailored to your business.

How is the definition of an accredited investor being expanded?

The proposed rule will amend the definition of an “accredited investor” as follows:

With regard to individuals, the proposed rule would add the term “spousal equivalent” to the definition of a spouse, and give accredited investor status to individuals:

• that have certain professional certifications or designations or other credentials; or
• whose status as a private fund’s “knowledgeable employee.”

With regard to entities, the proposed rule would expand the list of entities, including, but not limited to:

• entities that meet an investments test; and
• family offices with at least $5,000,000 in assets under management and their family clients.

Background

Under the U.S. federal securities laws, a company that offers or sells its securities must register the securities with the Securities and Exchange Commission (“SEC”) or qualify for an exemption from registration.[1] Regulation A+ and crowdfunding provide an exemption from registration that allow the company to raise capital to with unaccredited investors, however, the process for preparing these offering documents can oftentimes be just as burdensome on the company as registering the securities. Rule 506 of Regulation D provides additional exemptions from registration; for these exemptions, we recommend only raising capital from accredited investors. If the SEC is successful in broadening the scope of who is considered to be an accredited investor, more investors will hold accredited investor status, making it easier for private companies trying to raise capital using Rule 506.

What is an accredited investor?

Rule 501 of Regulation D of the Securities Act of 1933 (the “Securities Act”) defines an accredited investor. In summary, an accredited investor is: an individual that has a net worth of $1,000,000, excluding their primary residence; or an individual that has an annual income of $200,000 or more (or $300,000 combines with their spouse) for two years and has a reasonable expectation of meeting those income requirements in the upcoming year. Additionally, Rule 501 defines specific types of entities; and directors, executive officers, or general partners of the issuing company as being accredited.

Public Policy

The SEC depicts the “accredited investor” definition as a central component of Regulation D, stating that it is “intended to encompass those persons whose financial sophistication and ability to sustain the risk of loss of investment or ability to fend for themselves render the protections of the Securities Act’s registration process unnecessary.”[2] Considering this definition, it’s clear why the SEC would like to expand the definition of an accredited investor to “identify more effectively institutional and individual investors that have the knowledge and expertise to participate in our private capital markets and therefore do not need the additional protections of the registration under the Securities Act.”[3]

Wilson Bradshaw LLP is a boutique securities law firm in Irvine, California and New York City. We help businesses solicit investors for both public and private companies in a compliant manner. We restrict our practice to securities law, focusing on private and public offerings and SEC enforcement work.

[1] U.S. Securities and Exchange Commission, Accredited Investor, Fast Answers (Nov. 27, 2017), https://www.sec.gov/fast-answers/answers-accredhtm.html.

[2] U.S. Securities and Exchange Commission, Report on the Review of the Definition of “Accredited Investor”, Files (Dec. 18, 2015), https://www.sec.gov/files/review-definition-of-accredited-investor-12-18-2015.pdf.

[3] U.S. Securities and Exchange Commission, 17CFR Parts 230 and 240, Release Nos. 33-10734; 34-87784; File No. S7-25-169, Amending the “Accredited Investor” Definition (Dec. 18, 2019), https://www.sec.gov/files/review-definition-of-accredited-investor-12-18-2015.pdf.

General Solicitation is the act of marketing a capital raise publicly. Rule 506(b) of Regulation D prohibits the use of general solicitation to market securities. (link: https://www.sec.gov/fast-answers/answers-rule506htm.html)

Additionally, Rule 502(c) prohibits:

(1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television and radio; and

(2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.

See: https://www.equitynet.com/crowdfunding-terminology/general-solicitation

The Securities and Exchange Commission (SEC) takes a case-by-case approach when determining whether a company is engaging in general solicitation.

Prohibited communications tend to bebroad-based; they are not targeted to a specific audience. A typical example of general solicitation is telling potential investors in a newspaper the terms of an offering and inviting them to purchase securities.

A pre-existing relationship between the issuer and a potential investor is strong evidence that general solicitation has not taken place. A relationship is pre-existing if the it was formed before a securities offering commences, or if it was established through a registered broker-dealer or investment adviser before the registered broker dealer or investment adviser participated in the offering.

A pre-existing relationshipmay arise in business, social settings, or any other context. The general rule is that the pre-existing relationship must be of some duration and substance. The SEC defines a substantive relationship as “[a relationship] in which the issuer (or person acting on its behalf) has sufficient information to evaluate, and does, in fact evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.”

The relationship must be established from actual effort to get to know the person, rather than “just checking some box” or waiting a set amount of time.

See: https://www.wealthforge.com/insights/what-constitutes-a-pre-existing-substantive-relationship-in-a-506b-offering

The SEC has stated in past no-action letters that a third-party broker-dealer may establish a pre-existing relationship with a potential investor by sending the potential investor a generic form that providesenough information for an issuer’sevaluation of the potential investor’s financial circumstances. The generic form may not reference the offering the issuer is undertaking.

See: http://www.wnj.com/files/Publication/a941cb2d-f6db-40da-9cb0-85b44f514c70/Presentation/PublicationAttachment/ba8ac6ec-6388-4a90-b2fa cb6b5b30328d/FAQ_Regarding_the_Private_Placement_of_Securities_under_Regulation_D_Rule_506.pdf

If you are unsure of whether your company is following Regulation D or engaging in general solicitation, call Wilson, Bradshaw & Cao, LLP today to speak with an experienced securities lawyer.

See: https://www.nyventurehub.com/2015/09/09/new-sec-guidance-on-what-constitutes-general-solicitation/

Rule 502(c) prohibits:

(1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television and radio; and

(2) Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.

See: https://www.equitynet.com/crowdfunding-terminology/general-solicitation

A pre-existing relationship between the issuer and a potential investor is strong evidence that general solicitation has not taken place. A relationship is pre-existing if the relationship was formed before a securities offering commences, or when it was established through a registered broker-dealer or investment adviser before the registered broker dealer or investment adviser participated in the offering.

A pre-existing relationshipmay arise in business, social settings, or any other context. The general rule is that the pre-existing relationship must be of some duration and substance. The SEC defines a substantive relationship as “[a relationship] in which the issuer (or person acting on its behalf) has sufficient information to evaluate, and does, in fact evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.”

The relationship must be established from actual effort to get to know the person, rather than“just checking some box” or waiting a set amount of time.

See: https://www.wealthforge.com/insights/what-constitutes-a-pre-existing-substantive-relationship-in-a-506b-offering

The SEC has stated in past no-action letters that a third-party broker-dealer may establish a pre-existing relationship with a potential investor by sending the potential investor a generic form that providesenough information for evaluation of the potential investor’s financial circumstances. The generic form may not reference the offering the issuer is undertaking. See: http://www.wnj.com/files/Publication/a941cb2d-f6db-40da-9cb0-85b44f514c70/Presentation/PublicationAttachment/ba8ac6ec-6388-4a90-b2facb6b5b30328d/FAQ_Regarding_the_Private_Placement_of_Securities_under_Regulation_D_Rule_506.pdf