REG D 504
This rule is considered by many as the perfect answer for the company just starting out that needs to raise less than $1 million but canâ€™t afford to go through the whole SEC registration process. Until they grow to a point where they can afford it, Rule 504 offers such companies an out:
An exemption to raise up to $1 million
No disclosure criteria
Few general solicitation and resale restrictions
No limit as to the number or type of investors
Actually, Congressâ€™s original intent in 1982 for Rule 504 was to set aside a clear and workable exemption for small issuers to be regulated by state blue sky requirements, but by the same token, to be subjected to federal anti-fraud provisions and civil liability provisions. Rule 504 exemption is provided for almost any type of organization, including corporations, partnerships, trusts, or other entities. However, it is not applicable to companies already reporting to the SEC (subject to the "34" Act) or investment companies.
You Cannot Exceed $1 Million
The total offering amount under Rule 504 can be up to $1 million in a 12-month period, less the aggregate offering of all securities sold within 12 months before the start of a 504 offering. So, if a company has raised $100,000 in private money in the previous 12 months, it can still raise up to $900,000 without being accused of breaking the rules, or integration.
Generally speaking, there are no specific disclosure requirements under Rule 504 (disclosing what the company is about, what it intends to do, or who is connected with it). This means that, theoretically, an issuer can have a purchaser sign a subscription agreement and purchase stock without any information about the company being disclosed. However, the rule is dependent on the blue-sky laws of each state in which the securities are offered. This means that if a state's blue-sky rules require disclosure, it must be provided regardless of Rule 504.
Rule 504 also provides that at least $500,000 of securities must be sold pursuant to a registration under a state's securities law. Consequently, an offer must comply with the blue-sky laws of each individual state in which it is offered. In many states, this negates the effective simplicity of Rule 504 and the federal government's intent, because many state's blue-sky laws are more restrictive than Reg D.
A word of caution to the entrepreneur regardless of the amount of disclosure the issuer is willing to provide, Rule 504 does not dismiss the issuer from the federal requirements, nor is there an exemption from the fraud provisions, including the areas of material omissions or misstatements. The penalties for noncompliance are severe, including monetary fines and mandatory jail sentences.
Number of Investors
With its limited disclosure requirements, Rule 504 also allows an issuer to sell securities to an unlimited number of investors. Theoretically, a company could raise $1 million by selling its stock at a penny a share to 100 million different investors. Obviously, the economics are not too attractive, but thereâ€™s no rule that stops an issuer from selling $500 blocks of stock to 2000 investors.
Rule 504 is the only rule under Reg D that permits an unlimited number of investors. A final note on Rule 504 is that the exemption provides for sales of securities of either debt or equity. This opens the door for combinations of both via convertible debentures. By way of explanation, convertible debentures are a debt issue (debenture) that is convertible to a preferred or, most commonly, common stock at some future date, usually at a predetermined price.
There are several other rules and exemptions besides the Reg D exemption discussed above. They are worth looking into and are discussed below under the headings of Regulation A and the Small Corporate Offering Registration (SCOR).
As pointed out in the last section, the principal advantage of an exemption from registration is that the buy-and-sell transactions can take place as soon as the parties decide to proceed. It eliminates the necessity of preparing and filing a prospectus with the SEC, and it saves legal costs, plus accounting and registration fees.
Exemptions under the Securities Act of 1933 (33 Act) are listed as exempted securities and exempted transactions. They can save both time and money. The only drawback is they can take a legal genius to interpret them. Theyâ€™re full of loopholes, and the courts have shown no qualms about ruling against the entrepreneur in their interpretations. Regardless, the end results should make them worth pursuing. But since the whole area of exemptions is so complex, the entrepreneur should not proceed without first seeking the advice of qualified legal counsel to determine the best form of exemption to apply for.