Why the Reg D Accredited Investor is Preferable for Private Placement Offerings

Why the Reg D Accredited Investor is Preferable for Private Placement Offerings

Regulation D Rule 506(b) under federal securities law is commonly used to conduct private placements in a lawful manner. Companies often use these offerings because no limit is imposed on the number of accredited investors who can participate; in addition, no duty is imposed upon issuers to provide specific information to a Reg D accredited investor. Finally, issuers are not bound by state registration requirements.

The Costs of Including Non-Accredited Investors
If one proceeds with a Rule 506(b) offering, non-accredited investors may be included, but only in conjunction with meeting some expensive requirements. As many as 35 non-accredited investors may be included, but disclosure document requirements are extensive, similar in complexity for the requirements of a public offering registered with the SEC.

The extra requirements involved rarely make the potential capital raised through non-accredited investors feasible in terms of the expense involved. The legal and accounting costs of complying under Rule 502(b)(2) can reach into the tens of thousands of dollars easily. tes

An additional condition is imposed for each non-accredited investor under Rule 506(b), and that is that each one of these investors (either alone or with a purchaser representative) must have adequate experience and knowledge in business and financial matters to properly evaluate the risks and merits of the potential investment.Under a Rule 506(b) offering, issuers must be able to demonstrate that they had a substantive prior relationship with the investor prior to their knowledge of the investment opportunity. In determining whether or not a substantive relationship exists, one would consider the duration of the relationship and the extent of familiarity between the parties. Purchaser representatives are often used in this case to represent entire classes of non-accredited investors to ensure the sophistication requirements are fulfilled. This is yet another potential cost of going the non-accredited investor route.

Also, issuers who include non-accredited investors and their offerings are limited in their ability to modify the offering exemption.

These all make it more desirable to do a 506 (c) offering under which companies are required to sell only to accredited investors.

Practice Considerations for Choosing Accredited Investors
The significance of a $20,000-$30,000 investment by a non-accredited investor can mean that the investor may demand more information about the investment status, be critical of any underperformance, and even potentially take legal action if the investment loses value or the company fails. These potential risks are less likely when using the Reg D accredited investor exemption. This is because accredited investors are by definition better prepared to absorb the failure of an investment. In other words, they have the financial capacity to make an investment and suffer a failure of that investment without excessive personal financial difficulty.

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