Regulation D Offerings

The Securities and Exchange Commission has programs that allow private companies the ability to raise capital - without becoming a publicly listed company and without having to complete a full registration with the SEC (a time consuming and expensive task).

"Regulation D" is an exemption under the Securities Act of 1933, instituted in 1982, that allows private companies the ability to raise capital though the sale of securities, typically their common or preferred stock, without being subjected to the expensive and arduous SEC registration process that publicly reporting companies must complete. These Regulation D private stock offerings can be prepared quickly and for minimal cost making them very attractive to growing private companies that need investor capital but are not ready for a full IPO.

The Regulation D programs are typically called "Direct Public Offerings" because the stock being sold, while privately held, is being offered "directly" to the public by the subject company. The DPO programs were designed for small business and are therefore less complex than a fully registered Initial Public Offering but retain the same core benefits of an IPO. Most companies that use the DPO programs typically issue (or sell) between 10-30% of the company's share capital - depending on whether it is a first round funding or later stage funding and the amount of capital being raised through the offering. The company principals retain control over the majority of the issued shares and thus retain control over the company. Investors receive a return based on the performance of the company and the amount of shares they own.

Most companies use the programs to raise from $50,000 to $10,000,000 in investor capital. Regulation D Offerings have proven to be successful for a wide variety of transaction and industry types: corporate seed capital, corporate expansion capital, film production capital, real estate equity funding (acquisitions, development projects, golf courses, rehab), capitalization for early to pre-IPO stage Internet and technology companies, expansion funding for retail companies, and product development and distribution funding.

There are three primary SEC Regulation D exempt programs; the Regulation D 504 Offering, Regulation D 506 Offering, and the Small Corporate Offering Registration ("SCOR") Offering. Determining which program best suits your company is based primarily on transaction size:
Regulation D 504 Offering: allows companies to raise up to a maximum of $1,000,000 in a 12 month period. The 504 is the least restrictive of the Regulation D programs regarding structure and disclosure. The 504 is the most popular and widely used of the Regulation D programs.
Regulation D 506 Offering: allows companies to raise capital through the sale of securities with no principal amount cap per 12 months. The 506 program provides an exemption for limited offers and sales of securities without regard to the dollar amount of the offering. Most companies use the 506 program to raise amounts from $1,000,000 up to $10,000,000.
Small Corporate Offering Registration ("SCOR") Offering: The SCOR is a more sophisticated version of the 504 offering. The SCOR offering provides a standardized disclosure format that is accepted by 43 States and allows increased freedom of solicitation and advertising over the standard Regulation D 504 exempt program. The standardized disclosure format (the U-7 form) also allows the company to comply with a large number of individual States securities laws utilizing one regional review instead of presenting the company's offering materials to each individual State regulator for review. The SCOR does require audited financial statements for the past 2 fiscal years for offerings exceeding $500,000 and has a maximum 12 month cap of $1,000,000.

A Regulation D Offering provides for fractional investments much more successfully and efficiently than utilizing only a business plan. A business plan alone cannot provide the basic fundamental necessity needed for raising capital from investors effectively - the framework necessary to offer and receive fractional investments. Business plans typically confine businesses and entrepreneurs to locating one or two wealthy individuals with the capability of investing a substantial amount of capital. These investors are hard to access and, since they are taking the majority if the risk, typically demand a large amount of ownership and control for their investment. A Regulation D Offering provides the legal framework and structure that allows individual investors to participate in the investment opportunity on a fractional basis.

In addition to being able to effectively raise capital from individual investors, a Regulation D Offering enables the company to utilize a vast and effective network of sophisticated and regulated funding resources unavailable to companies that just have a business plan - brokerage firms, fund managers, and individual stockbrokers. These are the most efficient and effective resources for raising equity capital - they are the same resources a public company uses to raise equity capital. When you consider that a single stockbroker typically has access to dozens if not hundreds of investors - it is easy to see why Regulation D Offerings provide a company with an inexhaustible resource for raising investor capital.

Most businesses and entrepreneurs make the mistake of presenting their opportunity to one individual investor at a time. This is highly inefficient, and when combined with the limitations of raising capital via a business plan only format, is also highly ineffective. A single stockbroker typically represents dozens of investors interested in early stage opportunities - thus a Regulation D Offering provides access to the largest, most effective source of private equity capital - securities brokers and the individual investors they represent.

Most entrepreneurs and businesses don't have the ability to identify quality investor prospects. By structuring a Regulation D Offering, the entrepreneur or business can easily research and contact stockbrokers, fund managers, and brokerages about their offering.

The company sets the terms and conditions of the Regulation D Offering and the investment to the prospective investors. In a situation that involves a venture capital group or single, wealthy investor, the situation is typically reversed. A company that has a Regulation D Offering in place is seen as more capable and serious to investors.
Additional rounds of capital investment can be structured more efficiently.

The detailed disclosures in a Regulation D Offering memorandum limit the liability of company principals. Many smaller companies waste time seeking capital through venture capital groups. Most venture capital firms are interested in capital investments exceeding $5,000,000 and companies in ultra high growth industries capable of producing very high annual returns. Many small companies seeking funding in the market do not match these criteria. A Regulation D Offering allows smaller companies the ability to leverage the smaller amounts of equity capital they need.

Companies utilizing only business plans to raise capital ultimately end up paying "finance brokers" large retainer fees to promote their business plans to investors. These finance brokers have extremely low success rates due to the same fundamental problem outlined above - business plans are not effective vehicles for private capital formation. A Regulation D Offering allows an emerging company to effectively target the best source of private
equity funding available for their company - the individual private investor.

The process for preparing and completing a Regulation D Offering is fairly straightforward.
Step One: Corporate Pre-Offering Preparation: Many early stage or new companies have corporate structures that incorporate a minimum amount of available share capital. Many companies opt for 1000-2500 total shares to keep their corporate structure simple.

Step Two: Private Placement Offering Memorandum Preparation: When selling your company's stock you will use an offering disclosure document to inform investors about the pertinent details about the company and the stock offering. This document is the disclosure document, or as popularly known the "offering memorandum". While the 504 program has no prescribed disclosure requirements, it is always recommended that you utilize an offering memorandum to assure proper disclosure of all pertinent corporate details. This disclosure document also protects the company and company principals because it informs investors of all the needed disclosure items before they invest.

Some typical disclosures include information about: the company's business, company management, market for the company's product or services, use of invested proceeds, stock offering details (share restrictions, voting rights, etc.), details about shares held by management, details about risks investors may face (lack of operating history, product development risks, reliance on a single distributor, etc), recent significant transactions, and other disclosures related to the company's overall condition.

The company's offering memorandum will include a Subscription Agreement which is the "stock sales contract" between the investor and the company. This Subscription Agreement comes included with an Investor Suitability Questionnaire which helps the company determine an investors suitability for investing in the offering.

Step Three: Filing the Federal Form D Compliance Document: The Form D Compliance document is the only filing information that is required by the Securities and Exchange Commission in Washington, DC. This 8 page document details information about the offering, the company, use of proceeds, and the principals of the company. This is an "informational only" document and is not subject to a review or approval by the SEC.

Step Four: Selling Your Stock to Investors: Your company is now ready to sell its stock to investors via the Regulation D process. The resources for marketing and selling the stock are NASD securities brokers (stockbrokers), brokerage firms, and fund managers. You have also provided your company with the invaluable capability of allowing individual investors to share in your opportunity on a fractional basis.

Step Five: On-going Offering Compliance: When selling your company's stock to investors, there are certain States that require information about the offering before you can sell to investors in that State. This information is presented to these States in the form of informational filings, most similar to the Form D, and are commonly called "Blue Sky" filings.

This is the route that most businesses and entrepreneurs take when seeking capital for their company. What are the disadvantages to using a business plan as a funding vehicle?

• Business plans are excellent at presenting the company information and their concept - they are notoriously ineffective at raising capital.
  
• Business plans do not provide any type of framework or mechanism to facilitate the investment of capital. Investors want to be provided with a pre-determined, efficient, and concise investment framework.
  
• By marketing a business plan, you do not have access to sophisticated funding resources. Stockbrokers and brokerages will not work with you because you have not structured an SEC offering.
  
• The resources a company is then forced to utilize are infamous for being highly ineffective. These include "finance brokers", "finance finders", "finance consultants", etc. and most are looking for one thing in common - a large front fee of some sort. Most call it an "underwriting fee" or a "retainer" - it is guaranteed wasted money, and worse, wasted time for the subject company.
  
• It is not unusual for companies to look towards other "alternative" funding methods like collateralizing the transaction with an "insurance bond" or "financial guarantee". These methods do not work and typically have one thing in common - a front fee of some sort before you can have access to this collateral instrument - which doesn't usually exist in the first place.
  
• Even well established, sophisticated companies make the mistake of using a business plan to solicit funding.

Regulation D Offerings have been shown to be the most effective method a private company can utilize to raise investor capital. The resources that are then available to the company are all highly regulated by the SEC and are easily identified. Best of all - they are effective. A Regulation D Offering also provides the framework for allowing individual investors to invest in the company easily and efficiently. A Regulation D Offering is a critical addition to a corporate business plan.

Many companies in the process of raising capital typically make the mistake of seeking "venture capital" firms to invest in their company and concept. What are some of the problems with venture capital funding?

• Most VC's typically want a controlling interest in the subject company - and most companies are unwilling to give up control of their company and the direction of their corporate concept to outsiders.
  
• VC's typically look for companies in ultra-high growth industries - this excludes many companies that would provide a very good investment vehicle for the individual investor but are in industries that are not deemed "high growth" by the VC community.
  
• VC's typically like to invest 2nd or 3rd round - which leaves the seed capital company stranded.
  
• VC's, due to the fact that they have an inordinate amount of capital at risk, are notorious for interfering in the day to day management practices of the company and are often at odds with the original founders and managers of the company.
  
• VC's want to maximize their return in a minimum period of time - this concept, and the corporate changes needed to effectuate this mission, is often at odds with the original corporate vision of the company.

Regulation D Offerings allow the company to control the investment transaction, determine how much of the company to sell, and by spreading the invested amount over a number of investors, minimizes investor intrusions into management. A typical first round funding Regulation D Offering involves the sale of only 20-25% of the subject company's stock ownership vs 51-60% for a first round funding under a venture capital type structure.

Many companies hope to find one wealthy individual (a difficult task at best) that has the financial wherewithal to capitalize their corporate business plan. This scenario is very similar to Venture Capital Groups - thus refer to the list above - the pitfalls are similar.

A Regulation D Offering makes it easy to identify and contact funding resources since broker-dealers and stockbrokers are now an available resource. Also, the framework and structure of an offering makes it easy to sell shares to individual investors without the aid of a stockbroker. Finding one individual wealthy investor with enough disposable capital to complete a corporate funding is also very difficult.

The Internet has definitely changed the landscape of business - however the use of the Internet to promote company business plans seeking capital is not as successful as most individuals would imagine.

• A very high percentage of the "investors" that typically review an online business plan are finance consultants that will offer nothing but wasted time and money to the company in question. There are actually very few real investors seeking investment opportunities on these Internet sites.
  
• Even if you are successful in locating an investor through one of these services - you will be in the "Single Wealthy Investor" scenario as detailed above.
  
• Most of these websites require the payment of a fee. Even after paying the fee, you are still left with a business plan that is in no way an effective vehicle for raising capital.

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