Private Placements of Securities: Rule 504, 505, and 506

Private placements offer privately held companies a means of obtaining financing from investors through the sale of stock without the regulatory burdens, delay, and expense of a public offering - and without regard to the prevailing conditions in the public securities market.

U.S. securities laws generally prohibit the offer and sale of securities unless they have been registered under the Securities Act of 1933 and the securities ("blue sky") laws of the states in which they are offered. Nevertheless, these laws permit the offer and sale of securities without registration upon compliance with one of the currently available express exemptions from registration.

Private placement exemptions are among the most commonly used exemptions from registration. They allow a company to raise money privately without publicly soliciting investors. In preparing for a private placement, the company prepares offering materials containing information about the company and the securities being offered. The company then approaches a limited number of investors who satisfy certain suitability standards, so-called accredited investors - without general solicitation or advertising. Last, filings are made with the SEC and with the appropriate state securities commissions.

The company selling the securities does not become a public company by reason of the private placement and does not become subject to the periodic reporting and ongoing disclosure requirements under the securities laws. Resales of the securities sold in a private placement are restricted, and typically no trading market in these shares develops. Shares acquired in such transactions are stamped with a legend stating that such shares have not been registered in a public offering.

Private placements can be structured in various ways, but most are designed to comply with one of the three alternative provisions of Regulation D of the Securities Act of 1933, depending on the amount of financing sought and the type of investors to be solicited.

Rule 504

Rule 504 allows a privately held company to raise up to $1 million within a 12-month period. The securities may be offered to an unlimited number of investors, and no specific type of disclosure material is required to satisfy the exemption. In some instances, Rule 504 offerings may be made through public solicitations and the securities sold are not subject to resale restrictions and investor accreditation standards. While no federal registration is required, state governments also regulate offerings. In Alaska and Montana, for example, companies may raise up to only $500,000 by the sale of securities to investors residing in those states because they have no disclosure laws applicable to the offering. And while a private placement memorandum is not required, it is probably a good idea to create one to minimize legal liability.

Rule 505

Rule 505 allows a company to raise up to $5 million within a 12-month period. Rule 505 may not be used by an investment company or a company that is disqualified due to prior misconduct relating to the securities laws by the company or its officers, directors, principal shareholders, or other affiliates. The securities may be sold to an unlimited number of "accredited investors" and up to 35 nonaccredited investors. Specific types of disclosure must be given to nonaccredited investors, similar to that which is required for Rule 506 offerings, under $7.5 million.

Rule 506

Rule 506 does not limit the dollar amount of the securities that may be sold in a private placement. As with Rule 505, the securities may be sold to an unlimited number of accredited investors. However, each nonaccredited investor must, either alone or with a purchaser representative, have such knowledge and experience in financial and business matters that the investor is capable of evaluating the merits and risks of the prospective imvestment (or the company must believe at the time the securities are sold that each nonaccredited investor satisfies this requirement). Rule 506 requires detailed disclosure of relevant information to potential investors; the extent of disclosure depends on the dollar size of the offering.


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