Securities Offerings: Raising Capital the Right Way

What counts as a security?

More things are securities than most people expect. Under the Howey test, an investment contract is a security when a person invests money in a common enterprise expecting profits from the efforts of others. That covers stock, LLC and partnership interests sold to passive investors, many promissory notes, and most real estate syndication interests. Calling an arrangement a loan, a joint venture, or a profit share does not change the analysis, and the anti-fraud rules apply to every securities sale, whether or not it is exempt from registration.

Which exemption should I use?

Selling securities requires registration with the SEC or an exemption. Most small and mid-sized raises use one of these:

Rule 506 is the default for real estate sponsors and fund managers because there is no dollar cap and state securities laws are largely preempted for the offering itself. Confirm current limits with your attorney before relying on any figure above.

506(b) vs 506(c): which one fits?

Choose 506(b) when you raise from people you already have a substantive relationship with and do not need to advertise. It is simpler: investors can self-certify as accredited. If you take any non-accredited investors, you must give them detailed disclosure similar to a registered offering, which is why most sponsors stick to accredited investors only.

Choose 506(c) when you want to market publicly through social media, podcasts, webinars, or a website. The trade-off is that you must take reasonable steps to verify each investor's accredited status, typically by reviewing tax returns, bank and brokerage statements, or getting a letter from a CPA, attorney, or registered adviser. Self-certification is not enough.

Who is an accredited investor?

An individual generally qualifies by meeting any one of these:

• Income over $200,000 in each of the last two years ($300,000 with a spouse or partner), with an expectation of the same this year.
• Net worth over $1 million, not counting the primary residence.
• Holding a Series 7, Series 65, or Series 82 license in good standing.

Certain entities also qualify, including many trusts, LLCs, and corporations with over $5 million in assets, and entities whose owners are all accredited.

What documents does an offering need?

• Private placement memorandum (PPM) with risk factors, use of proceeds, sponsor background, fees, and conflicts.
• Subscription agreement and investor questionnaire to document each investor's status and suitability.
• Operating or partnership agreement for the issuing entity.
• Bad actor questionnaires for the issuer, its officers, managers, and 20% owners, and anyone paid to solicit investors.
• Investor verification materials for 506(c) offerings.

What filings are required?

Federally, file Form D electronically with the SEC within 15 days after the first sale. Form D filing is not technically a condition of Rule 506, but failing to file can lead to SEC enforcement under Rule 507 and creates state problems. At the state level, Rule 506 offerings are generally treated as covered securities, but each state where you sell can still require a notice filing and fee. For sales to Texas residents, that notice goes to the Texas State Securities Board, and many states accept Form D filings through NASAA's electronic filing system. Your attorney tracks the dates and states for you.

Real estate syndications

When several investors put money into one property managed by a sponsor, the interests are almost always securities. Syndicators typically use an LLC or limited partnership to own the property, raise capital under Rule 506(b) or 506(c), and set up a waterfall that pays investors a preferred return before the sponsor's promote. Property-level documents matter too: see real estate legal services for contracts, entities, and closings, and fund formation if you plan to raise across multiple deals.

Common mistakes

• General solicitation in a 506(b) offering. Posting the deal publicly can destroy the exemption.
• Not verifying accredited status in a 506(c) offering. A checkbox is not verification.
• Paying unregistered finders. Transaction-based compensation to someone who is not a registered broker-dealer can give investors rescission rights.
• Optimistic projections with no basis. Anti-fraud liability attaches to misleading statements even in exempt offerings.
• Missing Form D or state notice deadlines.
• Skipping the bad actor check.

Frequently asked questions

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