Rule 504 Offering

For small businesses and startups looking to raise capital, navigating the complex landscape of securities law is a critical step. One important avenue is Rule 504 of Regulation D. Often referred to as the “Seed Capital Exemption,” this rule allows smaller companies to engage in the limited offering and sale of their securities without the need to register these transactions under federal securities laws. What follows is a summary look at Rule 504, highlighting its provisions, opportunities, and compliance considerations.

Rule 504 permits eligible companies to raise up to $10 million in any 12-month period in a non-public offering. While many startups and other companies looking to fundraise are eligible, it is important to note that Exchange Act reporting companies, investment companies, companies without a specific business plan, and blank check companies are not eligible to offer securities under the Rule. 

One of the main attractions of this exemption is its relative flexibility compared to other exemptions under Regulation D. For instance, unlike Rule 506(b) or Rule 506(c), which have more stringent investor requirements, Rule 504 allows offerings to be sold to an unlimited number of investors, including non-accredited investors. But, similar to the Rule 506 exemptions, there are no individual investment limits pursuant to Rule 504 as well. Issuers of 504 offerings also do not have to conduct verification of investors, e.g., as to their “accredited” status.

What many prospective issuers view as the main drawback of conducting a 504 offering is that, unlike those under Rule 506, Rule 504 offerings are not exempt from compliance with state securities laws (also known as “blue sky” laws). For many issuers, this presents a challenge that ends up steering the offering towards Rule 506 or another exemption. Furthermore, there are additional hurdles (in the form of exception requirements to meet) to clear if the offering is to be marketed broadly (i.e., via advertising or general solicitation), versus Rule 506(c) which poses no such hurdles. 

Issuers using Rule 504 must also be mindful of anti-fraud provisions under federal securities laws, which require all information provided to investors to be free of false or misleading statements. Ensuring compliance with these provisions requires careful planning and thorough documentation, and prospective issuers are encouraged to seek the advice of competent legal counsel on these matters.