Key Definitions Under Rule 501 of Regulation D

Regulation D under the Securities Act of 1933 provides exemptions that allow companies to raise capital without registering their securities with the U.S. Securities and Exchange Commission (SEC). This framework is useful for startups and other private companies seeking funding. Central to this regulation is Rule 501, which provides the official definitions for terms used throughout Regulation D. These definitions establish the boundaries for who can invest, how offerings are structured, and how compliance is measured, making them important for any company or investor in a private placement.

Defining the Accredited Investor

The primary definition within Rule 501 is that of the “accredited investor.” This classification identifies individuals and entities presumed to have the financial sophistication and capacity to bear the risks of investing in unregistered securities. For issuers, selling to accredited investors simplifies compliance obligations and expands their potential funding pool. The SEC has established several pathways for an individual or entity to qualify for this status.

Financial Thresholds for Individuals

The traditional tests for individuals to qualify as accredited investors are based on financial standing. The first is a net worth test, requiring an individual, alone or jointly with a spouse or spousal equivalent, to have a net worth exceeding $1 million. A key detail in this calculation is the exclusion of the value of the person’s primary residence. While the mortgage reduces net worth, any positive equity in the home cannot be used to meet the $1 million threshold.

The second pathway is an income test. An individual can qualify with an annual income over $200,000 in each of the two most recent years and a reasonable expectation of the same in the current year. For married couples or those with a spousal equivalent, the joint income threshold is $300,000, with the same two-year and current-year requirements.

Professional Criteria for Individuals

The SEC has expanded the accredited investor definition to include individuals with certain professional credentials. Individuals who hold a Series 7, Series 65, or Series 82 license in good standing automatically qualify as accredited investors. This acknowledges that their training and examination confer a level of understanding of securities and markets sufficient for evaluating private investment risks.

Another category is the “knowledgeable employee” of a private fund. An employee who has participated in the investment activities of the fund for at least 12 months, and is not performing solely clerical or administrative duties, is considered an accredited investor for the purpose of investing in that fund.

Qualifying Entities

Rule 501 specifies various types of entities that are automatically deemed accredited investors. These organizations are considered sophisticated by nature due to their role and regulation within the financial industry and include:

• Banks and savings and loan associations
• Registered brokers or dealers
• Insurance companies
• Registered investment companies and business development companies

For other entities, qualification is often based on assets. Corporations, partnerships, LLCs, and certain trusts with total assets exceeding $5 million can qualify, provided they were not formed to acquire the securities being offered. The rules also extend accredited status to “family offices” with at least $5 million in assets under management and their “family clients,” as defined under the Investment Advisers Act of 1940.

Other Key Definitions in Rule 501

Purchaser Representative

A purchaser representative is an individual with sufficient knowledge and experience in financial and business matters to evaluate an investment’s merits and risks. Appointed by a non-accredited investor, the representative helps them make an informed decision. The representative cannot be affiliated with the issuer unless a pre-existing relationship with the purchaser exists, and they must disclose any material relationship with the issuer to the purchaser in writing. This role provides a layer of protection for less sophisticated investors participating in certain offerings.

Calculation of Number of Purchasers

Rule 501 provides a specific method for counting purchasers in a Regulation D offering, which is relevant for exemptions that limit non-accredited investors. The rule excludes certain individuals and entities from this count. Accredited investors are not included, and relatives of a purchaser sharing the same principal residence are counted as a single purchaser, as is a non-contributory employee benefit plan where the trustee makes all investment decisions.

Aggregate Offering Price

The aggregate offering price is the total sum of all consideration the issuer will receive for its securities. This includes cash and the value of services, property, notes, or the cancellation of debt. If securities are offered for both cash and non-cash consideration, the price is based on the cash offering price. For non-cash transactions, the value is determined by recent bona fide sales of that consideration or by its fair value if no sales exist.

Business Combination

A business combination under Rule 501 refers to transactions like a merger, consolidation, or acquisition where one company’s securities are exchanged for another’s. It includes any transaction under Rule 145 of the Securities Act, which governs reclassifications of securities and asset transfers. This definition helps classify corporate reorganizations that involve issuing new securities under Regulation D.

The Role of Rule 501 Definitions in Private Offerings

The distinction between accredited and non-accredited investors is central to offerings under Rule 506(b). This rule permits an issuer to raise an unlimited amount of capital from an unlimited number of accredited investors but restricts the number of non-accredited investors to 35. The “calculation of number of purchasers” definition is applied here. An issuer could sell securities to 100 accredited investors and 35 non-accredited investors and still be in compliance, as the 100 accredited investors are excluded from the official count.

In contrast, offerings under Rule 506(c) rely almost exclusively on the “accredited investor” definition. This rule allows issuers to use general solicitation and advertising to market their offering, which is prohibited under Rule 506(b). The trade-off is that the issuer may only sell securities to accredited investors. Furthermore, the issuer must take reasonable steps to verify their status, creating a higher compliance burden.

The “aggregate offering price” definition is prominent in other exemptions, such as Rule 504. This rule allows for offerings up to $10 million in a 12-month period. The precise calculation of the aggregate offering price is necessary to ensure the issuer does not exceed this ceiling.