Rule 504: All You Need to Know

October 06, 2020October 06, 2020
Rule 504: All You Need to Know

There are many options when it comes to raising capital for businesses. If your needs are not too great, a simple plea from friends and family for cash in exchange for equity will help you get enough together to get started. However, unless your relatives are particularly generous, you likely won’t have a long runway with this option. 

Alternatively, you can bring on new partners or investors for a piece of the company pie. This option allows you to raise more funds, but for a greater stake in your company, and often much less autonomy for the founding members.

Other options include taking out loans (which you won’t easily qualify for if you’re a small, young business with a short financial history), issuing SAFE and convertible notes, or going for Series A funding. These are all a bit more complex and a bit riskier than the first options, but are important to take into consideration. 

If you are looking to sell off equity in exchange for funding or to bring on new partners, you would be well-advised to hire a small business attorney to help you with the paperwork. These contracts can get complex and you don’t want to risk an oversight that might cost you down the road. BizCounsel can help you find the best business lawyer to fit your budget, and it only takes two minutes to see if you qualify!

Almost all of these capital-raising options we’ve mentioned involve securities and are therefore regulated by the U.S. Securities and Exchange Commission (SEC). Securities are any financial instrument that hold values, like stocks, bonds, or options. Each securities offer or sale must be registered with the SEC to be in compliance with the Securities Act of 1933 federally, and with individual “blue-sky laws” at the state levels. That is, unless it meets an exception, one of which is Rule 504.

What is Rule 504?

Normally, when a company wants to trade securities, they have to follow a strict set of registration guidelines. These regulations came about after the Stock Market Crash of 1929 and the government stepped in to ensure that companies were being honest to their potential stockholders. The Securities Act requires a company to file documents stating information about the company itself, the securities on offer, and the actual offering. 

However, there are several federal exemptions to this filing that were later added.

The SEC’s Regulation D includes the most common forms of exceptions to the federal registration requirement. Reg D specifies certain safe harbors and exemptions in Rules 504, 505, 506(b) and 506(c).  

Rule 504 allows companies to raise up to $5 million in a 12-month period without registering. 

Until 2016, it was only up to $1 million per year, but the new update to the law has now increased the limit significantly. However, companies are still required to file a notice with the SEC when offering a sale of securities under Rule 504. 

There are certain companies that are not allowed to avail of Rule 504:

  • Exchange Act reporting companies
  • Investment companies
  • Companies without a specified business plan or those who have stated their intent to be merged or acquired by another business
  • Companies that are deemed “bad actors” and disqualified from Rule 504

As a general rule, companies seeking to rely on Rule 504 are not allowed to engage in public solicitation to get investors. 

This means you can’t advertise openly to get more investors, therefore it generally limits the people who can engage in securities exchange under Rule 504 to people already in the company’s circle.

Even if a company takes advantage of the Rule 504 exemption from filing, it is still obligated to provide its investors with adequate information about the company and offering. 

Otherwise, they may run the risk of violating certain antifraud provisions in the securities laws. So, a company cannot mislead its investors by providing them with false information or unfounded claims. 

Withholding important information qualifies as misleading by omission, so it’s important to lay out all your cards on the table when talking to investors. 

Does Rule 504 Vary From State to State?

Since the SEC is a federal institution, its regulations apply across the nation, including Rule 504. 

However, this doesn’t mean that state laws can simply be ignored. Each state has its own laws, such as the previously mentioned blue-sky laws, which regulate securities exchanges within each state. If you want to avail of Rule 504 federally, you may still be required to file a registration with the state or states you are trading in. Otherwise, you will need to find a blue-sky exemption for each state.

Different states have different exemptions, so you need to know the laws as they pertain to each state your offering is available in. Registrations can be very pricey, which can be a significant factor for a company already trying to make ends meet through raising capital, especially if you need to register in multiple states.

As these blue-sky exemptions need to be evaluated on a state-by-state basis, it is highly advisable that you involve a legal expert in securities to help you with this process. With each additional state you involve, there is more complexity added to the process. A business lawyer will be able to provide you with guidance in this and other areas as your company grows.


Raising capital for a budding company is hard work, and government regulations simply add yet another hurdle to the process. 

To ease this burden on smaller companies who only need up to $5 million in securities exchanges per year, the SEC has allowed for the Rule 504 exemption to registration. This saves smaller companies from the arduous task of filing federally. 

However, while you may fall under the federal exemption for registering, you may still be required to file in all the states where you are offering or selling your securities. It can become very complex to sort out the various blue-sky laws and their exemptions when dealing with multiple states. 

For this reason, it is especially important to work with a lawyer who has experience in securities exchanges. Mistakes can be costly, and figuring out how to navigate this complicated system on your own is going to leave you open to the risk of fines down the road. 

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