A subscription agreement is an investor’s request to become a member of a limited partnership (LP). It also serves as a two-way warranty between a corporation and a new shareholder (subscriber). The company intends to sell a specific number of shares at a fixed price in exchange for the subscriber’s promise to buy the shares at the same price.

How Subscription Agreements Are Regulated

Subscription agreements are generally covered by SEC Rules 506(b) and 506(c) of Regulation D. These stipulations define the method of conducting an offering and the amount of material information that companies are required to disclose to investors.

When new limited partners are added to an offering, general partners seek the approval of existing partners before making changes to the subscription agreement. Raising capital through a Reg D investment entails far fewer stringent requirements than a public offering. This allows companies to save time and sell securities that they would not be able to issue otherwise in some cases.

Subscription Agreements With Private Placements

When a company wishes to raise capital, it will often issue shares of stock for purchase by either the general public or through a private placement. The primary disclosure form for potential general public investors is a prospectus. The prospectus is a disclosure document listing information about the business and its underlying security.

A private placement is a sale of stock to a limited number of accredited investors who meet specific criteria. The criteria for accredited status include having a particular level of investment experience, assets, and net worth. Investors will receive a private placement memorandum as an alternative to the prospectus. The memorandum provides a less comprehensive description of the investment.

In many cases, a subscription agreement accompanies the memorandum. Some agreements outline a specific rate of return that will be paid to the investor, such as a particular percentage of company net income or lump sum payments.

Also, the agreement will define the payment dates for these returns. This structure gives priority to the investor, as they earn a rate of return on the investment before company founders or other minority owners.

KEY TAKEAWAYS

• A subscription agreement is an agreement that defines the terms for a party’s investment into a private placement offering or a limited partnership (LP).
• Rules for subscription agreements are generally defined in SEC Rule 506(b) and 506(c) of Regulation D.
• Regulation D lets companies doing specific types of private placements raise capital without needing to register the securities with the SEC.