What Is a Subscription Agreement?
A subscription agreement is an investor’s formal request to join a limited partnership (LP) or invest in a private placement. It serves as a bilateral agreement between a company and a new shareholder (subscriber). The company commits to selling a predetermined number of shares at a set price, and the subscriber agrees to purchase the shares at that price.
Key Takeaways
- A subscription agreement defines the terms for a party’s investment into a private placement offering or a limited partnership (LP).
- The SEC’s Rule 506(b) and 506(c) of Regulation D typically frame subscription agreements.
- Regulation D allows companies to raise capital via specific private placements without registering the securities with the SEC.
Understanding Subscription Agreements
Broadly, a partnership is a business agreement between two or more individuals who collectively own the business. This entity does not pay taxes independently; instead, profits and losses are distributed to each partner, who then pays taxes according to their share. Common examples include law firms and accounting firms formed as general partnerships.
In a limited partnership (LP), a general partner manages the partnership and recruits limited partners through a subscription agreement. Potential limited partners apply, and after meeting certain qualifications, the general partner may approve their inclusion.
Limited partners usually provide capital through a one-time investment and have no active role in daily operations, substantially reducing their risk compared to full partners. Their liability is limited to the amount of their initial investment, as specified in the subscription agreement.
The subscription agreement outlines the investment experience, sophistication, and net worth of the potential limited partner.
How Subscription Agreements Are Regulated
Subscription agreements often fall under SEC Rules 506(b) and 506(c) of Regulation D. These rules stipulate how offerings should be conducted and outline the required level of material disclosures to investors.
As new limited partners join, the general partner secures the existing partners’ consent before amending the subscription agreement. Raising capital through Regulation D entails fewer regulatory hurdles than a public offering, enabling companies to save time and issue securities they might otherwise find challenging to offer.
Subscription Agreements With Private Placements
When raising capital, companies may issue shares for purchase by the public or via a private placement. For public investors, the primary disclosure document is a prospectus, detailing the business and its securities.
A private placement, however, involves selling stock to a limited group of accredited investors who fulfill specific investment experience, asset, and net worth criteria. These investors receive a private placement memorandum instead of a prospectus—a less exhaustive investment description.
Usually, a subscription agreement accompanies this memorandum. Some agreements stipulate a specific rate of return, either as a percentage of the company’s net income or lump-sum payments. They also set payment dates, often giving priority to the investor to earn returns before company founders or minority owners.
Related Terms: Limited Partnership, Private Placement, Prospectus, Accredited Investor.
References
- U.S. Securities and Exchange Commission. “Private Placements - Rule 506(b)”.
- U.S. Securities and Exchange Commission. “General Solicitation — Rule 506(c)”.
- Internal Revenue Service. “Tax Information For Partnerships”.
- U.S. Securities and Exchange Commission. "‘Accredited Investor’ Net Worth Standard".
