However, in practice the Section 4(a)(2) exemption is often not strong enough protection (since we're talking potentially significant civil and criminal charges) so companies go for the Reg D safe harbors even when not technically required. Particularly for unsophisticated / unaccredited investors, the courts have found that 4(a)(2) is not good enough, even when the sale was arguably private. See, for example, SEC v. Ralston Purina Co., 346 U.S. 119 (1953). [1]
Following the path of Reg D 506 is actually quite simple, and carries no downside. But even with Reg D 506 you generally try to avoid unsophisticated investors, since then you get into scenarios where you are supposed to provide 'access to the kind of information that a registration statement would disclose' which is very difficult. The crowdfunding regs in theory are supposed to help alleviate this.
[1] - http://scholar.google.com/scholar_case?case=6019539454143305...
[2] - IANAL
Exemption from the registration requirements of the Securities Act
is the question. The design of the statute is to protect investors
by promoting full disclosure of information thought necessary to
informed investment decisions.[10] The natural way to interpret the
private offering exemption is in light of the statutory
purpose. Since exempt transactions are those as to which "there is
no practical need for [the bill's] application," the applicability
of § 4 (1) should turn on whether the particular class of persons
affected needs the protection of the Act. An offering to those who
are shown to be able to fend for themselves is a transaction "not
involving any public offering."
The end result is selling shares to the night janitor is almost certainly not allowed by 4(a)(2) but glad it turned out alright this time.
If the person getting the stock qualifies as a "friend or family", the restriction doesn't apply. Hence the term "Friends and Family Round".
It's a very bad idea to ignore the "reg D" type rules, but it's not the kind of thing where random people are likely to be able to report you to the SEC and get you fined.
Yeah, it probably violates some securities laws... but when everyone makes lots of money on the deal, there's rarely an issue. When investors lose money, they're all too happy to bring up securities law violations and fraud claims. Better to do everything by the book and not give anyone an excuse to sue you later.
I'm not a securities lawyer, but in a nutshell, startup companies should prefer a very small number of professional (and accredited) investors.
I recall that if you raise money from people in only one state you may be able to rely on state level rules and registration requirements
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Another challenge is you are limited to the # of owners you can have in a pre-IPO company.