Are you thinking of raising money for your startup, investment fund, or real estate syndication? If so, be sure to remember the golden rule of securities law: every sale of securities must be (i) registered with the SEC or (ii) exempt from registration.
Here, we’ll discuss Rule 506(b) and Rule 506(c) — two of the most popular ways businesses privately place their securities without registration.
Regulation D
Regulation D, titled Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933, provides a safe harbor from the registration requirements of the securities laws. In other words, if you comply with the rules, you can be confident that the SEC won’t be knocking down your door.
Both Rule 506(b) and Rule 506(c) are Regulation D offerings, shielding your business’s offer and sale of securities from SEC registration. If you’re not sure whether you’re offering securities in the first place, check out this article on the definition of a security.
Now, let’s get down to business.
Summary of the Differences Between Rule 506(b) and Rule 506(c)
The table below summarizes the main differences between Rule 506(b) and (c). The rest of the article will dive into the details.
Rule 506(b)
Rule 506(b) of Regulation D is often called the “friends and family” exemption from registration. It’s a true private placement of securities.
General Solicitations Prohibited
When offering securities under Rule 506(b), there must be no general solicitation or advertising to market the securities.
Prohibited public offers of securities are discussed in Rule 502(c) and would include the following channels:
- Newspapers
- Television
- Blogs
- Radio
- Podcasts
- Seminars
So what can you do?
One-on-one meetings with potential investors are safe, so long as you have a prior substantive relationship.
According to SEC guidance:
A “substantive” relationship is one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor. Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship.
We’ve previously discussed the definition of an accredited investor. Typically, accredited investors have an annual income of at least $200,000 ($300,000 with their spouse) or a net worth of at least $1 million.
A sophisticated investor is one who “has such knowledge and experience in financial and business matters that he [or she!] is capable of evaluating the merits and risks of the prospective investment.”
In short, you must know whether the investor is accredited or sophisticated before you talk about your securities offering. The deeper the relationship, the better.
Limited Number of Investors
In Rule 506(b) offerings, you can have up to 35 non-accredited investors and an unlimited number of accredited investors. All non-accredited investors must be sophisticated investors (see the definition above). Accredited investors can self-certify their accredited status.
Unlimited Offering Amount
Issuers can offer and sell an unlimited amount of securities under Rule 506(b).
Significant Information Must Be Provided to Investors
This is where Rule 506(b) starts to get a little tricky.
According to Rule 502(b), you have to give non-accredited investors the same kind of information that you would have to provide in a registered offering of securities, as detailed in Form 1-A.
In other words, you’ll need to provide extensive information regarding:
- Financials
- Business plan
- Risk factors
- How you plan to use the money raised
- Information regarding management
Commit to honest and transparent communication with investors of all types. Otherwise, you may get in trouble for violating anti-fraud laws.
Happily, you don’t need to provide the above information to accredited investors. However, you should always be available to answer questions by prospective investors, accredited or otherwise.
Rule 506(c)
Rule 506(c) is a relatively new beast, blending the concepts of private and public offerings.
General Solicitations Permitted
In Rule 506(c) offerings, issuers can advertise their securities. Feel free to hop on a podcast, email your contact list, and fire up your marketing machine.
Unlimited Number of (Accredited) Investors
In Rule 506(c) offerings, you can have an unlimited number of accredited investors. However, unlike in a Rule 506(b) offering, all investors must be accredited.
When determining whether an investor is accredited, you can’t rely on a wink and a handshake. Even a signed self-certification isn’t sufficient. According to Rule 506(c)(2)(ii), issuers must take reasonable steps to verify accredited status.
Examples of reasonable steps include:
- Reviewing tax returns, bank statements, and consumer reports.
- Getting a letter from a broker, CPA, or attorney stating that the investor is accredited.
- Hiring a third party, like VerifyInvestor, to confirm an investor’s accredited status.
Unlimited Offering Amount
Issuers can offer and sell an unlimited amount of securities under Rule 506(c).
Limited Information Must Be Provided to Investors
Rule 506(c) offerings don’t require the extensive disclosure required by Rule 506(b). However, even when offering exclusively to accredited investors under Rule 506(c), avoid misrepresenting your business and the offering. Transparency and honesty are key!
Additional Regulation D Requirements for Rule 506(b) and Rule 506(c) Offerings
You’re not done yet! Both 506(b) and 506(c) offerings have a few more requirements:
- Form D. You must file a Form D with the SEC within 15 days after the first sale of securities. You may also need to file notices in the states where your purchasers live.
- Bad Actors. The Rule 506 safe harbors are unavailable if certain people related to the business are bad actors — people who have certain criminal convictions, SEC disciplinary orders, or issues with FINRA.
- Restricted Securities. Securities issued under Regulation D are “restricted securities.” That means the purchasers can’t sell them again unless the securities are (i) registered with the SEC or (ii) sold under an exemption from registration.
Need Help Selling Securities?
If you’re thinking of selling shares, units, LP interests, convertible notes, or any other securities, complying with securities laws is essential. If you have questions about Rule 506(b), 506(c), or other exemptions from registration, reach out today.
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