Rules 506(b) and (c) of Regulation D allow private funds two ways of raising capital without the need to register the securities with the SEC. When setting up a fund, choosing between one of these exemptions is a primary and important decision to make. The manner of fundraising is different for each. When comparing Rule 506(c) vs. 506(b), you want to choose the exemption that most closely matches your capital raising needs.
Features of Rule 506(b)
Rule 506(b) allows issuers to raise an unlimited amount of funds provided they do not generally solicit or publicly advertise the offering. Issuers may raise funds from an unlimited number of accredited investors and up to 35 non-accredited investors. Any non-accredited investors must qualify as sophisticated investors, however, and these investors must be provided disclosure documentation often provided in Regulation A offerings. Also, issuers may not publicly advertise a Rule 506(b) offering.
506(b) Benefits
• Purchasers may self-verify
• No regulation by state blue-sky laws
• No burdensome disclosure documents filed if only using accredited investors
506(b) Drawbacks
• Issuers may not publicize the fund or operate a crowdfunding campaign while fundraising
• Must file Regulation A required disclosure documents if taking on non-accredited investors
Features of Rule 506(c)
Rule 506(c) permits the issuer to use general solicitation and advertising and puts no limits on the amount of capital raised. The issuer must take reasonable steps to verify a purchaser is accredited or do so through a third-party verification service.
506(c) Benefits:
• Offerings not under state blue-sky laws
• Public marketing of an offering allowed to a larger base of investors than simply professional and personal networks through emails and one-on-one conversations.
506(c) Drawbacks:
• Some investors shrink back from providing sensitive information to issuers with which they are not personally acquainted.
• The investor verification process can be time-consuming and expensive depending on the method chosen.
• Lawyers and accountants may be unlikely to certify accredited investor statuses except for larger, more profitable clients due to the liability they take on when they certify accredited statuses of investors.
Issuers that file a capital raising effort under Rule 506(b) can switch it to operating under Rule 506(c) if they choose to market and advertise the offering. However, the reverse may not be done – changing from 506(c) to 506(b) – if they have already advertised the offering while under 506(c).
When it comes to Rule 506(c) vs. 506(b), there are advantages and disadvantages to each exemption. You must carefully evaluate your goals as an issuer in determining which avenue best matches your capital-raising needs.
