When you’re issuing an offering, it’s important to know who’s who to determine whether Regulation D 506(b) or 506(c) comes into play. These rules determine how companies are allowed to sell securities. If all investors are accredited, there is no difference between either rule. If even just one investor is unaccredited, a considerable amount of information must be provided regarding a Rule 506(b) offering.
What is an Accredited Investor?
Whether your company raises funds under Rule 506(b) or 506(c) can largely be determined by whether investors are accredited or unaccredited. However, it’s important first to have an understanding of what an accredited investor is. Per the Securities and Exchange Commission, an accredited investor can fall into several categories, including:
- A bank, insurance company, savings and loan association, or business development company
- An SEC-registered broker-dealer or state-registered investment adviser
- A plan established and maintained by a state for the benefit of its employees with more than $5 million in assets
- An employee benefit plan, if an investment adviser makes investment decisions and the plan has assets totaling over $5 million
- A tax-exempt charity with assets exceeding $5 million
- A director, executive officer, or general partner of the company selling securities
- An enterprise in which all the equity owners are accredited investors
- An individual with income exceeding $200,000 in each of the two prior calendar years
- An individual with a net worth or joint net worth of at least $1 million
- Some trusts exceeding $5 million in assets
- A family office with assets of more than $5 million under its management
A knowledgeable employee — as defined in Rule 3c-5(a)(4) under the Investment Company Act — of the issuer of an offering where the issuer is a 3(c)(1) or 3(c)(7) private fund is also defined as an accredited investor.
What is the Difference Between Rule 506(b) and Rule 506(c)?
Rules 506(b) and 506(c) of Regulation D provide two ways to raise capital without registering the security with the Securities and Exchange Commission. When starting a new business, it’s essential to weigh the pros and cons of Rule 506(b) and Rule 506(c) to determine the best method to raise capital for your company. Choosing between these exemptions is a crucial decision — and it will determine how funds are raised. While offerings are not subject to blue-sky laws under either rule, each rule comes with certain benefits and limitations.
One of the major differences between Rule 506(b) and Rule 506(c) is that advertising or general solicitation of a 506(b) offering is prohibited. A company must have a pre-existing and “substantiative” relationship with an investor in order to approach them about the offering. With a 506(c) offering, there are no limitations on advertising whatsoever. The offering can be marketed on television, social media, etc.
Only accredited investors are permitted to purchase 506(c) offerings. In contrast, 506(b) offerings can include up to thirty-five (35) unaccredited investors provided they fulfill specific requirements and are “sophisticated.” In other words, they have the experience necessary to understand the risks of an investment opportunity. While accreditation is verified with 506(b) offerings using a questionnaire, companies making 506(c) offerings have much more stringent requirements — self-certification is not permitted.
Critically, if all investors are accredited, there are limited disclosure requirements for 506(b) offerings. If any investors who are unaccredited, a significant amount of information must be provided by the company about the security.
Contact an Experienced New York Business Attorney
It’s vital for companies who will be raising capital to understand the complexities of Rule 506(b) and Rule 506(c). A knowledgeable business law attorney can best advise you regarding the benefits and limitations of each rule and help ensure you remain compliant with SEC regulations. Brinen & Associates is committed to providing strategic advice to entrepreneurs and business owners for a wide variety of business matters. Call (212) 330-8151 or send us a message to learn more about how we can help.