Regulation D is the section of the Securities Act of 1933 that creates exemptions for private companies to sell securities without registering those securities with the SEC. Rules 506(b) and 506(c) of Regulation D detail two sets of requirements that allow a private company to avoid the costly process of registering its equity offering (such as is done, for example, via an IPO).
While Rule 506(b) and 506(c) have some similarities, including the fact that offerings are private and unlimited in terms of size, there are a few important differences that must be taken into account:
- Rule 506(B) does not allow for ****general solicitation, meaning you cannot openly advertise the fact that you are raising money. This ban on general solicitation includes communications such as social media posts, mass emailings, even potentially participation at a pitch fest. As such, all sales must be made to investors with whom the company has a pre-existing relationship. Consulting with qualified counsel is critical to ensure your communications under Rule 506(b) don’t create regulatory problems.
- The benefit of Rule 506(b) is that the pool of investors can include both accredited investors and up to 35 non-accredited investors. These accredited investors are generally allowed to self-certify their status via an accredited investor questionnaire, while the non-accredited investors must meet certain sophistication requirements.
On the other hand:
- Rule 506(c) allows for general solicitation, meaning you can discuss the offering using social media, e-mail, offline methods, etc.
- The restriction in Rule 506(c) is that only accredited investors are allowed to invest. The SEC’s “accredited investor” definition was updated in mid-2020.
- Rule 506(c) places the burden of validating Accredited Investor status on the company, which must proactively follow specific SEC guidelines to meet the verification standards. An investor’s “Accredited” status must be verified before providing any material information regarding the offering.
Beyond staying within the rules, weighing the pros and cons of each option prior to fundraising is critical because once an offering using one of these exemptions is running, the company is not allowed to simply switch back-and-forth between the two options.
