Rule 506(b) vs. 506(c) for Fundraising

Entrepreneurs have so many decisions to make when it comes to fundraising. They have to decide on the terms, what instrument to use, the size of the offering, and more. One of the decisions that may be overlooked, but can determine the success or failure of an offering is the choice between using Rule 506(b) vs. 506(c) under Regulation D.

Benefits and Disadvantages of Rule 506(b) vs. 506(c)
The advantage of fundraising under 506(c) for the entrepreneur is the ability afforded to utilize a larger swath of the available marketing avenues to contact a much bigger audience. Rule 506(b) only permitted contacting prospective investors if a pre-existing, substantive relationship already existed between the offeror and the investor. The outreach possibilities are much larger when you can fundraise through a highly trafficked social media account, a billboard on a busy highway, or a popular online or print publication.

When it comes to Rule 506(b) vs. 506(c), Rule 506(c) has the requirement of verifying an investor’s accredited status before they can participate in the investment opportunity. Rule 506(b) only requires issuers to demonstrate a “reasonable belief” that the investors are accredited, non-accredited, or sophisticated. The “reasonable belief” criteria are largely vague but considered to be met in large part through purchaser self-certification or by accessing public information that establishes the same.

To meet the requirements of Rule 506(c), the use of public information or the self-certification option is not enough. This Rule requires the issuer to take “reasonable steps” and use one of three ways, as directed by the SEC, to perform verification. These are:

  • Based on net worth through bank, brokerage, or other statements of current assets
  • Based on income through W2s, tax returns, or other government filings
  • Based on a verification letter from a broker, attorney, or CPA affirming the accredited status of the prospective investor

Which Option is Better?
When choosing the Rule 506 option that is best for your upcoming offering, each business needs to measure its challenges and timelines during any stage of the fundraising process. The SEC does allow issuers to change from a 506(b) to a 506(c) offering and vice-versa during a round if no general solicitation has been used. However, an issuer may not raise capital using both options at the same time. If the offeror chooses to conduct general solicitation, at that moment a new 506(c) offering must begin with the funds invested into the 506(b) offering closed and transferred into the new one.

Each offeror must evaluate Rule 506(b) vs. 506(c) when determining the best instrument to use based on the specifics of the investment.

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