Rule 506(b) of Regulation D: An Overview
Rule 506(b) of Regulation D (Reg D) is a “safe harbor” exemption that allows issuers to offer and sell securities without registering them with the Securities and Exchange Commission (SEC) [1]. This exemption is commonly used by small businesses and start-ups to raise capital from private investors.
Solicitation and Advertising
Under Rule 506(b), issuers are prohibited from using general solicitation or advertising to attract investors [1, 2]. Instead, investors must approach the issuer directly. This requirement is intended to prevent issuers from engaging in public offerings, which are subject to more stringent SEC regulations.
Accredited and Sophisticated Investors
Rule 506(b) allows issuers to raise an unlimited amount of money from an unlimited number of Accredited Investors and up to 35 Sophisticated Investors [1, 2]. Accredited Investors are individuals with a net worth of $1 million, excluding their primary residence, or an annual income exceeding $200,000 for the past two years (or $300,000 if married) and a reasonable expectation of the same for the current year [1]. Sophisticated Investors are individuals who have the knowledge and experience in financial and business matters to evaluate the merits and risks of the investment [1, 2].
Pre-Existing Relationship
To prove that they didn’t solicit investors, issuers relying on Rule 506(b) must demonstrate a pre-existing relationship with an investor that predates any offer to sell securities [1, 2]. This relationship can be established through personal contact, business dealings, or other means.
Self-Certification
Investors in Rule 506(b) offerings may self-certify their status as Accredited or Sophisticated Investors by checking a box on a pre-qualification form provided by the issuer [1, 2]. This self-certification process is designed to simplify the fundraising process and reduce the burden on issuers.
Conclusion
Rule 506(b) of Reg D provides a valuable exemption for small businesses and start-ups seeking to raise capital from private investors. By understanding the requirements of Rule 506(b), issuers can effectively utilize this exemption to meet their fundraising goals while complying with SEC regulations.
References
[1] Moschetti Law. (n.d.). Rule 506b of Reg D – Non-Accredited Investors & No Solicitation. Retrieved from https://www.moschettilaw.com/rule-506b-of-reg-d/
Key Facts
- Definition: Rule 506(b) is a “safe harbor” exemption that allows issuers to offer and sell securities without registering them with the Securities and Exchange Commission (SEC).
- Solicitation and Advertising: Under Rule 506(b), issuers are prohibited from using general solicitation or advertising to attract investors. Instead, investors must approach the issuer directly.
- Accredited and Sophisticated Investors: Rule 506(b) allows issuers to raise an unlimited amount of money from an unlimited number of Accredited Investors and up to 35 Sophisticated Investors.
- Pre-Existing Relationship: To prove that they didn’t solicit investors, issuers relying on Rule 506(b) must demonstrate a pre-existing relationship with an investor that predates any offer to sell securities.
- Self-Certification: Investors in Rule 506(b) offerings may self-certify their status as Accredited or Sophisticated Investors by checking a box on a pre-qualification form provided by the issuer.
[2] Syndication Attorneys. (n.d.). (506)b or 506(c) – That is the Question. Retrieved from https://syndicationattorneys.com/syndication-basics/506b-506c-question/
[3] Yieldstreet. (2023, February 22). Rules 506(c) and 506(b) Explained for Investors. Retrieved from https://www.yieldstreet.com/blog/article/506c-vs-506b/
FAQs
What is Rule 506(b)?
Rule 506(b) is a “safe harbor” exemption under Regulation D that allows issuers to offer and sell securities without registering them with the SEC, provided that certain conditions are met.
What are the key requirements of Rule 506(b)?
Issuers must not use general solicitation or advertising to attract investors, and they can only sell securities to Accredited Investors and up to 35 Sophisticated Investors. Issuers must also demonstrate a pre-existing relationship with each investor.
What is the difference between an Accredited Investor and a Sophisticated Investor?
Accredited Investors are individuals with a net worth of $1 million, excluding their primary residence, or an annual income exceeding $200,000 for the past two years (or $300,000 if married) and a reasonable expectation of the same for the current year. Sophisticated Investors are individuals who have the knowledge and experience in financial and business matters to evaluate the merits and risks of the investment.
How do I prove that I have a pre-existing relationship with an investor?
You can establish a pre-existing relationship through personal contact, business dealings, or other means. It is important to document your relationship with each investor, including the date and nature of your interactions.
Can I use general solicitation or advertising to attract investors under Rule 506(b)?
No, general solicitation or advertising is prohibited under Rule 506(b). Issuers must rely on their own personal networks and relationships to find investors.
Is there a limit on the amount of money I can raise under Rule 506(b)?
No, there is no limit on the amount of money that can be raised under Rule 506(b).
Do I need to file any paperwork with the SEC if I am using Rule 506(b)?
Yes, you must file a Form D with the SEC within 15 days of the first sale of securities.
What are the benefits of using Rule 506(b)?
Rule 506(b) provides a relatively simple and cost-effective way for small businesses and start-ups to raise capital from private investors. It also allows issuers to maintain greater control over their investor base.