506(b) vs. 506(c): Which One Fits Your Fundraise?

Choosing the right Rule 506 option under Regulation D of the Securities Act when raising private capital is often not simple. Rules 506(b) and Rule 506(c), the two most popular Reg D exemptions, have key differences.  Your best choice depends on factors such as your targeted investor type, your desired marketing approach, and your determined risk tolerance.

For example, with Rule 506(b), you are permitted to include both accredited and non-accredited investors.  However, you cannot advertise or solicit to new investors; you must rely on investors whom you already know. With Rule 506(c), your investor pool must consist only of accredited individuals and entities, but you are permitted to expand your investor base through advertising and general solicitation to investors whom you do not already know.

Let’s examine a more detailed comparison of the differences between Rule 506(b) and Rule 506(c) offerings.

Rule 506(b):

• Investor Type: Permits both accredited investors and up to 35 non-accredited investors who have proven sophistication and experience in financial and business matters to assess the investment.
• Investor Solicitation: Requires you to rely on investors with whom you already have a “pre-existing, substantive relationship” – as measured at the “commencement of the offering” – which limits the reach of your fundraising.  However, a Rule 506(b) offering might be faster to execute since it depends on existing connections.
• Investor Verification: Eliminates the requirement for accreditation status to be verified by an independent third party – accredited investors may self-testify to their accreditation status.
• Pro: If you have a group of trusted investors, you can close deals quickly without extensive marketing efforts or third-party accreditation compliance headaches.

• Cons: Not being able to attract new investors outside your existing circle, at the commencement of the offering, might slow your growth. Also, there is a very current risk in the regulators auditing your 506(b) offerings to confirm that you most certainly did have a “pre-existing, substantive relationship” with each of your investors.

• Best Suited Raises: Companies with an established existing investor network and those comfortable with a more limited investor pool. This option is best for closely held offerings among existing investor networks.

Rule 506(c):

•  Investor Type: Allows only accredited investors, but there is no limit on their number nor the amount raised.
• Investor Solicitation: Permits general solicitation and advertising, enabling you to market your offering widely to any investor whom you believe to be accredited when you solicit them.
• Investor Verification: Requires issuers to perform due diligence to verify investor accreditation status. This may include reviewing financial statements, using third-party verification services or securing an accreditation from another permitted party.
• Pro: If you’re seeking a broader investor base, have ambitious fund-raising goals, and are ready to take your organization to the next level, this is the best option.
• Con: You’ll potentially face higher compliance costs and more administrative work due to the strict verification requirements.

• Best Suited Raises: Companies with bigger advertising and marketing budgets that want to reach more investors especially if they anticipate additional raises in the future. Also, those willing to put in the extra effort and resources needed for the verification process.

Consider your risk tolerance

Essentially, the Rule 506 option you select depends on your specific situation: your current investor relationships, fundraising goals (whether you’re aiming for broad outreach and want to attract more investors), fundraising timeline, and your resources for compliance and verification.

If you’re more comfortable working with a smaller, known group of investors rather than a larger one with mostly unknown investors, a Rule 506(b) offering might be better. You can switch from 506(b) to 506(c) to start marketing the offering, but you can’t switch from 506(c) to 506(b) once public solicitation has begun.

Both Rule 506(b) and 506(c) offerings allow for unlimited fundraising amounts, so you are not limited in how much capital you can raise (unlike Rule 504, for example…) Interestingly, you can potentially combine both 506(b) and 506(c) choices among your different offerings to leverage existing relationships and expand your reach.

Why TOBIN

You should carefully evaluate your fundraising goals, investor relationships, and resources to determine which Reg D Rule 506 option best fits your needs. Consulting with an investment banker or broker-dealer is crucial when making fundraising decisions.  Even your securities counsel will want you to speak with a financial professional, especially a professional who actually owns the broker-dealer, like TOBIN.

Many people contact me with questions and seek guidance about the Reg D Rule options because of my vast experience and my straight talk.

Contact TOBIN today if you are ready to launch your first –  or next – private placement offering.  We would love to hear from you.