KNOW THE DIFFERENCE – EDUCATE YOURSELF!
Your Reg D Private Placement Offering:
Choosing between 506(b) and 506(c) for your Registration Exemption
Last month I wrote to you about your registration exemptions when you sell a Reg D private placement. Generally, the exemptions that we choose from are 506(b) or 506(c):
- 506(b) – Old fashioned, been-around-forever private placement offering exemption that can only be sold to investors with whom you have a “substantive, pre-existing” relationship
- 506(c) – Newer (only ten years!), bright and shiny private placement offering exemption that can be sold to any accredited investor
In last month’s newsletter, I bemoaned the fact that 506(b) offerings are more popular than 506(c) offerings and I couldn’t figure out why!
As hoped, I heard back from many of you. Thanks for that!
MY OBJECTIVE FOR THIS NEWSLETTER
My intention here is to convince you to issue a 506(c) offering rather than a 506(b) offering. A 506(b) offering is really not worth your time, and you may regret it.
- 506(c) offerings provide you with significant flexibility when accepting NEW investors who approach you AFTER an offering is launched.
- We can argue what “start of offering” means, but the regulators will win with their earlier date and not what you assume – don’t bother thinking that you can change their minds.
- There is more enforcement from FINRA, the regulator of broker-dealers, regarding infractions in the execution of 506(b) offerings than in the veracity of accreditation status of investors in the offering.
- In fact, I can’t find ANY enforcement actions from FINRA against broker-dealers for “inappropriate” general solicitation. But there are a handful of enforcement actions out there for broker-dealers accepting investors who were not substantive, pre-existing relationships.
WHAT REALLY IS THE DIFFERENCE BETWEEN 506(b) and 506(c), particularly for me as the issuer of private placement securities?
What is the difference between 506(b) and 506(c) in terms of execution?
A third-party accreditation letter, AKA “investor accreditation letter” or “AIC.”
That’s about it!
What is a third-party accreditation letter?
- A third-party accreditation letter provides verification that the investor is accredited, in addition to the investor self-attesting to this fact.
- Your selling broker-dealer can write this letter. (And if you need help with that, call or email me and I will teach them how and I will provide a template form to use.)
- Any attorney, BD, RIA or CPA can write this letter.
- Your investors can access services to obtain these letters.
- Still lost? Call me and I will work with your investor and write an accreditation letter for them.
Once an AIC is written, it is good for five years, as long as the investor confirms, in writing at the time of the investment, that they are still an accredited investor. No further third-party verification is required until that letter expires five years from the creation date.
HURDLES YOU MIGHT BE CONFRONTING IN MIGRATING TO 506(c)
Do your investors ridicule you for introducing a 506(c) offering?
- If so, ask them why they object.
- Do they object because they feel that you should only raise capital from investors that you already know at this moment?
- If so, why do they feel that way?
- This stance of “doing it the way we have always done it” is not a way to grow a business. We all want new customers all of the time.
- Discuss this with your investors.
Why would an investor object to the accredited investor verification process?
- If an investor objects to difficulty or lack of privacy, walk them through it.
- They only need to prove:
- Income of $200,000 ($300,000 joint) for the past two years.
- Net worth over $1M.
- Investors don’t need to reveal their entire financial history and asset holdings.
- Simply provide proof of assets (other than primary home) that are $1,000,000 more than the debt on one’s credit report (yes, they need to produce that, but only those pages that disclose outstanding debt!)
If someone says, “No, I will not write an AIC letter,” move on.
- There are many people who won’t write them – they misunderstand the risk.
- I have had attorneys tell me that they shouldn’t write them because they aren’t good at math (I am not kidding). The wire houses won’t write them because how in the world can they monetize that service? And CPAs often won’t write them either.
- Move on. Ask your broker-dealer to write the accreditation letter. Or read on.
Why does your securities counsel oppose a 506(c) offering? Here are some of the responses I have heard:
- 506(b) is the way we have always done it. Why change now?
- Response: Because we want to bring new investors into our offering as we grow in this expanding marketplace.
- 506(b) is easier.
- Response: We only need to add one additional step to turn our 506(b) offering into a 506(c) offering for the benefit of adding the entire universe of investors to our prospect list.
- I don’t know how to write an accreditation letter.
- Response: Our broker-dealer will manage that process for this offering.
- It’s too costly and difficult to obtain the statements and to retain the evidence of the investor’s accreditation.
- Response: Calm down – that is all broker-dealers do. They obtain and retain evidence in their sleep. Let them obtain the statements, retain the evidence and write the letter.
- There is risk of compliance with “relatively new verification requirements…”
- Response: The process for complying is clearly spelled out in Rule 506(c). The risk of compliance is much higher and much more subjective in proving that you have a “pre-existing, substantive relationship” with your investor.
- Response: Rule 506(c) outlines the process, which I view as a “safe harbor.”
- Response: There is a higher risk of compliance with 506(b) – if you bring a new selling group member into a 506(b) offering once it is in process, their investors will NOT be pre-existing investors in your offering and will not be permitted to invest. Just sayin’.
- It is too costly to comply with 506(c)
- Response: What? How is it too costly for your investor to pay $30 to secure an accreditation letter that will serve them for five years? That cost doesn’t even belong to the issuer; it belongs with the investor. And the asset lasts for five years.
- Your investors will find it inconvenient to produce an AIC letter.
- Response: Maybe. A little bit. But advantages and benefits take a little work. Our BD will help the investor obtain the letter, which lasts for five years and which opens up the possibility of investing in all of the 506(c) offerings out there. A letter is not limited to one offering – it belongs to the investor for five years for any offering. Freedom!
USE THE 506(c) EXEMPTION FOR YOUR NEXT PRIVATE PLACEMENT OFFERING
- The obstacles that you may see are minor.
- Clearly, using general solicitation for your offering makes the most business sense.
- 506(c) has less regulatory risk than a 506(b) offering.
- You can grow your investor base using the 506(c) exemption.
Want to convert your 506(b) to a 506(c)? It’s not hard. Read here – We’ve written about this before.
When you need a highly competent, super attentive leader in broker dealer services for your private placement offering, give me a call. I will give you an honest assessment of whether TOBIN and our private placement services are the right fit for you.
Justine Tobin
Founder and CEO
(704) 334-2772