Understanding Regulation D 506(b) and Regulation D 506(c): Key Differences and Considerations

In the world of finance and securities, raising capital is a critical aspect of a company’s growth and development. However, the process of raising funds can be daunting, especially when it comes to complying with various regulatory requirements. Regulation D, a section of the U.S. Securities Act of 1933, offers private companies an opportunity to raise capital without the need for full registration with state securities agencies or the Securities and Exchange Commission (SEC). This regulation provides a cost-effective means for private companies to secure outside capital. Within Regulation D, there are two prominent options: Rule 506(b) and Rule 506(c). In this comprehensive guide, we will delve into the specifics of both Rule 506(b) and Rule 506(c), highlighting their differences, advantages, and the considerations that issuers must keep in mind when choosing between them.

Regulation D Overview

Before delving into the specifics of Rule 506(b) and Rule 506(c), it’s essential to understand the broader context of Regulation D.

1. Regulation D Offers a Regulatory Avenue:
   • Regulation D offers an avenue for securities issuers to raise funds without registering with state securities agencies or the SEC. This exemption is a crucial regulatory framework that streamlines the fundraising process for private companies.
2. Mitigating Time and Cost Factors:
   • Registering with the SEC is a time-consuming and costly process. Public offerings require extensive disclosure, which can be burdensome for smaller companies. Regulation D helps private companies avoid these regulatory burdens.
3. Cost-Effective Capital Raising:
   • Regulation D provides private companies with a cost-effective means of raising capital from outside investors. By complying with the requirements of this regulation, issuers can access vital capital without the overhead of a full SEC registration.

Two Options Under Regulation D: Rule 506(b) and Rule 506(c)

Within the framework of Regulation D, there are two primary options for private companies seeking to raise capital: Rule 506(b) and Rule 506(c).

1. No Capital Limits:
   • Both Rule 506(b) and Rule 506(c) offer issuers the advantage of not having limits on the amount of capital they can raise or the amount a single investor may invest. This flexibility allows companies to secure the funding they need without constraints.

Rule 506(b)

Rule 506(b) is one of the options available under Regulation D, and it comes with its unique characteristics and requirements.

1. Investor Mix:
   • Rule 506(b) allows issuers to accept funds from an unlimited number of self-accredited investors and up to 35 non-accredited investors. This provision permits a mix of investor types, providing some flexibility in fundraising.
2. Prohibition on General Solicitation and Advertising:
   • Under Rule 506(b), issuers are prohibited from engaging in general solicitation or advertising to promote their offerings. This means that issuers cannot openly market their securities to the general public, making it more suitable for companies with established relationships with accredited investors.
3. Suitable for Established Relationships:
   • Rule 506(b) is particularly suitable for fund raisers and companies with established “pre-existing and substantive relationships” with many accredited investors. The emphasis here is on maintaining relationships and privacy in the fundraising process.

Rule 506(c)

Rule 506(c) is the other option under Regulation D, and it offers a different approach to capital raising.

1. Advertising and Solicitation:
   • Rule 506(c) permits issuers to advertise their offerings and solicit any investor whom they believe to be accredited. This provision allows for a more open approach to fundraising.
2. Verification Requirement:
   • To comply with Rule 506(c), issuers must take “reasonable steps” to verify investors’ accreditation status through a third-party accreditation process. This requirement ensures that only accredited investors participate but can be time-consuming and cumbersome.
3. Broad Solicitation with Increased Effort:
   • While Rule 506(c) allows issuers to broadly solicit investors through advertising and less restricted promotion, it also increases the time and effort required of investors due to the stringent verification process.

Choosing the Best Option

The choice between Rule 506(b) and Rule 506(c) is a critical decision for issuers, and it largely depends on the unique circumstances of each fundraising effort. Let’s explore scenarios in which each option may be the best fit.

506(b) May Be Best If:

1. Established Investor Base: If you already have a large investor base with whom you have established “pre-existing and substantive relationships,” Rule 506(b) may be your best option. This option emphasizes maintaining existing relationships.
2. No Need for Broad Solicitation: If your fundraising goals can be achieved without the need for broad solicitation and promotion to the general public, Rule 506(b) provides a more private fundraising approach.
3. Investor Preferences: Some investors may prefer Rule 506(b) offerings because they avoid the need for a third-party accreditation process, which they find invasive. Privacy is a significant consideration for these investors.

506(c) May Be Better If:

1. Resources for Promotion and Verification: If you have the resources and capacity to heavily promote your offering and undertake the necessary “reasonable steps” to verify investors, Rule 506(c) could be the better choice. This option allows for a broader investor base.
2. Expansion of Investor Pool: If expanding your pool of new investors is a priority, Rule 506(c) allows for solicitation of a wider range of investors, including those without prior relationships.
3. Evolving Accreditation Process: Some issuers opt for Rule 506(c) because they believe that the SEC’s ever-expanding definition of an accredited investor is making the accreditation process easier for both investors and issuers.

Expert Guidance

Navigating the intricacies of Regulation D and choosing the right option between Rule 506(b) and Rule 506(c) can be complex. Seeking advice from professionals who specialize in securities regulations and private capital raises is essential.

Why Seek Expert Guidance:

• Professionals like Tobin & Company specialize in providing guidance and expertise tailored to your specific situation.
• They can evaluate your unique circumstances, including your investor base, fundraising goals, and resources, to recommend the most suitable Regulation D option for your capital raise.

Regulation D offers private companies a valuable regulatory framework to raise capital efficiently and cost-effectively. Within Regulation D, Rule 506(b) and Rule 506(c) provide distinct approaches to fundraising, each with its advantages and considerations. By carefully evaluating your situation and seeking expert guidance, you can make an informed choice between these two options and successfully navigate the world of private capital raises while complying with regulatory requirements.