Many entrepreneurs and small businesses come to a decision where they need to raise funds through the offering of securities to outside investors. State and federal laws can determine who may or may not invest in your venture depending on the amount of capital you need to raise and the financial disclosures you are willing to make. Regulation D, enacted under the 1933 Securities Act allows for the avoidance of securities registration for a limited number of offerings used by small businesses – these come in the form of what are called “safe harbors.”
In order to avoid anti-fraud regulations of the Securities Act, issuers are required to provide sufficient information to prospective investors. However, each exemption under Regulation D has particular requirements regarding the number and types of investors who can participate, as well as the information the issuer must disclose. Below is a review of two of these exemptions.
Rule 506 (b)
Under this rule, there is no limit on the dollar value of an offering. Each of the investors must qualify as either an accredited investor under Regulation D, or they must have such considerable experience and knowledge in business and financial matters that they are capable of properly evaluating the risks and merits of any possible investment, what is called a “sophisticated investor”. Rule 506 (b) offerings can have an unlimited number of accredited investors, but are limited to 35 sophisticated investors. The accredited investor qualification involves meeting either the income or net worth requirements under Regulation D.
Rule 506 (c)
As under Rule 506 (b), Rule 506 (c) has no limitation placed on the dollar amount of an offering. However, all investors in the offering must qualify as accredited investors. Under this Rule, offerings may involve general solicitation and advertising, unlike with the other exemptions under Regulation D. Under Rule 506 (c), the burden rests on the investor to document their financial status in order to verify their qualifications as an accredited investor.
Under both Rules 506 (b) and 506 (c), companies have to be able to disclose certain information about the investment to prospective investors. While not specifically required, investors are usually given a document called a Private Placement Memorandum (PPM) which at the very least describes all the material terms of the offering, i.e. all the information a prospective investor would need to make an informed decision.
If you are thinking about conducting or investing in an offering under Rule 506 (b) or 506 (c), it’s important you keep in mind all of the different requirements above.
