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Understanding the Choice Between Rule 506(b) and Rule 506(c)

How do you choose between doing a Regulation D Rule 506(b) offer versus a Regulation D Rule 506(c) offer? Let’s explore the differences and why you choose one over the other.

Probably the question I hear more than any other is: “How do I choose between a Regulation D Rule 506(b) offer and doing a Regulation D Rule 506(c) offer? Are those two different? How do I do it?” So let’s talk about the differences.

Investor Eligibility Under Rule 506(b) vs. Rule 506(c)

Regulation D Rule 506(b) says you can raise an unlimited amount of money from an unlimited number of accredited investors, just like Regulation D Rule 506(c). There’s one difference between the two of them, and it comes in two different choices.

Under Rule 506(b), you’ve got the choice of taking accredited and non-accredited investors. You may have up to 35 non-accredited investors in any 90-day period. You don’t get that choice at all under Rule 506(c); you cannot have any non-accredited investors in Rule 506(c).

Advertising and General Solicitation Rules

So why wouldn’t you just choose Rule 506(c)? Well, it’s simple. Because under Rule 506(c), you can advertise.

Under Rule 506(b), you need to have a significant relationship with everybody that you would have as an investor. Because if you didn’t advertise to them, how did you get the money? That’s the question that has to be answered. And it’s answered kind of in the negative, right? Because if you didn’t advertise, how could you get the money?

So that’s why you have to have a relationship; otherwise, there’s no way you would have ever found them to invest.

The Role of Substantive Relationships in 506(b)

So the real question when I get asked, “Well, how do I choose which one?” The answer is simple: Where do you think your investors are coming from?

Do you know a lot of people who can invest in your property, and have you talked with them and kind of gotten a gauge that, “Oh, there’s no problem, I can raise $5 million from this group of people”?

Now, it’s not just friends and family, like your best friends that you’d go drinking with. It’s really that you have a substantive relationship, such that your investors feel like they can pick up the phone and ask you a question, and you feel like you have a general understanding of their level of sophistication. So that’s the definition of knowledge.

When Rule 506(b) Is the Better Choice

If you think about all the people that you know, you may have a pretty big sphere, and it may be possible for you to raise all that $5 million.

If it is, Rule 506(b) is probably the best choice, because you don’t have to go through an additional step that is under Rule 506(c), and that’s verification that they are, in fact, accredited.

You see, when you choose Rule 506(c), you get all the benefits of getting to advertise. But you can’t make the mistake of assuming that somebody is coming into the investment just because you think they might be an accredited investor and they said that they’re an accredited investor.

Accredited Investor Verification Under Rule 506(c)

Under Rule 506(c), you actually need a third party to raise their hand and say, “I know this person, and yes, they are indeed an accredited investor. I put my license on the line to say that’s true.”

So those people are the accredited investors under Rule 506(c); they have to be verified.

That’s why I say it’s just easier to do a 506(b) if you actually already have that relationship because whether they’re an accredited investor or not, it’s really up to their self-selection. You just need to have a good faith belief that they are, in fact, probably an accredited investor if they say they are.

How to Decide Which Rule to Use

So 506(b) or 506(c), look at your network and decide: Where are these people coming from?

Are they coming from your existing relationships? Or am I really going to need to advertise to have people invest with me who I just don’t know yet?

Those people eventually you will know, and you can include them as part of a 506(b).

Final Thoughts on Rule 506(b) vs. Rule 506(c)

I hope that helps. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. We focus exclusively on Regulation D Rule 506(b) and 506(c) offerings.