Understanding Rule 506: Unlimited Capital, Unique Investor Access, and Regulatory Flexibility

Companies with plans to raise capital quickly can find the process of registering for a public offering complex, time-consuming, and expensive. Hiring teams of lawyers and accountants to create offerings in compliance with the full SEC registration process can limit the availability of free capital to grow. With Regulation D exemptions, companies can efficiently raise the capital they need in private markets. Although less restrictive than public offerings, the remaining regulations within Regulation D still provide a structured system to manage private investments and safeguard both companies and investors against fraudulent activity.

Regulation D: Rule 506(b) and Rule 506(c)

The Rule 506 is quite different from Rule 504, and has its own benefits. With this rule, companies can raise an unlimited amount of money. There are two options under Rule 506: (b) or (c).

Rule 506(b) does not allow for general solicitation; no advertising or marketing can be used to help find investors. Like the former Rule 505, the company can sell the offerings to an unlimited number of accredited investors and up to 35 non-accredited but “sophisticated” investors. The non-accredited investors must have a business or financial background in order to participate. While there are no specific guidelines, non-accredited investors must be able to properly assess and evaluate the potential risks and rewards before they invest. Aside from opening the investor pool to a broader audience, Rule 506(b) also allows for some flexibility on the verification of accredited investors and exemptions from State Blue Sky Laws.

Rule 506(c) is the only rule that allows companies to broadly solicit accredited investors. Investors interested in investing must provide the company with documentation and financial statements to prove their accreditation. The verifying process costs money and time, but it is necessary in order to comply with SEC regulations. Rule 506(c) is also mostly exempt from the blue sky laws which eliminate a lot of extra filings, there are some cases where blue sky laws will apply, again, due diligence is always necessary.

• Rule 506(b):
  • No fundraising cap.
  • No general solicitation is allowed.
  • Can sell to accredited investors and up to 35 non-accredited but financially sophisticated investors.
  • Exemption from State Blue Sky laws reduces compliance complexity.

• Rule 506(c):
  • No fundraising cap.
  • Allows general advertising and solicitation.
  • Requires strict verification that all investors are accredited.
  • Broader reach to potential investors with fewer geographic limitations.

Rule 506 benefits companies with looking to raise capital efficiently. Investors and companies can safely and efficiently reach their goals with the exemptions, fraud protections, and unlimited fundraising capabilities of this rule.

For more information about how Reg D rules can add value to your company or portfolio, tune in to M2i’s Alternative Investments Chat podcast.