What is Regulation D Rule 506?

Part of Real Estate Syndication: The Passive Investors Guide

Table of Contents

1. Regulation D: What is a Reg D Offering?
2. What is Regulation D Rule 506?
3. What is a 506 B Offering?
4. What is a 506 C Offering?
5. How Regulation D Has Democratized Capital Raising
6. Frequently Asked Questions About Regulation D Rule 506
7. Regulation D Offering - Conclusion
8. Sources

Companies, especially startups and new businesses, are constantly looking for fundraisers that can provide them with a financial boost. However, due to the many agency controls surrounding fundraising, this can be a challenge. 

One way fundraisers can ease the burden of these regulations is through Regulation D. Regulation D provides an exemption from verifying securities paid to the SEC, among other demands. As a result, real estate investors frequently use it to raise capital.

Whether you’re a seasoned real estate investor or just getting started , a solid understanding of Regulation D is essential for your fundraising efforts. Here’s what you need to know.

Regulation D: What is a Reg D Offering?

Regulation D refers specifically to all exemptions to the Securities Act registration requirements, which new companies generally rely on to issue securities to accredited investors.

In short, these are private placement exemptions. As a result, when a company wants to sell securities to accredited investors and raise capital, they don’t need to register or declare with the SEC or make a full initial public offering.

The Regulation D exemption process can save a company time and money. They just have to meet the following Reg D requirements:

• Notify the corresponding state of business sale.

• Notify the SEC through a Form D with basic information about the issuer and the offer.

Prospective purchasers must meet a few rules to be eligible for this Securities Act exemption:

• Have sufficient experience and knowledge in commercial and financial matters that give them the title of accredited investors who can also manage economic investment risks.

• Commit not to resell public securities.

• Have access to information included in a prospectus for an offering of registered securities.

• It should be clarified that if a company is exempt from registration, it must provide sufficient information to accredited investors to avoid violations of truthfulness.

The most important part of Regulation D is Rule 506, which seeks an alternative to the most strict methods of selling securities and which have prohibitive costs for many companies. Let’s take a closer look.

What is Regulation D Rule 506?

Rule 506 B of Regulation D establishes two different exemptions from registration for companies that offer and sell securities. 

This rule is a “safe harbor” for the private offering exemption from the Securities Act. Those under rule 506 do not have to file reports with the Securities and Exchange Commission. But, they must show what corresponds to ‘Form D.’

There are two derivative rules of Rule 506: 506 B and 506 C. Now, let’s take a closer look at Rule 506. Specifically, let’s look at 506 B and 506 C.

What is a 506 B Offering?

Regulation D Rule 506 B allows new businesses to receive unlimited amounts of money through investments from as many accredited investors as they want, as well as up to 35 non-accredited investors.

A few guidelines companies need to adhere to when dealing with financial and business matters under this rule include: 

• Providing disclosure documents to non-accredited investors.

• Have previous relationships with non-accredited investors.

• Self-certification of accredited investors.

• The offering can not be advertised outside of your network

Rule 506 B is more affordable than other methods of raising capital since there are no specific federal securities laws or state securities laws. Plus, disclosures are much more relaxed, and no continuous reporting is required.  

Those non-accredited slots still require investors who can demonstrate a level of sophistication sufficient to gauge the risks of a private offering.

Now that you understand Rule 506 B, let’s look at its sister rule, Rule 506 C.

What is a 506 C Offering?

Rule 506 C targets startups and seeks to engage them in general solicitation and advertising. The difference between this rule and Rule 506 B is that new companies must take measures to verify that all investors participating are accredited.

This involves a lengthy procedure, including a review of brokerage statements, financial statements, credit reports, and tax documents, among others, to verify the status of investors before accepting a prospective investment. It should be noted that this rule does not support self-certification.

According to Rule 506 C, then, a company can advertise the offer if it meets the following requirements:

• Investors are all accredited

• The company takes measures of documentary verification and truthfulness through means of a CPA letter or self-accreditation sites that verify the investors accredited status

• This offering can be solicited outside your network

It can be said, then, that Rule 506 C is, although simpler, a little more rigorous than Rule 506 B. To govern these rigorous requirements is something called the 2013 JOBS Act. Let’s take a look at what this is.

The 2013 JOBS Act

The Employment Act of 2013, or Jumpstart Our Business Startups Act, offers an extension of Rule 506 as 506 C. This creates more opportunities for real estate investors and companies to obtain capital. This law also supported the development of current real estate crowdfunding.

Additionally, this extension of Rule 506 reiterates that investor applications have no prohibitions. Likewise, it allows issuers to raise an unlimited amount of money from many investors with no disclosure requirements.

Let’s take a closer look at legislation surrounding Regulation D and how it’s affected capital raised.

How Regulation D Has Democratized Capital Raising

Regulation D has succeeded in democratizing capital raising by allowing smaller businesses to grow and compete with larger institutions in the real estate investing arena.

These small businesses may engage in general advertising as well as solicitation of investment offers. Opportunities such as crowdfunding have also been opened, increasing the number of ways that individuals can raise capital.

With this in mind, let’s look at a few other FAQs about Regulation D Rule 506.

Frequently Asked Questions About Regulation D Rule 506

Regulation D Offering - Conclusion

Regulation D Rule 506 is the SEC framework that makes most private real estate syndications possible. Rule 506(b) lets sponsors raise from up to 35 non-accredited (but sophisticated) investors plus an unlimited number of accredited investors, but prohibits any form of general solicitation — meaning the sponsor can only approach investors with whom they have a pre-existing substantive relationship. Rule 506(c) lifts the general-solicitation ban and lets sponsors market deals publicly, but in exchange requires that every investor in the deal be a verified accredited investor, typically through a third-party letter from a CPA or attorney rather than self-certification.

For LPs, the practical difference shows up in how sponsors run their pipelines. A 506(b) sponsor builds an investor list privately over months or years and only opens a deal to that pre-existing list when it comes to market, which is why the relationship work happens long before any specific transaction is on the table. A 506(c) sponsor can advertise broadly but will need to verify your accreditation through a CPA or attorney letter before letting you wire. Either structure is legitimate and serves a different segment of the market; the question for an investor is which one matches how you actually want to source and evaluate private real estate opportunities.

Sources

1. SEC — Private Placements - Rule 506(b)
2. SEC — General Solicitation — Rule 506(c)
3. SEC — Assessing Accredited Investors under Regulation D
4. Cornell Law — Regulation D (Wex Legal Encyclopedia)