What The Difference is Between Rule 506(b) vs 506(c) in Private Placements

Discovering securities exemptions that help small businesses and give investors better returns has always been intriguing. As the 2008 recession caused significant financial losses for many, I found myself discussing investment opportunities with a friend. At the time, we only knew about stocks and residential real estate. However, investing in large multifamily real estate through private placements proved to be a resilient option during the recession, and it was surprisingly affordable.

When it comes to private offerings, it’s crucial to know the rules and take reasonable steps to ensure compliance. Rule 506b and 506c specifically regulate private offerings, which are different from public offerings like stocks. While the regulations may seem daunting, working with a securities attorney can ensure that everything is done properly, leading to potentially sweeter rewards.

Whether you’re raising funds or investing in private offerings, understanding the regulations and following them can make a significant difference in the success of the investment. The securities exemptions that stimulate small businesses and give regular investors better opportunities to earn better returns can be a valuable option to consider, and proper compliance is essential to make the most of it.

Common Exemptions and Registration Requirements

In order to comply with the Securities Act, offers and sales of securities must typically be registered with the Securities and Exchange Commission (SEC). However, most startups are unable to register their securities with the SEC and instead rely on an exemption from registration. Regulation D under the Securities Act provides various exemptions, allowing companies to offer and sell securities without registering the offering.

One of the special exemptions provided by Regulation D is Rule 506, which offers two distinct exemptions from registration for companies selling securities. These exemptions, known as rules 506b and 506c, allow companies to raise an unlimited amount of capital without having to register with the SEC.

Rule 506(b)

Rule 506(b) falls under Section 4(a)(2) of the Securities Act, which provides a safe harbor for companies that meet specific requirements. To qualify for this exemption, the company cannot advertise its securities to the general public. This includes social media, television, newspapers, and other forms of general advertising. The company can only offer securities to investors with whom it has a pre-existing relationship.

Under Rule 506(b), a company can sell its securities to an unlimited number of accredited investors and up to 35 non-accredited or sophisticated investors. The SEC’s definition of an accredited investor includes individuals with a net worth of at least $1 million, excluding their primary residence, or an annual income of at least $200,000 for the past two years, with the expectation of earning the same or higher income in the current year.

Companies relying on Rule 506(b) must provide certain disclosures to non-accredited investors, including financial statements and other material information. This rule is a popular exemption used by startups and small businesses to raise capital without having to register their securities with the SEC.

1. An individual with gross annual income exceeding $200,000 in each of the two most recent years or joint income with a spouse or partner exceeding $300,000. Based on one’s tax returns for those years and a reasonable expectation of the same income level in the current year.

2. A person whose individual net worth, or joint net worth with that person’s spouse or partner, exceeds $1,000,000, excluding the person’s primary residence.

Under Rule 506b, accredited investors can provide written confirmation of their eligibility, which is referred to as “self-accreditation.” This means that investors can declare in writing that they meet the above qualifications when subscribing to an offering such as a real estate syndication, where a group of investors partners to buy a significant real estate asset.

To be considered a sophisticated investor, one must have sufficient knowledge and experience in financial and business matters to evaluate an investment opportunity. This allows them to participate in private placements as unaccredited investors, without meeting certain financial criteria. However, they must still possess the financial means to invest.

In a 506b offering, having a pre-existing relationship with the issuer is a key requirement for potential investors. This can include being friends or family or having established some form of communication prior to the offering, such as through a mailing list or educational platform. This is what is known as a substantive relationship.

Rule 506(c)

Rule 506(c) is a securities exemption that allows only accredited investors and requires verification of their status. This exemption allows for general solicitation, which was previously prohibited. The JOBS Act of 2012 created Rule 506(c) to provide more opportunities for businesses and real estate investors to raise capital and stimulate the economy. Verification for this exemption can be done through a written representation from the investor’s CPA or investment adviser, or through a third-party representative like verifyinvestor.com. Investors can upload documents such as brokerage statements, a statement of real estate owned, and bank statements.

Conclusion

Accessing capital through private placements requires meeting SEC guidelines under the Securities Exchange Act. These regulations stimulate the economy by removing the burden of SEC regulation from issuers, while also providing investors with better access to more private investments, particularly in real estate.

Real estate investments offer several advantages, including long-term growth, cash flow, and tax benefits. While some may view real estate as an illiquid investment, it actually provides stability and insulation from the panics of the stock market. With multifamily real estate, investors can take advantage of economies of scale, allowing their assets to be managed by professionals and significantly diversifying their risk.

To access private placements, investors must meet the requirements of either Rule 506(b) or Rule 506(c). Rule 506(b) requires a prior relationship with the issuer, while Rule 506(c) requires accredited investor status and verification of financial qualifications. Both options offer access to better deals with better returns.

Investors seeking additional multifamily investment options can join The Fortress Federation Investment Club, which provides access to upcoming opportunities at no charge. Alternatively, investors can sign up for the QuickStart Guide to Investing in Real Estate Syndications to learn more about the tremendous advantages of real estate without the headaches of being a landlord.

In conclusion, private placements offer a valuable opportunity for investors to access capital and diversify their portfolios. Real estate investments, in particular, offer numerous advantages and can be accessed through either Rule 506(b) or Rule 506(c). Joining an investment club or accessing educational resources can help investors navigate the complexities of private placements and find the best investment opportunities.