Three and a half years into Title II Crowdfunding, I am asked this question a lot, sometimes by portals, sometimes by issuers.
A Chart, of Course
Three Important Differences
In a Rule 506(b) offering, the issuer may take the investor’s word that he, she, or it is accredited, unless the issuer has reason to believe the investor is lying.
In a Rule 506(c) offering, on the other hand, the issuer must take reasonable steps to verify that every investor is accredited. The SEC regulations allow an issuer to rely on primary documents from an investor like tax returns, brokerage statements, or W-2s, but they also allow the issuer to rely on a letter from the investor’s lawyer or accountant. In practice, that’s how verification is typically handled.
I strongly recommend that issuers do not verify investors themselves. Instead, they should use a third party like VerifyInvestor. If an issuer handles verification itself and makes a mistake, it’s possible that the entire offering could be disqualified. Conversely, once an issuer hands the task to VerifyInvestor, the issuer has, by definition, taken the “reasonable step” required by the SEC, and can sleep well at night.
If all the investors are accredited, there is no difference between Rule 506(b) and Rule 506(c).
If there is even one non-accredited investor in a Rule 506(b) offering, on the other hand, the issuer must provide a lot more information, specifically most of the information that would be included in a Regulation A offering.
The technicalities are important to the lawyer, but to the issuer or the portal, the bottom line is that if non-accredited investors are included the offering will cost $5,000 – $7,500 more, and take a little longer to prepare.
In a Rule 506(b) offering you can advertise only the brand. In a Rule 506(c) offering you can advertise the deal.
Ever watch the commercials for brokers and investment banks during a golf tournament? They feature an older guy and his very attractive wife, planning for a carefree and meaningful retirement. They message is: we can help you achieve your dreams. But they don’t show any of the actual investments they recommend! They’re only advertising the brand.
That’s the model for a website offering investments under Rule 506(b). We can advertise the website – the brand – but we cannot show actual investments. The website attracts investors who sign up and go through a KYC (know your customer) process following SEC guidelines. We have the investor complete questionnaires, we speak with the investor on the phone a couple times, we learn about his or her experience and knowledge investing – we develop a relationship. Then, and only then, can we show the investor actual investments.
In contrast, a website offering investments under Rule 506(c) can show actual investments to everyone right away.
Which is Better?
If I own a jewelry store, I have two choices:
- I can display jewelry in the front window where passersby can see it.
- I can display a sign in the front window saying “Great jewelry inside. Must register to enter.”
That’s why I prefer Rule 506(c).
But I also acknowledge three benefits of Rule 506(b):
- To include non-accredited investors, you must use Rule 506(b), or another kind of offering altogether.
- If you use Rule 506(c), you might lose bona fide accredited investors who are unwilling to provide verification.
- If you use Rule 506(b), which doesn’t require verification, you might get money from non-accredited investors who are willing to lie.
You can start an offering using Rule 506(b), then switch to Rule 506(c), as long as you haven’t accepted any non-accredited investors.
Conversely, once you’ve advertised a Rule 506(c) offering, you cannot go back and accept non-accredited investors, claiming you’re relying on Rule 506(b).
Questions? Let me know.
12 thoughts on “What’s the Difference Between Rule 506(c) and Rule 506(b) in Crowdfunding?”
Can an LLC be an accredited investor, or how.
Yes, an LLC can be accredited in several different ways. The most common is if all of its members (owners) are accredited.
Thank you for sharing this article. Very helpful.
A question for you if you have a moment. Can 506(b) and 506(c) be used simultaneously to finance a project, as two separate but parallel financing mechanisms? So, 506b offering would be aimed at one group, for maybe 50% of the funding and 506(c) at a different group for the other 50%, taking advantage of the strengths of each? Or is the situation that once you move into 506(c) territory, then that cancels out one’s ability to use 506b to fund a common project, even if it’s done as a separate offering. Thank you for your time.
No, you could not simultaneously raise capital for the same securities using both Rule 506(c) and Rule 506(b).
Thank you for taking the time to respond. Very kind.
If a venture fund is raising under 506(c), can they market to the public that they will be / are raising a fund, ahead of commencing their fund formation docs & process?
They sure can.
Many thanks Mark! Really appreciate it.
One more: If a VC raised and closed a fund under 506(c). Could a subsequent fund be under 506(b)? Or would you be locked into 506(c) for future raises too?
If a Form D incorrectly identifies an offering as a 506(c), when the offering really is a 506(b) that has never been advertised otherwise and all investors are accredited, can the issuer just file a Form D amendment to properly identify the offering as a 506(b)?
Yes. The Form D really has no legal significance. It’s just a recordkeeping tool of the SEC.
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