Suppose you raise money using Rule 506(c) offering. In your next offering you want to include a handful of non-accredited investors. Your AI assistant tells you to use Rule 506(b) for the new offering and that you must have a “romantic relationship” with every investor. Do you have “romantic relationships” with the investors from your Rule 506(c) offering?

Whoops! That’s what you get from using ChatGPT. It’s a “pre-existing relationship,” not a “romantic relationship.” 

Can you claim to have “pre-existing relationships” with investors you found online?

A Quick Refresher

Rule 506(b) and Rule 506(c) are both exemptions under SEC Regulation D, but they’re very different. Rule 506(c) lets you advertise — websites, social media, email blasts, whatever you want — but every investor must be accredited, and you have to verify that, most of the time. Rule 506(b) is the old-fashioned version: you can take up to 35 non-accredited investors and you don’t have to verify that anyone’s accredited, apart from asking them. And most important, you can’t advertise. You can include only investors with whom you have a pre-existing substantive relationship. 

Here’s a more in-depth description of the similarities and differences.

The question is whether you can use a 506(c) offering to find investors, then include them in a subsequent offering under Rule 506(b), sort of a two-step.

SEC Guidance

The SEC has answered this question in a Compliance and Disclosure Interpretation, sort of. In C&DI 148.01, the SEC confirms that it’s possible to convert Rule 506(c) investors into Rule 506(b) investors, which is good.  It just doesn’t tell you how to convert them. 

For a blueprint how to convert them, we turn to a no-action letter the SEC issued to an online venture capital platform called Citizen VC. For reasons that aren’t clear, Citizen VC wanted to conduct offerings under Rule 506(b), not Rule 506(c), but they wanted to do it by soliciting prospective investors online. As a first step, they had investors complete an online questionnaire. After the questionnaire, they went through a “relationship establishment period” that involved several steps. Among the most important, they spoke with the investor personally. They also accumulated information from the investors and third-party sources regarding the investor’s sophistication, financial circumstances, and ability to understand the nature and risks related to an investment. When they were able to reach a reasonable conclusion that the investment and the investor were suitable for one another, poof!, the preexisting relationship came into being.

If only romantic relationships were so easy!

Caveats

One, the Citizen VC investor was shown investments only after the process was completed. That’s very different than the typical Rule 506(c) kind of solicitation.

Two, C&DI 148.01 and Citizen VC do not mean that soliciting investors for Rule 506(c) offerings has anything to do with creating a pre-existing relationship. It doesn’t. If you have a pool of Rule 506(c) investors, you are starting from scratch.

Questions? Let me know.

Markley S. Roderick
Lex Nova Law
10 East Stow Road, Suite 250, Marlton, NJ 08053
P: 856.382.8402 | E: mroderick@lexnovalaw.com