Tag: rule 506 (b)

Can I Use Rule 506(c) To Build Pre-Existing Relationships?

On By crowdfundattnyIn Accredited Investor, Regulation D offeringsLeave a comment

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

SEC Proposes Major Upgrades To Crowdfunding Rules

On By crowdfundattnyIn Accredited Investor, Angel Fairs, Crowdfunding, Crowdfunding Articles, Crowdfunding Laws, Crowdfunding Portals, Crowdfunding Real Estate, Demo Days, Equity Crowdfunding, General Solicitation, Integration, JOBS Act, Raising Money, Regulation A, Regulation A Plus, Regulation A Plus Primer, Regulation D offerings, Rule 506, Rule 506(b), Rule 506(c), SAFE, SEC, SEC Proposals, SPV, Title II, Title II Crowdfunding, Title III, Title III Crowdfunding, Title IV of the JOBS Act, UncategorizedLeave a comment

The SEC just proposed major changes to every kind of online offering:  Rule 504, Rule 506(b), Rule 506(c), Regulation A, and Regulation CF.

The proposals and the reasoning behind them take up 351 pages. An SEC summary is here, while the full text is here. The proposals are likely to become effective in more or less their existing form after a 60-day comment period.

I’ll touch on only a few highlights:

  • No Limits in Title III for Accredited Investors:  In what I believe is the most significant change, there will no longer be any limits on how much an accredited investor can invest in a Regulation CF offering. This change eliminates the need for side-by-side offerings and allows the funding portal to earn commissions on the accredited investor piece. The proposals also change the investment limits for non-accredited investor from a “lesser of net worth or income” standard to a “greater of net worth or income” standard, but that’s much less significant, in my opinion.
  • Title III Limit Raised to $5M:  Today the limit is $1.07M per year; it will soon be $5M per year, opening the door to larger small companies.

NOTE:  Those two changes, taken together, mean that funding portals can make more money. The impact on the Crowdfunding industry could be profound, leading to greater compliance, sounder business practices, and fewer gimmicks (e.g., $10,000 minimums).

  • No Verification for Subsequent Rule 506(c) Offerings:  In what could have been a very important change but apparently isn’t, if an issuer has verified that Investor Smith is accredited in a Rule 506(c) offering and conducts a second (and third, and so on) Rule 506(c) offering, the issuer does not have to re-verify that Investor Smith is accredited, as long as Investor Smith self-certifies. But apparently the proposal applies only to the same issuer, not to an affiliate of the issuer. Thus, if Investor Smith invested in real estate offering #1, she must still be verified for real estate offering #2, even if the two offerings are by the same sponsor.
  • Regulation A Limit Raised to $75M:  Today the limit is $50M per year; it will soon be $75M per year. The effect of this change will be to make Regulation A more useful for smaller large companies.
  • Allow Testing the Waters for Regulation CF:  Today, a company thinking about Title III can’t advertise the offering until it’s live on a funding portal. Under the new rules, the company will be able to “test the waters” like a Regulation A issuer.

NOTE:  Taken as a whole, the proposals narrow the gap between Rule 506(c) and Title III. Look for (i) Title III funding portals to broaden their marketing efforts to include issuers who were otherwise considering only Rule 506(c), and (ii) websites that were previously focused only on Rule 506(c) to consider becoming funding portals, allowing them to legally receive commissions on transactions up to $5M.

  • Allow SPVs for Regulation CF:  Today, you can’t form a special-purpose-vehicle to invest using Title III. Under the SEC proposals, you can.

NOTE:  Oddly, this means you can use SPVs in a Title III offering, but not in a Title II offering (Rule 506(c)) or Title IV offering (Regulation A) where there are more than 100 investors.

  • Financial Information in Rule 506(b):  The proposal relaxes the information that must be provided to non-accredited investors in a Rule 506(b) offering. Thus, if the offering is for no more than $20M one set of information will be required, while if it is for more than $20 another (more extensive) set of information will be required.
  • No More SAFEs in Regulation CF:  Nope.

NOTE:  The rules says the securities must be “. . . . equity securities, debt securities, or securities convertible or exchangeable to equity interests. . . .” A perceptive readers asks “What about revenue-sharing notes?” Right now I don’t know, but I’m sure this will be asked and addressed during the comment period.

  • Demo Days:  Provided they are conducted by certain groups and in certain ways, so-called “demo days” would not be considered “general solicitation.”
  • Integration Rules:  Securities lawyers worry whether two offerings will be “integrated” and treated as one, thereby spoiling both. The SEC’s proposals relax those rules.

These proposals are great for the Crowdfunding industry and for American capitalism. They’re not about Wall Street. They’re about small companies and ordinary American investors, where jobs and ideas come from.

No, the proposals don’t fix every problem. Compliance for Title III issuers is still way too hard, for example. But the SEC deserves (another) round of applause.

Please reach out if you’d like to discuss.