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Two of the most popular exemptions real estate investors use to raise capital from investors are Rule 506(b) and Rule 506(c). These two rules have a lot in common, but there are also some distinct differences you need to be aware of.
Take a look at the differences between Rules 506(b) and 506(c) to see which one makes the most sense for any real estate deals you're considering.
What are rules 506(b) and 506(c) for?
Both of these rules fall under Regulation D of the Securities Act and are regulated by the Securities and Exchange Commission (SEC). As you can probably guess, they're also part of Rule 506.
Rule 506 of Regulation D has to do with selling securities without having to register with the SEC. These types of exemptions make it possible for companies to raise capital from investors without having to register a public offering.
Going public isn't a feasible option for most real estate investors, so having a way around the complex and expensive process of registering with the SEC is crucial.
What is Regulation D?
Regulation D was added to the Securities Act in 1982 to provide a safe harbor for companies to sell securities without registering with the SEC. This regulation has been amended several times throughout the years by adding, changing, and replacing rules.
Regulation D also laid out the accredited investor definition, although that definition has changed some over the years.
The most important part of Regulation D, for the purpose of this article, is that it included Rule 506. This provided an alternative to previous methods of selling securities that had more stringent requirements and were cost prohibitive to many companies.
Rule 506(b) was the result of Regulation D, which provided more companies the ability to raise money through a private offering. This has helped many businesses since then and has made a significant impact on the real estate industry.
This rule allows real estate investors and developers to raise an unlimited amount of money from an unlimited number of accredited investors and up to 35 non-accredited investors. This fundraising can be done without having to file anything with the SEC ahead of time or wait for any approvals.
The limitation to Rule 506(b) is that general solicitation is not allowed. This means that anyone selling securities under the exemption can only do so to investors they have a substantive relationship with. Issuers aren't able to offer their securities to people they didn't already know prior to the offering.
506(b) is also a much more affordable option than alternative methods since there aren't specific requirements on the disclosures or private placement memorandums. Disclosures are required to be given to non-accredited investors, but the extent of those disclosures is more relaxed than with other types of offerings.
Disclosures aren't required to be given to accredited investors, but anything given to them must also be provided to the non-accredited investors. The issuer also has to be available to answer any questions from potential investors about the securities offering.
While capital can be raised from up to 35 investors who don't meet the requirements to be accredited, the issuer still has to ensure that they're a sophisticated investor. For this purpose, sophisticated means that the investor has knowledge of investments or business and is familiar with the type of investment they're making.
The only filing requirement with a Rule 506(b) offering is that the issuer must file Form D with the SEC within 15 days of the first securities being sold. This form provides the SEC with information on the business, the principal, the amount of money being raised, and what it's being used for.
Once the offering is completed and all funds have been raised, the SEC doesn't require any ongoing reporting.
Rule 506(c) is an extension of Rule 506 from Regulation D. This came as a result of the Jumpstart Our Business Startups Act (JOBS Act) from 2012. This was done to provide more opportunities for businesses and real estate investors to raise capital to help stimulate the economy and was the birth of real estate equity crowdfunding as we know it today.
Under Rule 506(c), the SEC lifted the ban on general solicitation that was always in place under Regulation D exemptions. This means that people and businesses seeking investors can now advertise their investment opportunity to the general public.
The difference, however, is that non-accredited investors aren't able to participate in this type of Rule 506 offering. Issuers can still raise an unlimited amount of money from an unlimited amount of investors, but they all have to be accredited.
506(c) has an additional step required compared to 506(b). Since all investors have to be accredited, it's up to the issuer to verify their accredited investor status. This means they have to review documents such as tax returns or W2 statements to verify income, or documents that can prove the net worth of the prospective investor. Some issuers choose to use a third-party company to handle the process to satisfy the verification requirement.
The only additional filing that may be required is with the states they're selling securities in. They're still exempt from registration with them, but some states require a notice to be filed, along with a filing fee.
Otherwise, Rule 506(c) only requires Form D to be filed within 15 days of the first securities being sold.
Rule 506(b) versus 506(c)
Since both rule 506(b) and Rule 506(c) are born of the same Regulation D, they have a lot of similarities. There are also some important differences that anyone considering raising funds through one of these exemptions needs to consider before deciding which way to go.
|Amount of capital that can be raised||Unlimited||Unlimited|
|Non-accredited investors allowed?||Yes, up to 35||No|
|Disclosure requirements||Only to non-accredited investors||None|
|General solicitation allowed?||No||Yes|
|Accredited investor verification||Investors self-verify||Issuer must verify accredited status|
|State notices required||No||In certain states|
|Form D required||Yes||Yes|
How to choose which 506 exemption to use
The main deciding factor between choosing Rule 506(c) or 506(b) is going to be whether you already have people in your network who would invest in your deal. Since Rule 506(b) doesn't allow general solicitation, you'll have to rely on people you already know.
If you intend to raise funds from your personal network, then 506(b) may be the best option since you're not limited to accredited investors only.
If you'll need to rely on soliciting other investors, 506(c) is your only Regulation D option. The only drawback is that you're limited to accredited investors only.
Some people use 506(b) for the first deal they're selling securities for, but they may not be able to raise another round of funds from their personal network. This would require advertising the offering.
The bottom line of Rule 506(b) versus 506(c)
Both of these rules provide an excellent opportunity for real estate investors to raise capital to fund the down payment on a great real estate deal. There aren't any complicated SEC hoops to jump through, and the cost doesn't put it out of reach for most investors.
Decide which of the two exemptions is best suited for your deal, and keep detailed records of your relationship with the investors if you go with 506(b) and of the accredited investor verification process if you go with 506(c). These rules may give you an exemption from registering, but you can still find yourself in trouble if you don't follow the requirements.
If you're a real estate investor looking for ways to scale your business and move into bigger deals, these two Regulation D exemptions may be the way.
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