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Understanding the 506 (c) General Advertising Upgrade

Understanding the 506 (c) General Advertising Upgrade

by Erik P. WeingoldJanuary 2, 2016

burn_moneyRaising money is a critical consideration for any young company. For most entrepreneurs, the questions of where they can secure financing, and how they’ll achieve the funding they need will inform the foundation of their business strategy. Often, the personal circumstances of the entrepreneur in question influence the answers to these questions — but, federal securities laws also play a critical role. For some young businesses, calling up wealthy individuals and venture capital firms may seem like a logical place to start in obtaining financial support. In the past, these types of calls could have placed entrepreneurs in hot water because of the ban against general solicitation found in Rule 506(b) of Regulation D under the Securities Act of 1933.

However, regulations enacted by the Securities and Exchange Commission (SEC) have changed within the last few years, as a result of the 2012 “Jumpstart Our Business Startups” Act. The “JOBS” Act introduced Rule 506(c), an adaptation of the original Rule 506 that allows issuers to advertise their financing to the general public. Prior to the JOBS Act, companies could not use investor-based crowdfunding or otherwise advertise publicly to attract investors without going through a full registration with the SEC, which is an endeavor that is extremely costly and time consuming. Now, under Rule 506(c), startups are no longer restricted by that 80 year old prohibition on general solicitation, provided that all investors meet certain net worth thresholds. This dramatic change in the law has delivered significant results, and data recorded in 2014 suggests that early adopters have already raised over $14 billion by taking advantage of the new rule.

Benefits of Rule 506(c) over Rule 506(b)

The new Rule 506(c) provides a great deal of extra flexibility for young businesses hoping to raise capital, as only Rule 506(c) offerings offer advantages that impact the ability of entrepreneurs looking to communicate in a cost-effective way, with a wider audience. Just some of the benefits of accessing Rule 506(c) over Rule 506(b) include:

1.     The Flexibility of General Solicitation

The most significant advantage of structuring offerings under the 506(c) exemption comes in the form of general solicitation. The rule allows for issuers to market their offering any way they choose — whether that is online crowdfunding, a company website, in magazines, on billboards, or even through social media. The only limitation is that companies must still be very careful not to trigger the so-called federal anti-fraud rules. The best strategy for avoiding such legal exposure is through full disclosure regarding the business, its officers and directors, and complete risk factors . In other words, with the right planning, full disclosure through a properly drafted private placement memorandum or PPM, entrepreneurs can publicly attract investors.

2.     Accredited Investor Verification

Under the old rule, which still bans any general solicitation and is now Rule 506(b), investors are allowed to self-verify that they meet the net worth thresholds, thereby indicating that they are accredited investors. On the other hand, in a 506(c) offering, it is up to the company seeking the investment to verify that the investors are accredited. This means that the company must either collect documentation, such as tax returns or bank statements to verify investor net worth or income, or otherwise obtain third-party verification from the investor’s broker, accountant, or lawyer. This strategy of third-party verification is less intrusive and will probably be more acceptable to the typical investor.

3.     No Audited Financials

Under Rule 506(b), although companies are allowed to raise capital from up to 35 non-accredited investors, all investors must have a pre-existing relationship to the company (no public advertising) and the company must provide enhanced disclosure to investors, including audited financials. However, under Rule 506(c), although all investors must be accredited, there is no need for enhanced disclosures nor any audited financials. This is a big advantage because it greatly reduces the costs and time associated with putting together the disclosure documents (the PPM) necessary to comply with the regulations.

Is 506(c) Right For Your Company?

The new rule isn’t necessarily ideal for all circumstances. For example, the stricter requirements that come with verifying the accredited status of investors has put some issuers off using Rule 506(c). However, it’s worth noting that businesses can manage this problem by finding a reliable and efficient format for verifying investor net worth. Determining whether to go with 506(c) offerings will depend on several factors, including:

  • The scope and size of the company — businesses that need more capital may benefit more from 506(c) offerings because they allow for general solicitation and wider access to capital than the totally private 506(b) offering.
  • Existing relationships — if the business already has a popular service, product, or audience, then a 506(b) may be a better fit because it may be possible to access this existing base without the need for general solicitation, thereby avoiding the need for third party accredited investor verification. .
  • The need to access non-accredited investors — if you are positive that you could not raise the capital entirely from accredited investors, then you will have to rely on 506(b) (or some other available exemption). Just remember that you would also need to provide enhanced disclosure, including audited financials.

Accessing the Funds You Need

New updates and new rules have allowed issuers to choose the offering solution that’s best tailored to their particular circumstances. Failing to keep apprised of the sometimes rapidly changing securities laws associated with raising capital could mean that you’re missing out on valuable benefits that may serve to boost your company, and help you find the capital you need for success.

What do you think of Rule 506(c)? Do you have a plan in place for accessing the investors and funding you need? Let us know in the comments below!

About The Author
Erik P. Weingold
Erik P. Weingold
Erik P. Weingold is an entrepreneur and corporate securities lawyer with over 20 years experience under his belt. He has been practicing law since 1995, and since 1998 has been drafting PPMs that have been used to raise millions upon millions of dollars for startup companies and small businesses throughout the U.S. Erik is the founder and General Counsel to PPM LAWYERS.