Rule 506(b) vs Rule 506(c), Ohio Startups, and Securities Laws

By Drew Stevens - February 5, 2020 - Securities

If you’ve never consulted with a Columbus, Ohio securities attorney before, raising funding for your Ohio startup can be confusing and complex. Generally, unless your business falls under an exemption, you must register your investment offering at two levels – with the Securities and Exchange Commission at the federal level and the applicable securities departments at the state level.

Two of the more popular and powerful securities exemptions are Rule 506(b) and Rule 506(c). Here, our securities lawyer in Columbus, Ohio will walk through some of the key differences and features with Rule 506(b) vs Rule 506(c).

Rule 506(b) Features and Key Requirements

If you are pursuing exemption under Rule 506(b), you can raise an unlimited amount of money from an unlimited number of accredited investors. If you want to raise money from non-accredited investors, you are limited to 35 or less.

Defined under Rule 501 of Regulation D, being an accredited investor means the investor meets one of eight criteria. One often used requirement is §230.501(a)(6) – the investor had an income of $200,000 or more for the last two years and has a “reasonable expectation” of reaching that income for the current year. Alternatively, if the investor is married, the joint income threshold is $300,000.

Another widely used requirement is §230.501(a)(5) – the investor is a natural person whose net worth exceeds $1,000,000. If the investor is married and the combined net worth of the investor and the spouse exceeds $1,000,000, this also qualifies. Remember though that the primary residence of the investor cannot be included in calculating net worth.

However, especially in the early stages of an Ohio startup, the first round of investors can often include close family and friends who may not meet any of the requirements of being an accredited investor. Rule 506(b) does not bar these investors, but additional steps are required.

If you do sell securities to non-accredited investors, you must document that the non-accredited investors are “sophisticated.” To be sophisticated, a non-accredited investor, either alone or in conjunction with the investor’s personal representatives (lawyers, accountants), must have experience or knowledge in business and financial matters, so that the investor is capable of evaluating the potential merits and risks of investing in your company.

Another key 506(b) requirement is disclosure. With accredited investors, technically there is no obligation to disclosure certain information. However, if you do bring on non-accredited investors, the disclosure requirements are extensive. In addition to providing a private placement memorandum, your company must be available to answer questions from potential investors.

Whether you raise money from accredited investors or non-accredited investors, a best practice when talking to investors is to have them fill out an investor questionnaire. This will help document aspects like the investor’s primary residence, income, and ability to evaluate the risks and merits of the proposed investment.

Finally, one of the key limitations of a 506(b) offering is a prohibition on general solicitation. Your startup should avoid mass mailing and e-mail blasts, cold calling, and general advertisement in any medium, including websites, televisions, and radio.

Rule 506(c) Features and Key Requirements

Like Rule 506(b), Ohio startups that raise money under a Rule 506(c) offering can also raise an unlimited amount of money. However, one of the key differences with 506(b) is that a business can only raise money from accredited investors under Rule 506(c).

Further, Rule 506(c) requires the startup to take “reasonable steps” to verify accredited investor status. Depending on which requirement under §230.501(a) that the accredited investor is relying on, verification can include review of W-2s, tax returns, and/or bank statements. An investor questionnaire, alone, is deemed not sufficient for verifying accredited investor status.

Another key difference between the two rules is that Rule 506(c) does allow general solicitation. With 506(c), you can go buy that billboard advertisement, plaster your offering all over your website, run commercials on network television, and tweet your heart out on social media.

Columbus Securities Lawyer

If you need assistance with filing Form D with the SEC, filing with a securities department with a particular state, or raising funding and under Rule 506(b) or Rule 506(c), contact our firm today.