April 29, 2020
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There are a million and one decisions facing an entrepreneur when it comes to fundraising. The size of the offering, what instrument, what terms, and who to call first are some of the most fundamental. One that’s often overlooked, but a potential lever for success, is choosing between two regulatory options under Regulation D (“Reg D”).
Then There Were Two
Under the Securities Act of 1933, Reg D contains rules that exempt issuers of private securities from having to register with the SEC. Rule 506(b) in particular has allowed issuers to raise an unlimited amount of capital from unlimited numbers of accredited investors, and up to 35 unaccredited investors. In these offerings, however, issuers are not allowed to publicly advertise the fundraising effort and the offerings remain effectively “private.”
In July 2013, the JOBS Act ushered in the new Rule 506(c) in the spirit of expanding investment opportunities and access to capital. Fundraising under 506(c) is in a way no longer “private” since issuers are now allowed to use general solicitation or public advertising to market their offerings more broadly, via multiple channels including traditional and social media.
Pros and Cons
For an entrepreneur, the key advantage to raising under 506(c) is the ability to leverage a greater variety of marketing channels to reach a far wider audience. Under 506(b), issuers are only allowed to approach potential investors if there is a “substantive, pre-existing relationship” . Imagine the difference in outreach when promoting a fund-raise in a widely-followed Twitter account, a popular magazine, or the billboard on a busy freeway.
The downside to 506(c) is the additional requirement of having to verify investors’ accreditation status before their investments can be accepted. Under 506(b), issuers need only to establish “reasonable belief” that the purchasers of their securities are accredited investors or sophisticated, non-accredited investors. While the criteria for an accredited investor is clearly defined by the SEC, “reasonable belief” is relatively vague but generally thought to be satisfied by self-certification by the purchasers themselves or via publicly available information (e.g., LinkedIn profile or company bio website). Practically, startups raising under 506(b) on the Propel(x) platform do not need to take any additional steps once a user commits to invest – our team has already established “reasonable belief” of that user’s accredited investor status at the time of registration.
To comply with 506(c), however, self-certification and publicly available information are no longer sufficient, and additional “reasonable steps” must be taken following guidelines by the SEC in one of three ways:
- Verification based on income via tax returns, W2’s, or other government filings
- Verification based on net worth via brokerage, bank, or other current asset statements
- Verification of a letter from a CPA, attorney, or broker stating an individual’s qualification as Accredited
Depending on an investor’s document readiness, completing the verification process can take as little as 30 minutes or as long as weeks. On top of the time and effort required, each verification also comes with an expiration date. Even if an investor has been verified before, he or she must repeat the same process if the previous verification took place more than 3 months prior to the current investment.
How Propel(x) Supports 506(c) Offerings
Propel(x) is here to help when startups do decide general solicitation can be a useful fundraising lever.
First, Propel(x) uses a third-party service [Updated March 2017] to perform accredited investor verification for all investors committing interest in a 506(c) offering through a Propel(x) syndicate. There is no additional cost to the startup. The only difference facing investors in a 506(c) vs. 506(b) offering is following the syndicate document signing step; this is when they will be directed to our partner site for a simple online process for accredited investor verification. Click here to learn how this works.
Propel(x) has featured several 506(c) deals on our site: Seatrec, which builds thermo-recharging batteries that gather energy from temperature differences in the stratified ocean; Aromyx, which has developed a unique means of replicating the human sense of taste and smell to produce flavor profiles; and G-Tech, which manufacturers an external patch that monitors gastrointestinal activity. You can learn more about Seatrec, Aromyx, and GTech via our articles on Medium.
For investors that are successfully verified, their investment commitment will be confirmed and we will contact them to initiate the fund transfer process. No new verification is required if an investor invests into another 506(c) offering within 3 months. In the case that an investor does not pass the verification, his or her syndicate document will be voided and no interest committed.
Second, Propel(x) works with startups to conduct an integrated marketing campaign to get the word out about their fundraising efforts, including PR, content, and social media outreach The marketing campaign is developed in collaboration with and approved by the startup prior to its launch.
We will prominently feature the fund-raise on our landing page www.propelx.com, which is publicly accessible (i.e., visitors can view without logging in)
So 506(b) or 506(c)?
There is no right or wrong answer when choosing which 506 option to go with. Each startup has its own fundraising timeline and challenges, which could vary between rounds and even within a round. While an issuer cannot raise under both options concurrently, it is allowed to switch from 506(b) to 506(c) at any time during a round, and vice versa if general solicitation has NOT been used in any form in connection with the offering. Once the issuer decides to generally solicit, a new 506(c) offering must be effectively started and all capital committed into the 506(b) offering must be closed (i.e., all documents signed and funds transferred) .
Bottom line: remember the two 506 options as yet another lever to pull in fundraising, weigh the pros and cons. Propel(x) is here to support you.
 According to SEC, listing a deal behind a password protected site like Propel(x) available only to accredited investors falls into this category and does not constitute general solicitation
(Disclaimer: This article is meant to provide a simplified overview of a complex regulatory topic. It involves some interpretation and by no means should this material be considered regulatory or legal advice. Seek the advice of a licensed attorney in the appropriate jurisdiction before taking any action that may affect your rights.)