What’s the Difference Between Rule 506(c) and Rule 506(b) in Crowdfunding?

Three and a half years into Title II Crowdfunding, I am asked this question a lot, sometimes by portals, sometimes by issuers.

A Chart, of Course

Three Important Differences

Verification

In a Rule 506(b) offering, the issuer may take the investor’s word that he, she, or it is accredited, unless the issuer has reason to believe the investor is lying.

In a Rule 506(c) offering, on the other hand, the issuer must take reasonable steps to verify that every investor is accredited. The SEC regulations allow an issuer to rely on primary documents from an investor like tax returns, brokerage statements, or W-2s, but they also allow the issuer to rely on a letter from the investor’s lawyer or accountant. In practice, that’s how verification is typically handled.

I strongly recommend that issuers do not verify investors themselves. Instead, they should use a third party like VerifyInvestor. If an issuer handles verification itself and makes a mistake, it’s possible that the entire offering could be disqualified. Conversely, once an issuer hands the task to VerifyInvestor, the issuer has, by definition, taken the “reasonable step” required by the SEC, and can sleep well at night.

Information

If all the investors are accredited, there is no difference between Rule 506(b) and Rule 506(c).

If there is even one non-accredited investor in a Rule 506(b) offering, on the other hand, the issuer must provide a lot more information, specifically most of the information that would be included in a Regulation A offering.

The technicalities are important to the lawyer, but to the issuer or the portal, the bottom line is that if non-accredited investors are included the offering will cost $5,000 – $7,500 more, and take a little longer to prepare.

Advertising

In a Rule 506(b) offering you can advertise only the brand. In a Rule 506(c) offering you can advertise the deal.

Ever watch the commercials for brokers and investment banks during a golf tournament? They feature an older guy and his very attractive wife, planning for a carefree and meaningful retirement. They message is:  we can help you achieve your dreams. But they don’t show any of the actual investments they recommend! They’re only advertising the brand.

That’s the model for a website offering investments under Rule 506(b). We can advertise the website – the brand – but we cannot show actual investments. The website attracts investors who sign up and go through a KYC (know your customer) process following SEC guidelines. We have the investor complete questionnaires, we speak with the investor on the phone a couple times, we learn about his or her experience and knowledge investing – we develop a relationship. Then, and only then, can we show the investor actual investments.

In contrast, a website offering investments under Rule 506(c) can show actual investments to everyone right away.

Which is Better?

If I own a jewelry store, I have two choices:

  • I can display jewelry in the front window where passersby can see it.
  • I can display a sign in the front window saying “Great jewelry inside. Must register to enter.”

That’s why I prefer Rule 506(c).

But I also acknowledge three benefits of Rule 506(b):

  • To include non-accredited investors, you must use Rule 506(b), or another kind of offering altogether.
  • If you use Rule 506(c), you might lose bona fide accredited investors who are unwilling to provide verification.
  • If you use Rule 506(b), which doesn’t require verification, you might get money from non-accredited investors who are willing to lie.

Switching Midstream

You can start an offering using Rule 506(b), then switch to Rule 506(c), as long as you haven’t accepted any non-accredited investors.

Conversely, once you’ve advertised a Rule 506(c) offering, you cannot go back and accept non-accredited investors, claiming you’re relying on Rule 506(b).

Questions? Let me know.

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