Are you raising equity to invest in real estate? Part I. Rules 506(b) and 506(c): What to know before launching your Real Estate Fund...

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INVESTORS 

Rules 506(b) and 506(c) of Regulation D give private funds two ways to raise investment capital without registering the offering with the Securities and Exchange Commission (SEC). These exemptions allow issuers of private securities—including the general partners (GPs) of private funds—to avoid regulations the SEC mandates for registered securities offerings.

Choosing between the 506(b) and 506(c) exemptions is an important decision GPs have to make when they set up a fund. Each affects fundraising differently, and you’ll want to choose the exemption that best suits your fundraising needs. 

What is Rule 506(b)?

Rule 506(b) is part of Section 4(a)(2) in the Securities Act of 1933, which outlines rules companies or investors must follow to sell securities in a private offering.

506(b)’s defining feature: A GP can raise an unlimited amount of money as long as they do not publicly advertise or solicit investments for the fund.

Who can invest in 506(b) securities offerings?

Rule 506(b) permits GPs to raise money from an unlimited number of accredited investors and as many as 35 non-accredited investors. Non-accredited investors in the offering must be sophisticated investors, and they must be given additional disclosure documents similar to those typically provided in Regulation A offerings. Issuers cannot publicly market a 506(b) offering; this means that GPs raising a VC fund under the 506(b) exemption can’t advertise the fund or generally solicit investors.

506(b) benefits

·        Rule 506(b) offerings are not regulated by state blue-sky laws.

·        Purchasers can self-verify their accreditation status; GPs aren’t responsible for verifying accreditation.

·        If a GP only takes on accredited investors, they can avoid filing burdensome disclosure documents with the SEC that would need to be provided to non-accredited investors.

506(b) limitations

·        GPs are prohibited from talking about the fund publicly while fundraising, and from running a crowdfunding campaign to bring in capital.

·         GPs can’t take on non-accredited investors without offering the same disclosure documents typically required under Regulation A of U.S. securities laws.

An overwhelming majority of private fund GPs raise funds under the 506(b) offering rules. These include private equity, venture capital, and real estate funds, among others.

For an established firm, raising capital under 506(b) is often a no-brainer. It allows them to draw on their network of LPs and avoid going through the time and expense of actively verifying each LP’s accreditation status...