506(b) vs. 506(c) Funds

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• Rule 506 of Regulation D permits fund managers to raise funds without needing to register the offering with the SEC. They can elect to raise funds under Rule 506(b) or Rule 506(c).
• Only Rule 506(c) permits the issuer to publicly advertise the offering, but 506(c) also requires the issuer to take reasonable steps to verify the accredited status of investors.
• Determining whether a fund manager prefers to conduct a Rule 506(b) or 506(c) offering might come down to 1) if they can hit their fundraising targets without advertising and 2) if they have the processes in place to properly verify prospective investors’ accreditation status.

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By default, any offerings of securities made in the United States must be registered with the SEC. Registration can be a complex, expensive, and time consuming process. Fortunately, the SEC provides a few exemptions from registration, the most common of which are found under Rule 506 of Regulation D. By complying with the requirements of Rule 506, VCs can offer securities to certain investors without needing to register the offering with the SEC. 

There are two different offerings permitted under Rule 506—Rule 506(b) and Rule 506(c). Each have different requirements for what VCs can and must do with regards to marketing and accepting investments. 

In this guide, we’ll examine the stipulations and implications of Rule 506(b) vs. 506(c), their respective advantages and disadvantages, and give VCs some items to consider when making the best decision for their fund.

What Are Regulation D Offerings?

Before we dive into Rule 506(b) and Rule 506(c), let’s take a quick look at Regulation D itself. Regulation D was adopted by the SEC in 1982 to provide certain exemptions to issuers from the registration requirements listed in the Securities Act of 1933.

Fulfilling such registration requirements would require a level of disclosure equivalent to that of publicly listed companies. This would mean detailed prospectuses with audited financial statements, risk factors, management details, and more. And that’s just what needs to be made available to investors upon offering. They would also be subject to ongoing disclosure requirements on a quarterly and annual basis.

So, it’s no surprise that most venture offerings are conducted under Rule 506 of Regulation D, which exempts the offering from registration. It’s not just VCs who make use of this exemption. Many private placements of securities (even publicly traded ones) are also conducted under Rule 506.

Offering securities under Regulation D also exempts issuers from needing to register with state securities agencies. However, issuers may still have to make Blue Sky notice filings, depending on the state.

What Can VCs Do Under Rule 506(b) of Regulation D?

Rule 506(b) allows an issuer to raise an unlimited amount of capital from a theoretically unlimited number of investors, provided that the issuer does not engage in general solicitation. Let’s look at each element of Rule 506(b) in more detail. 

How much capital can VCs raise?

Under Rule 506(b), there are no limits to how much money fund managers can raise. In venture, this means fund size is only constrained by market demand and beneficial ownership spots in the fund. There are no limits to the amount each investor can contribute to the fund.

How many investors can VCs accept—and what type of investors must they be?

There is also technically no limit on the number of accredited investors to whom the issuers can offer the securities. But in venture, the number of limited partners an individual fund can have will be limited by the fund structure itself. For example, 3(c)(1) funds can generally only take up to 100 investors (or 250 investors if the fund is below $10M); while 3(c)(7) funds can take up to 2,000. Any more than this amount and the fund will have to register with the SEC.

Rule 506(b) also allows fund managers to offer their securities to up to 35 non-accredited investors. However, taking on even one non-accredited investor significantly increases the level of information an issuer must provide. This is because of Rule 502(b) under Regulation D, which states that issuers selling securities to non-accredited investors must provide audited financial statements, information on resale limitations, and other disclosures. Additionally, portfolio companies often require that their investors are themselves accredited. One way that a venture fund can satisfy that requirement is to have exclusively accredited investors as LPs. By not soliciting investments from non-accredited investors, even though technically permitted, venture funds often have an easier time investing in companies.

Because of this, VCs using Rule 506(b) still typically limit their fund to accredited investors in practice. However, note that Rule 506(b) also stipulates that fund managers can rely on the investor’s representation as to their accreditation status. 

What types of marketing efforts can VCs engage in under Rule 506(b)

Issuers are not permitted to perform any “general solicitation or advertising” for securities offered under Rule 506(b). There is no specific definition of what is and is not general solicitation. Generally, to determine whether a communication will be considered general solicitation, a fund manager should consider: 

1. Is the communication to a wide spread and anonymous audience?
2. Does the communication contain a call to invest?
3. Even if there is no call to invest, might the communication prime the market for the securities being offered?

This means the VC cannot advertise that they’re raising a fund on social networks such as Twitter or LinkedIn. Further, they must also be able to prove that all investors had a “pre-existing and substantive relationship” with them prior to the offering.

Note that the limitations on general solicitation only apply to specific offerings. So, for instance, a venture fund might be able to advertise their “brand” under Rule 506(b)—they just can’t ask investors to invest in a specific fund. Given the nuances here, many fund managers work with outside counsel to develop their marketing strategy. 

What Can VCs Do Under Rule 506(c) of Regulation D?

Rule 506(c) allows an issuer to raise an unlimited amount of capital from a theoretically unlimited number of investors using general solicitation. However, the issuer must then take reasonable steps to verify the accreditation status of each investor. Let’s look at each element of Rule 506(b) in more detail. 

How much capital can VCs raise?

Under Rule 506(c), there are no limits to how much money fund managers can raise or how much each investor can invest. It simply depends on how much the VCs can—and want to—raise. This is no different than Rule 506(b).

How many investors can VCs accept—and what type of investors must they be?

Similar to Rule 506(b), there is no limit to how many accredited investors to whom fund managers can offer the securities. However, unlike Rule 506(b), all investors in a 506(c) offering must be accredited investors—no exceptions.

Additionally, fund managers must take “reasonable steps” to verify the investors’ accreditation status. Unlike Rule 506(b), they cannot rely on investors’ self-verification. Such steps may include requiring proof of:

• Investors’ income in the form of tax returns or W-2s
• Investors’ assets based on brokerage or bank account statements
• Investors’ professional licenses

You can see the type of documentation AngelList requires as proof of accredited status here. As with determining whether something is general solicitation, there may be nuance to what “reasonable steps” might be. Many fund managers work with outside counsel on this topic too.

What types of marketing efforts can VCs engage in under Rule 506(c)?

Fund managers are allowed to broadly advertise under Rule 506(c). Fund managers can advertise they’re raising a fund on Twitter, and online platforms can prominently display the relevant funds anywhere on their site. Many AngelList Rolling Funds are raised under Rule 506(c), meaning fund managers can promote their funds online or in person.

Of course, general rules on advertising apply—they cannot be inaccurate or misleading in any way.

The Tradeoffs of Rule 506(b) vs. 506(c)

The following table  sums up the key differences between Rule 506(b) vs. Rule 506(c).

Should I Hold a Regulation D 506(b) or 506(c) Offering?

Ultimately, which exemption is best for your fund depends on the facts and circumstances around your fundraise—including how much you want to raise, the depth of your professional network, your track record, and a variety other factors. Here are two simple question that can help you make the best decision:

How confident are you that you can raise the funds you need from your private networks?

If you’re confident you can hit your target without any advertising, Rule 506(b) may make more sense as you are not required to verify the investors’ accreditation status. It also makes it easier for investors who might prefer to self-verify.

Do you have the willingness and capability to verify your investors’ accreditation status?

If you want the ability to advertise your fund to the public, ask yourself whether you have the resources to properly verify potential investors’ accreditation status. If you don’t have the proper processes and procedures in place, it might make this process too onerous for you. Some fund managers farm out the responsibility of verifying accreditation to a lawyer or another third-party service. 

When you raise your fund with AngelList, we handle all the accreditation verification process on your behalf.

Rule 506(b) vs. Rule 506(c) in Summary

Rule 506 has been highly positive for the venture capital ecosystem, playing a huge role in ensuring startups get the capital they need to grow. With effectively all VC funds being raised under Rule 506, it is imperative for VCs to understand the differences between 506(b) and 506(c). There is no one-size-fits-all answer, but hopefully you now have a better idea of how to determine the right course of action for your fund.