There are many decisions you need to make when setting up a fund, but one of the most important is which capital raising exemption you will choose.
If you decide to take the Regulation D exemption — which is most popular among newer capital raisers — you’ll also need to decide between creating a 506(b) or a 506(c) fund.
In this article, we’ll break down the advantages of Reg D funds, and compare the pros and cons of 506(b) and 506(c) funds, so you can decide which structure best supports your fundraising goals.
Why are Reg D Funds the Right Fit for Most Capital Raisers?
The three most common exemptions are Regulation A (Reg A), Regulation Crowdfunding (Reg CF), and Regulation D (Reg D). In general, Reg D is easier and less expensive for newer capital raisers.
These exemptions are provided by the U.S Securities and Exchange Commission (SEC) and allow companies to raise capital without having to go through the full registration process required for traditional public offerings.
In general, Reg D is easier and less expensive for newer capital raisers. You should consider Reg A only if you have a streamlined marketing machine and are willing to take on smaller, potentially unaccredited investors.
Here are some more details on the requirements for each exemption:
What’s the Difference Between 506(b) and 506(c)?
If you choose to take the Reg D exemption, you’ll next need to decide between a 506(b) or 506(c) fund.
The main differences between these two funds lie in the regulations around fundraising methods, and the limitations around who can invest.
Accreditation Requirements for Investors
A 506(b) allows you to take on capital from both accredited investors and up to 35 non-accredited investors.
A 506(c) fund, on the other hand, can only include accredited investors.
Solicitation and Advertising
506(b) offerings cannot be publicly advertised or openly solicited. As a fund manager, you can only approach potential investors with whom you already have a pre-existing relationship. You can’t market on a broad scale or use general advertising.
506(c) funds allow for public advertising and solicitation, giving fund managers the freedom to openly market their offerings to accredited investors.
Information and Reporting Requirements
If non-accredited investors participate in your 506(b) fund, you’ll be required to provide extensive financial disclosures, similar to those required for a public offering.
Since a 506(c) fund can only include accredited investors, fund managers are not required to provide the same level of disclosures and reporting to their investors.
Verification of Accredited Status
When taking on accredited investors for a 506(b) fund, the fund manager is not required to formally verify participants’ accreditation statuses. They should have a reasonable belief that the investors are accredited, but don’t need to perform a robust verification process.
506(c) funds, however, require fund managers to take reasonable steps to verify that all their investors are accredited. Self-certification is not enough. Many 506(c) fund managers will work with a third-party provider to complete this verification.
Questions to Consider When Choosing Your Fund Structure
506(b) and 506(c) funds both have their pros and cons, so it’s important to consider your specific goals and the makeup of your investor base when making this decision.
To help narrow in on the right structure for your fund, consider these questions:
- Do I already have relationships with plenty of investors in my network?
- Do I plan to advertise or market my fund?
- Are most of my target investors accredited?
- Am I willing to provide extensive financial disclosures and reporting?
- How will I go about verifying investors’ accreditation status?
Preparing to Launch A Fund? We’re Here to Help
Are you considering launching a fund or syndication and want more resources like this one? Download our free guide to the 6 questions every capital raiser should ask themselves before their first deal.
And if you’d like to learn more about how Avestor’s customizable fund model can support 506(b) or 506(c) funds while also unlocking new levels of flexibility for you and your investors, schedule a free strategy call with our team.