506(b) vs. 506(c) in Real Estate Syndications
Raising money for a real estate investment can feel overwhelming, especially with all the rules and regulations involved. But here’s the good news: you don’t have to go through the full process of registering your offering with the government if you qualify for an exemption. Two common exemptions from registration, namely Regulation D, Rule 506(b) and Rule 506(c), function as safe harbors, letting you legally raise capital without jumping through as many hoops. Each path has its own rules, so understanding the basics can help you choose the best option for your project. Below, we’ll break down the key differences between Rule 506(b) and Rule 506(c) offerings and help you evaluate which might be more appropriate depending on your situation.
Rule 506(b): The Original Private Placement Exemption
Key Features:
One of the most noteworthy aspects of Rule 506(b) offerings is that such offerings come with certain limitations on the types of investors who can participate and how they can advertise. Under this safe harbor, sponsors are prohibited from engaging in “general solicitation” to attract investors, meaning they must instead rely on potential investors in their network with whom they have a pre-existing and substantial relationship[RS1] . A “pre-existing” relationship is one that exists before an offering or via a broker-dealer or investment adviser prior to their involvement in the offering, while a “substantive” relationship is one formed when the issuer or its professionals evaluate and confirm an investor’s accredited status. Generally, if the sponsor has a “preexisting and substantial relationship” with anyone to whom the securities are offered, the SEC will find that there was no general solicitation.
Another key feature of Rule 506(b) is that it allows up to 35 non-accredited, sophisticated investors to participate in the syndication. Accredited investors, as defined by the U.S. Securities and Exchange Commission (“SEC”), are individuals or entities that meet certain eligibility thresholds. Individuals may qualify as accredited investors primarily through financial or professional criteria. Financial qualifications include a net worth exceeding $1 million, or annual income surpassing $200,000 individually or $300,000 jointly with a spouse or partner for the past two years. Professional criteria include holding securities-related licenses such as the Series 7, Series 65, or Series 82, being a director, executive officer, or general partner (GP) of the issuer, or being a “knowledgeable employee” of a private fund. Entities can qualify as accredited investors based on, among other factors, their financial structure or ownership. For instance, entities owning investments or assets exceeding $5 million are eligible, while entities where all equity owners are accredited investors also meet the criteria.
Up to 35 non-accredited investors may participate in a Rule 506(b) syndication provided these individuals are “sophisticated,” meaning they have enough financial knowledge and experience to evaluate the risks and merits of the investment. Under such circumstances, investors will be required to self-certify their accredited or sophisticated investor status, and no issuer or third party review is mandated.
Notably, any non-accredited investor must receive comprehensive disclosure documents similar to those provided in Regulation A offerings. Accredited investors, however, can participate without such detailed disclosures. Despite this, since all issuers selling securities under Regulation D are subject to the antifraud provisions of the federal securities laws, it is best practice to provide comprehensive disclosure to all investors via a Private Placement Memorandum (PPM).
Pros and Cons of Rule 506(b[JS2] ):
One of the biggest advantages of Rule 506(b) is the ability to include non-accredited, sophisticated investors, which can be especially helpful for first-time syndicators or those with a strong network of investors who may not all meet the accredited investor qualifications. The flexibility of including non-accredited investors can make it easier to reach fundraising goals, especially if the sponsor has developed a trusted investor base over time. Furthermore, a significant benefit of Rule 506(b) is that sponsors are not required to verify that the investors are accredited investors. Instead, they can rely on self-certification, where investors simply attest to meeting the accredited investor criteria, such as income or net worth thresholds. This process makes the offering much less burdensome for both the sponsor and the investor, reducing administrative costs and eliminating the need for documentation like tax returns or financial statements. While this simplifies the process, sponsors still have the responsibility to ensure that any non-accredited investors are “sophisticated,” meaning they have enough knowledge and experience to understand the risks involved.
However, the limitation on general solicitation can be a significant drawback, particularly for syndicators who are looking to expand their investor network beyond personal or professional contacts. For first-time syndicators or those with a limited network of accredited investors, Rule 506(b) may be the more favorable option, as it allows the sponsor to approach friends, family, and colleagues who may not qualify as accredited investors. However, these offerings rely heavily on the sponsor’s existing relationships, which could limit the amount of capital they can raise over time. The cost of capital should also be closely considered, given the heightened disclosure requirements that apply when selling securities to non-accredited investors.
Rule 506(c): Lifting the Ban on General Solicitation
Key Features:
Rule 506(c) was born from Title II of the JOBS Act and provides more flexibility in terms of marketing and solicitation. Unlike Rule 506(b), sponsors conducting an offering under Rule 506(c) are allowed to engage in general solicitation[1] and advertise the investment opportunity to the public. This makes it possible to reach a much broader audience through online marketing, social media, email campaigns, and other public forums.
However, the trade-off for the ability to solicit widely is that Rule 506(c) offerings are strictly limited to accredited investors. Sponsors must take “reasonable steps” to verify that each investor meets the accredited investor criteria, which can be more rigorous than the self[JS3] [RS4] -certification allowed under Rule 506(b). Sponsors typically must verify that an investor meets the accreditation criteria as outlined above by requesting and reviewing tax returns and asset statements, license registrations, and corporate documents, as necessary, or by obtaining third-party certifications from attorneys, investment advisors, brokers, or accountants, among other methods of verification.
Pros and Cons of Rule 506(c):
The major advantage of Rule 506(c) is the ability to use public marketing to attract investors, which can be particularly beneficial for syndicators who have exhausted their immediate network or are looking to raise larger amounts of capital. The ability to advertise can also help newer syndicators expand their presence in the real estate investment community, offering visibility to their projects. However, the limitation to accredited investors can narrow the potential investor pool, particularly for first-time syndicators or those who don’t have access to a wide network of high-net-worth individuals. Additionally, the mandatory verification process for accredited investors adds a layer of administrative burden, as sponsors must ensure they are compliant with the SEC’s accreditation verification standards. This can involve requesting sensitive financial documents from investors, which may be a deterrent for some potential investors.
Tech-enabled service providers like Bootstrap Legal can help you to confidentially, efficiently, and conveniently verify investors’ accredited statuses. For sponsors conducting offerings in reliance on Reg D, Rule 506(c), working with such a third party often reduces friction with investors and supports a compliant outcome.
For experienced syndicators with an established track record and who are ready to scale their operations, Rule 506(c) offers tremendous flexibility. The ability to market openly means sponsors can reach new investors and raise capital faster, particularly if they are targeting high-net-worth individuals or institutional investors. Conversely, for first-time syndicators, the restriction to accredited investors might pose a challenge if their existing network doesn’t meet those qualifications.
Conclusion
Navigating the complexities of capital raising can be challenging, especially when it comes to choosing the right exemption under Regulation D. Both Rule 506(b) and Rule 506(c) offer unique benefits, allowing real estate syndicators to structure their offerings in ways that suit their particular goals, networks, and marketing strategies. Rule 506(b) provides the flexibility to include non-accredited, sophisticated investors and self-attestation, which is advantageous for those with a close-knit network not exclusively comprised of accredited investors. Meanwhile, Rule 506(c) opens the door to broader marketing opportunities, giving sponsors the chance to scale quickly by reaching accredited investors through general solicitation.
Ultimately, the best choice depends on your syndication’s needs, investor relationships, and long-term objectives. With the right planning and a thorough understanding of the regulations, you can confidently raise the capital needed for your real estate venture while staying compliant. Remember, each path comes with trade-offs, so carefully assess what aligns best with your project’s scale, target investors, and compliance capabilities. With these insights in hand, you’re well-equipped to make an informed decision that supports your growth and investment goals.
[1] The rule states that general solicitation includes, but is not limited to, “any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and … [a]ny seminar or meeting whose attendees have been invited by any general solicitation or general advertising.” 17 C.F.R. § 230.502(c).