April 26, 2017
Regulation D Rule 506(b)
THIS DOCUMENT IS FOR INFORMATIONAL PURPOSES ONLY. THIS DOCUMENT IS NOT TO BE CONSTRUED AS LEGAL ADVICE.
Of the various exemptions from full-fledged registration with the SEC, Rule 506(b) of Regulation D is our preferred offering exemption. 506(b) is the traditional exemption from SEC registration and often makes the most sense for multifamily syndications.
Under 506(b) solicitation and advertising of a private offering is prohibited. The standard means of acquiring investors is via a pre-existing relationship. Generally, we recommend at least three (3) meetings with the individual before discussions of investing, and this relationship should exist prior to the property going under contract.
506(b) allows issuers to raise an unlimited amount of capital; however there are restrictions on whom you can raise the money from. Under 506(b) eligible investors include up to 35 sophisticated unaccredited investors and unlimited number of accredited investors. Below gets into what each of those two terms mean.
As opposed to 506(c), the verification process is self-certification, and an investor questionnaire along with a reasonable belief you are receiving accurate information is the general means of accomplishing this.
Another major benefit of 506(b) compared to other offering types is that it preempts state law. In other offering exemptions you have to be particularly careful you are not only following the federal exemption; but also the states securities regulations as well. What federal preemption means in terms of 506(b) is that as long as you are in compliance with the federal regulation, you are in compliance with the states’ regulations as well.
Issuers should be filing Form D with the SEC (your attorney should handle this). Typically, the only state requirement is a notice filing with a copy of Form D and a filing fee in each state an investor resides in (New York is the exception to this rule as their requirements are more onerous).
What is an Accredited Investor?
A natural person can be an accredited investor via one of several ways. The first is an annual income exceeding $200,000 in each of the prior two years and reasonably expecting the same for the current year. This definition of an accredited investor can also be met if an individual together with a spouse combines for at least $300,000 annual income each of the last two years and reasonably expects same for the current year.
The second manner a natural person can be an accredited investor is to have a net worth of over $1,000,000 excluding the value of the person’s primary residence.
A bank, insurance company, registered investment company, employee benefit plan if the investment decision is made by a bank, insurance company, or registered investment adviser; or an employee benefit plan with more than $5,000,000 of assets are all accredited investors.
A private business development as defined in Section 202(a)(22) of the Investment Advisers Act of 1940 is an accredited investor. These are generally the private venture capital entities.
Business entities (partnerships, corporations, etc.) and trusts will also be deemed to be accredited investors if the entity owns assets in excess of $5,000,000 and is not formed for the specific purpose of acquiring the interests offered.
What is a Sophisticated Unaccredited Investor?
A sophisticated unaccredited investor is loosely defined by the SEC. Obviously they are unaccredited if they do not meet any of the standards listed above. However, to be considered “sophisticated” they must have “sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.”
If you have any questions, please feel free to contact us at the number listed above.