Rule 506(b) of Regulation D is the most commonly used registration exemption when companies raise capital through private securities offerings. This Rule generally allows companies to receive unlimited funding from an unlimited number of accredited investors as long as these companies refrain from conducting general solicitation during the process. Below, we offer some suggestions that can help your company and its agents, officers, and brokers avoid engaging in general solicitation or advertising, which can potentially put at risk your capital raising efforts.
Only a Pre-existing Substantive Relationship
Companies operating under Rule 506(b) must only solicit and offer investment opportunities to individuals with whom they already have a “pre-existing substantive relationship.” According to the SEC, a substantive relationship refers to the company (or a representative of the company) possessing adequate information to assess a potential investor’s financial status and level of sophistication, in order to determine whether the investor has accredited investor status or sophisticated investor status, and, that the company (or its representative) does in fact make this assessment.
Under Rule 506(b), a prospective investor may self-certify as an accredited investor, however, the company must evaluate the prospective investor’s financial status and sophistication in order to develop a substantive relationship with the prospective investor. This involves the prospective investor responding to the company’s request (or the broker-dealer representing the company) to fill out a supplied questionnaire that allows the aforementioned evaluation.
In addition to the relationship being substantive, it must also be “pre-existing” in order to avoid general solicitation. In other words, the relationship between the company and the prospective investor must have been developed prior to the issuing of the securities offering. If a broker-dealer is representing the company in this process and the broker-dealer had a pre-existing relationship with the prospective investor prior to the broker-dealer’s participation in the offering, the SEC’s pre-existing requirement is then fulfilled.
No Solicitation Through Mass Communication
The company (and its representatives) must not share the existence or terms of the securities offering or any materials associated with the offering with the press or the general public. The prohibition includes any mass communication to advertise the offering, including the use of cold callings, mass mailings, mass emails, or advertisements through social media or on websites. General solicitation would also include any types of requests to contact the company for more information about the offering or to attract interested investors.
Limit Fundraising Activities to Select Individuals or Groups
As mentioned above, to avoid general solicitation your fundraising activities as an issuer must be restricted to those with which it has a pre-existing and substantive relationship. These individuals may include past or current investors in your company, investors in any previous companies you have owned, or your family and friends.
Solicitations for investors should be limited to individuals (prospective investors) with whom you have had a pre-existing relationship for at least 30 days prior to the issuance of your securities offering, and about whom you have information regarding their financial circumstances and sophistication.
It is important to follow these and any other requirements and guidelines about avoiding the practice of general solicitation under Rule 506(b) in order to ensure your compliance with securities law, avoid penalties or sanctions, and preserve your securities offering.
