What passive investors should know about 506b and 506c syndications

In 2012, the Jumpstart Our Business Startups Act (JOBS Act) was signed into law. The bill allowed businesses to advertise and sell securities, but only if they were made available to accredited investors that are verified. After the JOBS Act was passed, the existing Rule 506 was split into two sections: 506b and 506c.

While rule 506b and 506c are similar in many respects, there are some key differences that passive investors should keep an eye on.

506(b) Syndications

The original rule, which is now known as Rule 506(b), allows businesses to raise as much capital as they would like, from an unlimited number of accredited investors, and up to 35 sophisticated investors.

An accredited investor, according to the SEC, is anyone who earned at least $200,000 for the past two years and is expected to have an income of $200,000 in the current year. Investors who don’t meet that income threshold but have a net worth above $1 million (excluding their primary residence), are also considered accredited investors. For couples to qualify, their income must be a minimum of $300,000, or they must meet the same net worth requirement.

A sophisticated investor does not meet the income or net worth requirements to be an accredited investor, but has sufficient experience and/or knowledge in business, financing, and investments in order to properly evaluate the risks and rewards of an investment.

Under the rules of 506(b), investors can go through a self-certification process that confirms they meet the definitions of an accredited or sophisticated investor.

Companies or sponsors that sell securities under rule 506(b) are not allowed to use any form of general advertising to promote their deal offering. To comply with this law, the sponsor has to prove that they have a pre-existing and substantial relationship with you, the investor, before they present you with any investment offerings.

506(c) Syndications

The new rule, 506(c), allows issuers who are selling securities to generally advertise, as long as they only make offerings to accredited Investors. If you are not an accredited investor, you are not eligible to invest in 506(c) syndications

Self certification is not allowed under rule 506(c). To qualify for the 506(c) rule exception, an issuer has to follow steps to verify that all of their investors are accredited at the time they made their investment. As an investor, this means the issuer must review or hire somebody to review your financial information, such as W-2s, tax returns, brokerage statements, and credit reports in order to verify that you meet the criteria to be an accredited investor.

Major Differences Between the 506(b) and 506(c) Exceptions

To recap, the major differences between the 506(b) and 506(c) exceptions are:

• - Investors are allowed to self-certify under 506(b), but not 506(c)
• - If you are a non-accredited investor, you are only legally allowed to invest in 506(b) syndications
• - You must have a substantive, pre-existing relationship for 506(b) syndications, but not 506(c)
• - General solicitation and advertising isn’t allowed for 506(b) but is for 506(c)