Part 2 of 7 in the Capital Raising Series | Veritas Global Law PLLC
When attorneys and investment professionals discuss private placements, Rule 506(b) is often the default starting point—and for good reason. This Regulation D exemption combines unlimited capital-raising potential with a straightforward compliance framework, making it the foundation of countless venture capital investments, private equity transactions, and fund formations.
Yet 506(b)’s apparent simplicity masks important nuances. The prohibition on general solicitation defines your investor outreach strategy. The option to include non-accredited investors creates disclosure obligations that many issuers prefer to avoid. And the 2020 amendments to Regulation D changed the disclosure landscape in ways that affect offering structures today.
This article provides a comprehensive examination of Rule 506(b)—not just its requirements, but the strategic considerations that determine whether it’s the right exemption for your capital raise.
The Core Framework: What Rule 506(b) Offers
Rule 506(b) provides several fundamental advantages that explain its popularity:
• No Dollar Limit: Unlike Rule 504 ($10 million cap) or Regulation CF ($5 million), Rule 506(b) imposes no ceiling on the amount you can raise. Whether you’re seeking $500,000 in seed funding or $500 million for a private equity fund, the same exemption applies.
• Federal Preemption: Securities offered under Rule 506(b) are “covered securities” under the National Securities Markets Improvement Act, meaning state registration requirements don’t apply. While states can require notice filings and collect fees, they cannot impose substantive review or additional registration hurdles. For issuers raising from investors across multiple jurisdictions, this preemption provides significant practical advantages.
• Flexible Investor Base: Rule 506(b) permits unlimited accredited investors and up to 35 non-accredited investors who meet certain sophistication requirements. This flexibility distinguishes 506(b) from Rule 506(c), which requires all investors to be accredited.
• Self-Certification for Accredited Status: Unlike Rule 506(c), which requires issuers to take reasonable steps to verify accredited investor status, Rule 506(b) permits reliance on investor self-certification. A well-drafted accredited investor questionnaire typically satisfies this requirement, reducing both cost and friction in the investment process.
The General Solicitation Prohibition: What It Actually Means
The defining characteristic of Rule 506(b)—and its most significant limitation—is the prohibition on general solicitation and general advertising. Understanding what this means in practice is essential for any issuer considering this exemption.
General solicitation includes any offer made through public communication channels: advertisements in publications, broadcasts, mass mailings, seminars with general invitations, publicly accessible websites, and social media posts directed at the general public. The core question is whether the communication is directed at persons with whom the issuer (or its agents) has a pre-existing, substantive relationship.
What Constitutes a Pre-Existing Relationship?
The SEC has provided guidance indicating that a pre-existing relationship exists when the issuer has sufficient information to evaluate the prospective investor’s sophistication and financial circumstances—and had this relationship before the offering commenced. The relationship needn’t be lengthy, but it must be “substantive” rather than merely formal.
This creates practical implications for how you source investors:
• Existing business relationships—customers, suppliers, partners—typically qualify, provided they predate the offering.
• Professional networks—attorneys, accountants, financial advisors—may introduce investors with whom they have pre-existing relationships.
• Angel groups and investor networks can work within 506(b) if they pre-qualify members before presenting specific investment opportunities.
• Cold outreach—whether by email, LinkedIn, or any other channel—generally constitutes general solicitation and is prohibited.
Demo Days and Pitch Events
Startup accelerators and incubators frequently host demo days where portfolio companies present to potential investors. Whether these events constitute general solicitation depends on who is invited. If attendance is limited to persons with whom the organizer has pre-existing relationships—and who have been pre-screened for sophistication and accredited status—the event may be structured to comply with 506(b). Open invitations or publicly advertised events present problems.
Many accelerators now structure demo days under Rule 506(c) to permit broader attendance, or carefully limit invitations to maintain 506(b) compliance. Understanding your program’s approach—and ensuring your own communications align with it—is essential.
Non-Accredited Investors: The 35-Investor Rule and Its Implications
Rule 506(b) permits inclusion of up to 35 purchasers who are not accredited investors, provided each such investor (either alone or with a purchaser representative) has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the investment. This provision creates optionality that distinguishes 506(b) from 506(c)—but exercising this option triggers substantial compliance requirements that warrant careful consideration.
The Sophistication Standard in Practice
Unlike accredited investor status—which relies on objective thresholds for income, net worth, or professional credentials—sophistication is a subjective, fact-specific determination. The SEC and courts examine whether the investor possesses sufficient knowledge and experience to evaluate the merits and risks of the particular investment being offered.
Factors relevant to a sophistication determination include:
• Educational Background: Degrees or coursework in business, finance, accounting, or related fields may support sophistication, though formal education alone is rarely sufficient.
• Professional Experience: Work history in finance, investment management, corporate leadership, or the issuer’s industry carries significant weight. A CFO with years of experience analyzing investments differs materially from someone without financial background.
• Prior Investment History: Experience with private placements, venture investments, or similar illiquid securities demonstrates familiarity with the risks involved. Investors who have participated only in public market investments may lack relevant experience.
• Understanding of Specific Risks: The investor must be able to evaluate the particular risks of the offering—not just investment risk generally. An experienced real estate investor may not be sophisticated for a biotech investment, and vice versa.
• Access to Information: The ability to obtain and analyze information about the issuer, either independently or through advisors, supports a sophistication finding.
A successful entrepreneur without significant wealth might qualify as sophisticated; a wealthy individual who inherited assets but has no investment experience might not. The determination is highly contextual, and issuers bear the burden of establishing that each non-accredited investor met the standard at the time of investment.
Documenting Sophistication: Best Practices
Because the sophistication standard is subjective and may be challenged years after an offering closes, contemporaneous documentation is essential. Issuers should implement a systematic process for evaluating and documenting each non-accredited investor’s qualifications.
Recommended documentation practices include:
• Detailed Questionnaires: Go beyond basic yes/no questions. Ask specifically about educational background, professional experience, prior investment history, and familiarity with the issuer’s industry. Request descriptions rather than checkboxes.
• Personal Interviews: For investors whose sophistication is not self-evident from their questionnaire responses, conduct interviews to assess their understanding. Document the conversation, including specific questions asked and responses received.
• Written Representations: Obtain signed representations confirming the investor’s sophistication, their understanding of the investment’s risks, and their acknowledgment that the securities are illiquid and speculative.
• Supporting Documentation: Where available, retain copies of resumes, professional credentials, or other documents that corroborate the investor’s claimed experience.
• Contemporaneous Notes: Record the issuer’s analysis of why each investor was deemed sophisticated, referencing specific factors from the questionnaire and any interview. This memo should be prepared before the investment closes—not reconstructed later.
Red flags that may undermine a sophistication determination include:
• lack of any investment experience beyond savings accounts and public stocks.
• inability to articulate the risks of the specific investment.
• reliance on the issuer’s representations without independent evaluation; and
• financial circumstances suggesting the investor cannot afford to lose the investment.
Purchaser Representatives: An Alternative Path
Rule 506(b) provides an alternative for investors who cannot independently satisfy the sophistication requirement: they may participate if assisted by a “purchaser representative” who meets specified qualifications. This mechanism allows less sophisticated investors to participate while ensuring that someone with appropriate expertise evaluates the investment on their behalf.
Under Rule 501(h), a purchaser representative must satisfy three requirements:
• Sophistication: The representative must have such knowledge and experience in financial and business matters that they are capable of evaluating the merits and risks of the prospective investment—the same standard that would apply to the investor directly.
• No Disqualifying Relationships: The representative cannot be an affiliate, director, officer, or other employee of the issuer, or a beneficial owner of 10% or more of any class of the issuer’s equity securities. However, the representative may be affiliated with the investor (such as a family member or employee of the investor).
• Written Acknowledgments: The representative must provide written disclosure to the investor of any material relationship with the issuer or its affiliates, and the investor must acknowledge in writing that the representative is acting as their purchaser representative.
Attorneys, accountants, and investment advisors often serve as purchaser representatives for their clients. However, the representative’s role is substantive—they must actually evaluate the investment and be available to answer the investor’s questions. A purchaser representative who merely signs paperwork without meaningful engagement creates liability exposure for both the representative and the issuer.
The 35-Investor Counting Rules: Who Counts and Who Doesn’t
The 35-investor limit applies to purchasers, not offerees—an issuer may solicit more than 35 non-accredited investors, provided no more than 35 actually purchase securities. However, the counting rules contain nuances that affect how investors are tallied.
Exclusions from the 35-investor count:
• Accredited Investors: All accredited investors are excluded from the count entirely. An offering could have 500 accredited investors and 35 non-accredited investors without exceeding the limit.
• Relatives: A relative of a purchaser who has the same principal residence as the purchaser counts as a single purchaser together with that purchaser.
• Trusts and Estates: A trust or estate in which a purchaser and any of their relatives collectively hold more than 50% of the beneficial interest counts together with that purchaser.
Entity look-through rules may increase the count:
• Entities Formed for the Purpose of Investment: If a corporation, partnership, trust, or other entity was formed for the specific purpose of acquiring the securities being offered, each beneficial owner of the entity counts separately toward the 35-investor limit.
• Pre-Existing Entities: Entities that existed before the offering and were not formed for the purpose of the investment are generally counted as a single purchaser, provided the entity itself meets the sophistication requirement (typically through its management or governing body).
These counting rules require careful tracking. An issuer approaching the 35-investor limit should analyze each potential non-accredited investor to determine whether they count toward the limit and whether any look-through provisions apply.
Mandatory Disclosure Requirements Under Rule 502(b)(2)
When any non-accredited investors participate in a Rule 506(b) offering, the issuer must provide specific disclosure documents to all non-accredited purchasers. These requirements, set forth in Rule 502(b)(2), constitute one of the most significant burdens of including non-accredited investors.
Following the 2020 amendments harmonizing Regulation D with Regulation A, the disclosure requirements are now tied to Regulation A’s framework. Non-reporting company issuers must provide:
| Offering Amount | Financial Statement Requirement | Additional Disclosures |
| Up to $20 million | Balance sheet dated within 120 days; if audited statements available, they must be provided | Non-financial information required by Part II of Form 1-A |
| $20 million to $75 million | Financial statements reviewed by independent public accountant | Non-financial information required by Part II of Form 1-A |
| Over $75 million | Audited financial statements | Non-financial information required by Part II of Form 1-A |
The non-financial disclosure requirements under Part II of Form 1-A are substantial, including:
• Description of the issuer’s business, including principal products or services, competitive conditions, and dependence on key customers or suppliers
• Risk factors specific to the issuer and the offering
• Use of proceeds from the offering
• Description of the issuer’s property and facilities
• Management’s discussion and analysis of financial condition and results of operations
• Information about directors, executive officers, and significant employees, including compensation
• Related party transactions
• Description of the securities being offered
• Plan of distribution
Additionally, issuers must make available the opportunity to ask questions and receive answers about the offering, and must provide any additional information requested by a purchaser to the extent the issuer possesses it or can acquire it without unreasonable effort or expense.
For accredited-investor-only offerings, no specific disclosure is mandated by Rule 506(b) itself—though anti-fraud provisions still require that any information provided be accurate and complete, and that material information not be omitted.
Liability Exposure and Rescission Risk
Including non-accredited investors creates liability exposure that extends well beyond the offering period. If an issuer’s sophistication determination is later found deficient, or if required disclosures were inadequate, the consequences can be severe.
Rescission Rights: Investors in a defective private placement may have the right to rescind their investment—meaning the issuer must return their investment plus interest, regardless of the company’s current financial condition. In a failed venture, this creates a claim against whatever assets remain. In a successful venture, it allows investors to recapture their investment while other shareholders bear the dilution of subsequent financings.
Loss of Exemption: A single deficient non-accredited investor can potentially invalidate the exemption for the entire offering. If Rule 506(b) was not properly satisfied, the offering may constitute an unregistered public offering in violation of Section 5 of the Securities Act. This exposes the issuer and potentially its officers and directors to SEC enforcement, as well as private rescission claims from all investors—not just the non-accredited ones.
Statute of Limitations Considerations: Under federal securities law, rescission claims generally must be brought within one year of discovery of the violation (or when it should have been discovered) and within three years of the sale. However, state law claims may have different, sometimes longer, limitation periods. An issuer cannot assume that the passage of time has eliminated exposure.
Burden of Proof: In any dispute, the issuer bears the burden of proving that the exemption was properly satisfied. This includes demonstrating that each non-accredited investor was sophisticated, that all required disclosures were provided, and that no general solicitation occurred. Inadequate contemporaneous documentation makes this burden difficult to meet.
Why Most Issuers Avoid Non-Accredited Investors
Despite the theoretical ability to include non-accredited investors, the vast majority of Rule 506(b) offerings limit participation to accredited investors only. The reasons are practical and economic:
• Disclosure Costs: Preparing the required disclosure documents—particularly audited or reviewed financial statements and comprehensive narrative disclosure—typically costs $25,000 to $75,000 or more in legal and accounting fees. This expense must be incurred before the first non-accredited investor participates.
• Sophistication Documentation Burden: Evaluating and documenting sophistication for each non-accredited investor requires time and creates ongoing administrative overhead. Each additional investor compounds this burden.
• Smaller Check Sizes: Non-accredited investors typically write smaller checks than institutional or high-net-worth accredited investors. The cost of compliance per dollar raised is therefore higher.
• Liability Premium: The enhanced litigation risk from sophistication challenges and disclosure deficiencies creates an implicit cost that sophisticated issuers factor into their exemption selection.
• Ongoing Investor Relations: Non-accredited investors may require more hand-holding, more frequent communications, and more education about the realities of illiquid private investments. This administrative burden continues long after the offering closes.
For most issuers, the calculus is straightforward: limit the offering to accredited investors to minimize cost, complexity, and liability. The 35-investor allowance exists as an option, but exercising it requires careful evaluation of whether the additional capital justifies the substantial additional burden.
The 2020 Disclosure Amendments: What Changed
In November 2020, the SEC adopted amendments to harmonize the disclosure requirements across different exemptions. For Rule 506(b) offerings that include non-accredited investors, the amendments replaced the previous disclosure framework with requirements tied to Regulation A.
Under the current rules, when non-accredited investors participate in a 506(b) offering, issuers must provide financial statement information and other disclosures comparable to those required under Regulation A. The specific requirements depend on whether the issuer is eligible to use Regulation A and the offering amount, as detailed in the disclosure table above.
Form D Filing Requirements
Issuers relying on Rule 506(b) must file a Form D with the SEC no later than 15 calendar days after the first sale of securities. Form D is a brief notice filing—not an application for approval—that provides basic information about the issuer, the offering, and the exemption claimed.
Key Form D considerations:
• Timing: The 15-day deadline runs from the first sale, not the first offer. “Sale” generally means when the investor makes an irrevocable commitment and the issuer accepts it.
• Amendments: If the information in Form D becomes materially inaccurate, or if the offering continues for more than one year, an amended filing is required.
• Public Availability: Form D filings are publicly available through the SEC’s EDGAR database. Investors, competitors, and journalists can access them. Issuers should be aware that filing reveals basic information about their capital raise.
• Failure to File: While failure to file Form D does not automatically disqualify an exemption, it can have consequences. Some states condition their notice filing procedures on timely federal Form D filing, and the SEC has brought enforcement actions in cases involving Form D violations.
State Notice Filing Requirements
Although federal law preempts state registration for Rule 506 offerings, states retain authority to require notice filings and collect fees. Most states have adopted relatively streamlined notice filing procedures, often accepting a copy of the federal Form D along with a state-specific form and fee.
Notice filing requirements vary by state. Some states require filing before the first sale to residents; others allow filing within a specified period after the sale. Fees range from nominal amounts to several hundred dollars. Failure to comply with state notice requirements can result in enforcement actions and may affect the availability of state exemptions for future offerings.
For offerings involving investors in multiple states, tracking and meeting each state’s requirements adds administrative complexity. Many issuers engage service providers who specialize in Blue Sky compliance to manage this process.
Bad Actor Disqualification Under Rule 506(b)
Rule 506(d) disqualifies issuers from relying on Rule 506 (both 506(b) and 506(c)) if certain “covered persons” have experienced specified “disqualifying events.” This bad actor provision requires careful attention early in the offering process.
Who Are Covered Persons?
The bad actor rules apply to:
• The issuer itself, including predecessors and affiliated issuers
• Directors, executive officers, and other officers participating in the offering
• General partners and managing members of the issuer
• Beneficial owners of 20% or more of the issuer’s outstanding voting equity
• Promoters connected with the issuer
• Compensated solicitors and their associated persons, directors, and executive officers
What Are Disqualifying Events?
Disqualifying events include:
• Criminal convictions within the past ten years (five years for issuers) in connection with securities purchases or sales, making false filings, or conduct involving financial institutions
• Court injunctions and restraining orders within the past five years related to securities activities
• Final orders from state securities, banking, insurance, or credit union regulators, federal banking agencies, or the NCUA barring association or involvement in securities, banking, or insurance activities
• SEC disciplinary orders relating to brokers, dealers, investment advisers, or their associated persons
• SEC cease-and-desist orders related to certain securities violations
• Suspension or expulsion from SRO membership or association
• U.S. Postal Service false representation orders within the past five years
Conducting the Bad Actor Inquiry
Issuers must take reasonable steps to determine whether any covered person has a disqualifying event. This typically involves:
• Identifying all covered persons based on their relationship to the issuer
• Distributing questionnaires asking about potential disqualifying events
• Conducting background checks through SEC databases, FINRA BrokerCheck, and state regulatory records
• Documenting the inquiry process and results
If a disqualifying event is discovered, the issuer may still proceed with the offering if: (a) the event occurred before the Rule 506(d) effective date (September 23, 2013) and is disclosed to investors, or (b) the SEC grants a waiver for good cause. Disclosure of pre-existing events doesn’t cure the disqualification—it simply converts what would be an exemption-destroying problem into a disclosure obligation.
Practical Strategies for 506(b) Offerings
Beyond understanding the rules, successful 506(b) offerings require attention to practical execution:
Document Your Pre-Existing Relationships
The general solicitation prohibition means you must be prepared to demonstrate that each investor had a pre-existing substantive relationship with you or your authorized intermediaries. Maintain records of when and how relationships originated—prior business dealings, introductions through professional networks, or qualification through investor platforms that pre-screen members.
Use Robust Accredited Investor Questionnaires
While 506(b) permits self-certification, your questionnaire should be detailed enough to support a reasonable belief that the investor qualifies. Ask about the specific basis for accredited status—income, net worth, or professional credentials—and obtain representations that the information is accurate. This creates a contemporaneous record that can be important if questions arise later.
Coordinate Marketing with Legal Counsel
Founders often underestimate how broad the general solicitation prohibition reaches. A LinkedIn post mentioning that you’re raising capital, a tweet linking to your pitch deck, or a blog post describing your funding round can all constitute general solicitation—even if you don’t include specific offering terms. Review your marketing plans with counsel before launching any communications that reference fundraising.
Plan Your Form D Strategy
Some issuers prefer to file Form D at the last permissible moment to minimize public disclosure of their capital-raising activities. Others file promptly to ensure compliance and avoid any question about timing. Consider your preferences and discuss timing with counsel, keeping in mind state notice filing deadlines that may be triggered by the first sale.
When Should You Consider Rule 506(c) Instead?
Rule 506(b) remains the right choice when:
• Your investors come from existing relationships and networks
• You want to minimize verification burden and cost
• You may want to include sophisticated non-accredited investors
• You prefer a streamlined investment process with self-certification
However, if you need to reach new investors through advertising, online platforms, or public marketing—Rule 506(c) may be the better path. The next article in this series explores Rule 506(c) in depth, including recent SEC guidance that has significantly simplified the verification process.
Take the Next Step
Structuring a Rule 506(b) offering involves more than checking boxes—it requires understanding how the rules apply to your specific situation, investor base, and capital-raising strategy. From documenting pre-existing relationships to navigating state Blue Sky requirements, the details matter.
Schedule a consultation with Veritas Global today. Our securities attorneys can help you evaluate whether Rule 506(b) fits your offering, prepare compliant documentation, and manage the filing process from Form D through state notice requirements.
This article is for informational purposes only and does not constitute legal advice. Securities regulations are complex and fact-specific; consult qualified counsel before structuring any offering.
