Rule 506(b) under Regulation D lets businesses raise unlimited funds privately without SEC registration. But there’s a catch: you can’t use public advertising or general solicitation. This means no public posts, mass emails, or social media campaigns. Instead, you must have a pre-existing, substantive relationship with potential investors before discussing deals. Violations can void your exemption, leading to legal and financial penalties.
Key Points:
- Who Can Invest? Unlimited accredited investors and up to 35 sophisticated non-accredited investors.
- No Public Solicitation: All communications must stay private and targeted to known contacts.
- Documentation Required: File Form D with the SEC within 15 days of your first sale.
- Consequences of Non-Compliance: Loss of exemption, rescission claims, SEC penalties, and potential state-level fines.
To stay compliant:
- Build relationships with investors before sharing offering details.
- Use password-protected platforms for deal materials.
- Train your team to avoid accidental solicitation (e.g., social media posts).
- Leverage tools to track investor interactions and deadlines.
506(b) vs. 506(c): Choose 506(b) for private, relationship-based fundraising or 506(c) for public marketing with stricter investor verification. Both require careful adherence to SEC rules and documentation.
What Counts as General Solicitation
How the SEC Defines General Solicitation
The SEC describes general solicitation as any public communication – whether through print, broadcast, or digital channels – that is openly accessible to individuals without a pre-existing relationship. Examples include public webinars, widely advertised seminars, or unrestricted online content that stirs interest in a future offering.
If someone without an established connection can access offering details, it qualifies as general solicitation. This includes content on public websites, social media posts, or any digital material that isn’t secured by password protection. Even if the communication doesn’t directly mention securities, it can still cross the line if it “conditions the market” by generating interest in a future offering.
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Grasping these boundaries is critical for recognizing activities that may breach these rules.
Activities That Violate the Rules
Now that the scope of general solicitation is clear, let’s look at specific activities that can lead to violations. Some actions, though seemingly harmless, can fall afoul of the rules. For example, Munchee Inc. and AriseBank faced SEC actions for using public blog posts, social media, and mass communications that referenced offering specifics. Violations can include sharing details like raise amounts or deal terms on platforms such as LinkedIn or Twitter, sending mass emails, or cold-calling individuals without prior relationships.
Tilden Moschetti, Esq., highlights this common pitfall:
"The most common 506(b) mistake is the innocent-looking social media post that blows the exemption."
What Communications Are Allowed
Acceptable communications are limited to factual business updates that don’t spark public interest in a specific securities offering. Building investor relationships offline, using password-protected portals for offering materials, and tracking interactions through CRM systems are all compliant practices. The key is ensuring relationships are verified before discussing any deal terms.
The Citizen VC, Inc. No-Action Letter from August 2015 offers a useful compliance guide. Citizen VC established relationships by connecting with potential investors offline via phone calls to discuss their investing experience and goals. They verified identities using third-party credit reports and fostered meaningful interactions before granting access to a password-protected portal for offering details. This process met the SEC’s requirements while maintaining digital efficiency.
This underscores the importance of having a pre-existing relationship in place before sharing specifics about an offering.
Consequences of Breaking Non-Solicitation Rules
Failing to follow non-solicitation rules can lead to serious consequences that impact both the business and its leadership.
Losing Your Exemption Status
Violating general solicitation rules can strip you of your Rule 506(b) exemption. Without this exemption, your private placement is reclassified as an unregistered public offering. This opens the door for investors to demand rescission, requiring you to return their entire investment plus interest.
For example, in December 2017, the SEC stepped in to halt Munchee Inc.’s unregistered offering due to unauthorized public solicitation. The company was forced to stop its offering and return all proceeds to investors before any tokens were issued.
SEC Penalties and Investigations
The SEC doesn’t take violations lightly. Penalties can include lengthy enforcement actions, which are both costly and time-consuming. These investigations can drain resources and divert attention from growth initiatives. Potential consequences include injunctions, cease-and-desist orders, and the requirement to return funds.
Take the case of AriseBank in January 2018. The SEC obtained an emergency court order to stop their unregistered offering, which had used general solicitation to raise $600 million. The result? A freeze on assets, the appointment of a receiver, and the complete shutdown of operations.
Perhaps even more damaging is the "Bad Actor" disqualification. This penalty can bar both the issuer and its management from using Regulation D exemptions for future fundraising – typically for 5 to 10 years. As Tilden Moschetti, a syndication attorney at Moschetti Law, warns:
"Good counsel costs far less than rescission claims and investigations."
State Law Penalties
Even though Rule 506(b) preempts state registration requirements, states still have the power to investigate fraud and enforce penalties. Depending on where your investors reside, you may need to file notices and pay fees. Failing to meet these obligations can trigger state-level enforcement under Blue Sky laws.
State penalties often add to federal ones, leading to fines, administrative actions, and cease-and-desist orders. This creates additional regulatory hurdles for startups, emphasizing the importance of strong internal compliance – something we’ll explore next.
How to Stay Compliant with Rule 506(b)
To stay on the right side of Rule 506(b), focus on building strong pre-existing relationships, managing communications carefully, and ensuring your team is well-trained in compliance protocols. Join our AI Acceleration Newsletter here for weekly updates on compliance strategies. Below, you’ll find specific steps to help you navigate these requirements effectively.
Building Relationships Before You Fundraise
Rule 506(b) is all about relationships – it’s not about broadcasting your deal to the masses. To comply, you must establish a pre-existing substantive relationship with every investor before presenting your offering. This involves understanding their financial situation and investment experience well in advance.
Keep detailed records of investor interactions. Document when and how you first connected with each investor, and note the point at which the relationship became substantive – when you gained insight into their financial goals, risk tolerance, and experience.
A great example is Citizen VC’s approach. Their process begins with a questionnaire and continues with offline calls, creating verifiable pre-existing relationships.
Set a clear timeline for relationship-building. Use this period to send introductory emails, hold phone calls, and share educational materials about your business. These interactions should focus on your investment philosophy and general information – not the specifics of your current offering. Once you’ve assessed the investor’s sophistication and built trust, you can move forward with discussing deal terms.
How to Communicate with Investors Safely
Once you’ve verified relationships, it’s crucial to handle communications securely. Use password-protected portals to store offering materials, and limit discussions about deal terms to private channels. These could include direct emails, private video meetings, or small, invitation-only events with established contacts.
You can share general business information – like details about your products or financial condition – publicly, but avoid anything that could be interpreted as an "offer" or an attempt to condition the market for your raise.
"Rule 506(b) is a relationship game, not a broadcast game. If you want to blast your deal to the world, that is 506(c), not 506(b)." – Tilden Moschetti, Esq., Syndication Attorney
Creating Internal Compliance Policies
Staying compliant also requires strong internal policies. Train your team on the rules around non-solicitation – one careless post on social media could jeopardize your exemption. Develop written policies that ban publicizing deal terms and ensure all investor communications go through approved channels.
Implement compliance safeguards. File Form D with the SEC within 15 days of your first securities sale. Conduct annual "Bad Actor" questionnaires for key individuals, including officers, directors, and anyone holding 20% or more of voting equity. Use standardized investor questionnaires to confirm accredited or sophisticated status before granting access to your Private Placement Memorandum.
If you’re considering working with non-accredited investors (up to 35 are allowed), establish a clear policy from the start. Be aware that including non-accredited investors comes with additional disclosure requirements and costs. To avoid this complexity, many founders choose to work exclusively with accredited investors.
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Rule 506(b) vs. Rule 506(c): Which to Choose
Rule 506(b) vs 506(c) Fundraising Comparison Chart
Deciding between Rule 506(b) and Rule 506(c) largely depends on how you plan to approach investors and the type of investors you want to include. Rule 506(b) focuses on relationship-driven fundraising, allowing up to 35 sophisticated non-accredited investors alongside accredited ones. On the other hand, Rule 506(c) enables public marketing, letting you advertise your offering on platforms like social media or podcasts – but every investor must go through a verification process.
The core difference lies in how investor accreditation is handled. Under Rule 506(b), you can rely on self-certification questionnaires, where investors confirm their status, establishing a "reasonable belief" of accreditation. Rule 506(c), however, requires "reasonable steps" to verify accreditation, which often involves reviewing sensitive documents like tax returns, W-2s, or bank statements, or obtaining verification letters from professionals like CPAs or attorneys. This step adds complexity and may dissuade some investors who are hesitant to share private financial information.
Here’s a breakdown of the key differences:
Side-by-Side Comparison
| Criteria | Rule 506(b) | Rule 506(c) |
|---|---|---|
| Public Advertising | Prohibited (no ads, social media posts, or public mentions) | Permitted (ads, social media, podcasts, and public webinars allowed) |
| Investor Types | Unlimited accredited + up to 35 sophisticated non-accredited | Accredited investors only |
| Verification Method | Self-certification questionnaire (reasonable belief) | Document-based verification (e.g., tax returns, bank statements, or CPA letters) |
| Relationship Requirement | Pre-existing substantive relationship required | No prior relationship needed |
| Disclosure Burden | High if non-accredited investors are included, triggering extensive requirements | Standard disclosures |
| Best For | Relationship-driven, private raises with an existing network | Marketing-focused raises targeting new audiences |
These contrasts can help you determine which rule fits your fundraising strategy.
Go with Rule 506(b) if your focus is on leveraging existing relationships and you want to avoid the hassle of formal verification. This option works well for "friends and family" rounds, where you might include trusted partners or early supporters who fall short of the $200,000 income or $1 million net worth benchmarks but understand the risks involved. Keep in mind that including non-accredited investors raises disclosure requirements significantly, which is why most founders stick to accredited investors under this rule.
Opt for Rule 506(c) if your strategy involves reaching out to new audiences through public marketing. This rule is perfect for campaigns that rely on public channels to attract investors. However, you’ll need to manage – or outsource – the verification process, and be aware that some investors may be reluctant to provide sensitive financial documents. Regardless of the rule you choose, remember that both require filing Form D within 15 days of your first sale and are subject to "bad actor" disqualification rules.
Key Takeaways
To stay compliant, it’s crucial to establish substantive investor relationships before discussing the specifics of any deal. This means carefully documenting every interaction with investors in your CRM. Avoid public advertising, social media posts, or sending mass emails about your raise. Keep your offering limited to accredited investors and up to 35 sophisticated but non-accredited investors. Also, don’t forget to file Form D within 15 days of your first sale – this is absolutely non-negotiable. Want to learn how AI can make compliance easier and help strengthen investor relationships? Check out our free AI Acceleration Newsletter here.
Under Rule 506(b), accreditation verification is simpler, relying on self-certification questionnaires instead of the more detailed documentation required under 506(c). But this simplicity requires strict discipline. For example, use password-protected portals for sharing offering materials, conduct "bad actor" screenings for key managers and 20% owners, and maintain a detailed regulatory file of all communications and filings. This method lays the groundwork for introducing automation tools to streamline compliance further.
AI tools can turn compliance from a tedious manual process into a streamlined, automated advantage. For instance, platforms like M Accelerator’s Elite Founders program can track relationship timelines in your CRM, scan communications to prevent accidental solicitation, and automatically organize regulatory documents. These tools are invaluable if the SEC ever questions your exemption, as they can prove the existence of substantive pre-fundraise relationships.
Deciding between Rule 506(b) and 506(c) should depend on your network and marketing approach. If you have strong existing relationships and want to avoid the hassle of formal income verification, 506(b) is the way to go. But if you need to reach new audiences through public channels and can handle the document-heavy verification process, 506(c) might be a better fit. Just remember: never use both exemptions simultaneously for the same project. Regulators could treat them as one and potentially disqualify your 506(b) exemption.
FAQs
What is a pre-existing substantive relationship under Rule 506(b)?
A pre-existing substantive relationship under Rule 506(b) refers to a connection between a company and a potential investor that enables the company to evaluate the investor’s financial standing and sophistication. For this relationship to qualify, it must be established before any securities offering is made. Typically, this is done through prior meaningful interactions or assessments.
The relationship must be both substantive – providing enough insight to judge the investor’s suitability – and pre-existing, meaning it existed before the offering. This is a critical aspect of adhering to Rule 506(b)’s prohibition on general solicitation.
What steps can companies take to comply with non-solicitation rules under Rule 506(b)?
To stay within the boundaries of Rule 506(b), companies need to steer clear of any general solicitation or advertising for their securities offerings. This means no public posts on social media, no paid ads, and no distributing offering materials to the general public. Instead, the focus should be on connecting with individuals with whom you already have a preexisting substantive relationship. This relationship should provide enough insight into their financial knowledge and sophistication.
For non-accredited investors, companies must go beyond self-certification. Verifying their qualifications through documentation or detailed questionnaires is essential. Additionally, maintaining thorough records of your investor relationships and communications is crucial. These records can serve as evidence of compliance should an audit occur.
If you’re a founder aiming to streamline investor outreach while staying compliant, AI-powered tools can be a game-changer. These tools can simplify processes and help ensure you’re meeting all regulatory requirements.
Want to learn more about using AI to simplify compliance and investor relations? Sign up for our free AI Acceleration Newsletter and get weekly tips on building smarter systems!
What’s the difference between Rule 506(b) and Rule 506(c)?
Rule 506(b) lets you raise funds privately without public advertising. It also allows you to sell to up to 35 non-accredited investors, as long as they’re provided with detailed disclosures about the offering. On the other hand, Rule 506(c) opens the door to public marketing, but restricts sales to accredited investors only, and their accreditation must be verified.
Knowing these distinctions is essential to stay compliant and align your fundraising approach with the right investor audience for your startup.
