Raising Capital – Rule 506(c) Offerings Better Than Alternatives


by Jim Verdonik | Feb. 12, 2014

CrowdFunding Chia-Li ChienThere’s been a lot written lately about the SEC’s proposed crowdfunding rules and new Rule 506 (c).

But most of the articles don’t address the bottom line issue:  Which exemption is best for most companies that are trying to raise capital?

Here’s the bottom line answer:  New Rule 506 (c) provides much greater capital raising flexibility than both the proposed crowdfunding rules and traditional private placement exemptions.

Only Rule 506 (c) offerings have all the following advantages that affect your ability to communicate to a wide audience on a cost efficient basis:

– Allow you to use social media, advertising and other solicitations with the only limit being that you are not allowed to commit fraud.  Social media is a cost efficient tool for attracting investors if you know how to use it.
- Allow maximum flexibility about what you disclose to investors and how you disclose it, subject only to the requirement that you not commit fraud.
- Do not require financial statements that have been reviewed or audited by independent accountants no matter how much money you raise.
– Provide an exemption from state rules that require pre-sale filings and reviews by state securities administrators, which can cause delays and extra offering expenses.
– Allow you to raise any amount of capital.
– Have no post-sale filing requirements other than filing Form D with the SEC and some states.

The one downside to Rule 506 (c) offerings is that you must sell only to accredited investors and take reasonable steps to verify that all your investors are accredited.   See my blog post on July 18, 2013 that discusses the accredited investor verification process.

Accredited investor verification is a small price to pay for all the advantages Rule 506 (c) offerings provide.


Financial statement requirements in crowdfunding offerings and Rule 506 (b) and 505 offerings that include non-accredited investors can double or triple your capital raising expenses.  Crowdfunding’s requirement that you must continue to file reports with the SEC for an indefinite time period after you raise money is also a cost burden.  And you can use social media in crowdfunding offerings only if you limit yourself to a notice that is a lot like the traditional “tombstone” ads you see in the Wall Street Journal.  BORING doesn’t sell in social media.  In return for all these limits, the crowdfunding rules will permit you to raise small amounts of money from many investors without worrying whether the investors are accredited.  That’s not a great deal compared to the short-term and long-term costs of complying with the crowdfunding rules.

So, does crowdfunding offer no benefits?


As discussed above, Rule 506 (c) offerings give you great flexibility in what you say, how you say it and what social media and other advertising and solicitation tools you use.  Choices and alternatives are generally good things, but they can present problems.  Using social media effectively is a skill that not every business has.  If you are not effective in how you use social media, your sales effort will fail.  The one stop shop approach that provides all the technology and regulatory compliance will be attractive to some people.

Some people like to do the work to renovate their own homes.  Others prefer to hire a contractor to do it for them.  They either lack the skills to do it themselves or they don’t have the time.  For that they pay a higher price.  Some people will decide to pay the SEC’s regulatory price required to use the proposed crowdfunding exemptions.

The primary benefits of crowdfunding platforms is that they will offer a clear pathway for investors and businesses to meet.  This will be particularly true of crowdfunding platforms that specialize by industry.  They will attract investors that are interested in that particular industry.

Think of it like cable TV channels.  If you want the news, you know what channels specialize in news.  The same goes for movies, history, travel and cooking.  Investors seeking certain types of deals will gravitate to crowdfunding platforms that specialize in their type of deal.  That’s a valuable service.

Of course, having the best of both crowdfunding platforms channel to investors and Rule 506 (c) flexibility is what most people will probably choose.

There is no reason why you have to accept the restrictions of the SEC’s crowdfunding rules to take advantage of crowdfunding platform services.  If you comply with Rule 506 (c)’s accredited investor verification rules, you will be able to do Rule 506 (c) offerings through crowdfunding platforms.  Indeed, until the SEC’s proposed crowdfunding rules become effective, these hybrid offerings types of offerings will be the only deals you can do through crowdfunding platforms.

Crowdfunding platforms will be one of many types of technology and marketing services people operate to facilitate 506 (c) offerings.  That will allow businesses raising capital to use social media in creative ways to drive people to their crowdfunding platform offering instead of being limited to ineffective tombstone advertisements.  Another benefit of combining Rule 506 (c) with crowdfunding platforms will be that you can avoid the SEC’s proposed requirement that you use only one crowdfunding platform.  Rule 506 (c) contains no such restriction.  So, you can use multiple channels to communicate with investors.

Combining crowdfunding technology with Rule 506(c) offerings will present some regulatory and technical challenges to the intermediaries who operate crowdfunding platforms, but it will offer many benefits to businesses raising capital.

Of course, no single exemption is best in every circumstance for every company trying to raise capital.

Here’s a table that shows the requirements for eight different offering exemptions, including proposed crowdfunding rules and traditional Rule 506 (b) offerings.

Judge for yourself which type of offering exemption gives you the best deal:

SEC SECURITIES OFFERING EXEMPTIONS

 

Crowd Funding
(Proposed Regulations not in effect)

Rule 506 (c)

Rule 506 (b) 
(if have all Accredited Investors)

Rule 506 (b) 
(if include any non-accredited investors)

Social Media and Other Advertising Permitted

Yes, but only limited advertising outside the intermediary’s portal

Yes, limited only by anti-fraud rules

No

No

Exemption from State Securities Filings Before Sale

Yes (1)

Yes(1)

Yes (1)

No

Allows Sales to Non-Accredited Investors

Yes

No

Yes

Yes

Accredited investor Verification Required

No

Yes

No

No

Dollar Limits

$1 million in 12 months

No

No

No

Specific Disclosure Rules Apply

Yes, very structured disclosure

No, only anti-fraud rules apply

No, only anti-fraud rules apply

Yes, very structured disclosure(2)

Audited Financial Statements Required

Yes unless less than $100,000 (3)

No

No

Yes(4)

Required to file with SEC

Yes

Form D (5) (6)

Form D (5)

Form D (5)

Post-Offering Reporting Obligations

Yes, burdensome post offering filings

Form D

Amendments

(5)

Form D Amendments

(5)

Form D Amendments

(5)

Integration

Risks with  other Offerings

Unclear (7)

Yes (7)

Yes (7)

Yes (7)

Limits on Amounts any Single Investor Can Invest

Yes.  Limits are based on investor net assets and income levels.

No

No

No

 

SEC SECURITIES OFFERING EXEMPTIONS

 

 

Rule 505 (if have all Accredited Investors)

Rule 505 if include any non-accredited investors)

Rule 504

Section 4 (2)

Social Media and Other Advertising Permitted

No

No

No

No

Exemption from State Securities Filings Before Sale

No

No

No

No

Allows Sales to Non-Accredited Investors

Yes

Yes

Yes

Yes

Accredited investor Verification Required

No

No

No

No

Dollar Limits

$5  million

$5 million

$1 million in 12months

No

Specific Disclosure Rules Apply

No, only anti-fraud rules apply

Yes, very structured disclosure

(2)

No, only anti-fraud rules apply

No, only anti-fraud rules apply

Audited Financial Statements Required

No

Yes (4)

No

No

Required to file with SEC

Form D (5)

Form D(5)

No

No

Post-Offering Reporting Obligations

Form D Amendments

(5)

Form D Amendments

(5)

No

No

Integration

Risks with  other Offerings

Yes (7)

Yes (7)

Yes (7)

Yes (7)

Limits on Amounts any Single Investor Can Invest

Any investor can invest up to the $5 million total offering limitation amount.

Any investor can invest up to the $5 million offering limitation amount..

Any investor can invest up to the $1 million total offering limitation amount.

No

 

  1. (1)   Post- sale filing requirements of states are not pre-empted.  Fraud provisions of state laws are not pre-empted.
  2. (2)   Rule 502 (b) requires to the extent material to an understanding of the issuer, its business and the securities being offered the information required by Part II of Form 1-A of Regulation A, but special rules apply to public reporting companies and foreign private issuers.
  3. (3)   Proposed rules require for offerings greater than $500,000, audited financial statements, but (i) for offerings $100,000 or less, issuers can substitute their income tax return and financial statements certified by the issuer’s principal executive officer, and (ii) for offerings between $500,000 and $500,000, issuers can substitute reviewed financial statements.
  4. (4)   Rule 502 (b) requires to the extent material to an understanding of the issuer, its business and the securities being offered three different audit requirements depending on the size of the offering: (i) for offerings up to $2,000,000, the financial statements required by Article 8 of Regulation S-X, except that only the balance sheet as of a date not more than 120 days before the offering begins nee sot be audited, (ii) for offerings up to $7,500,000. audited financial statements that a “small reporting company” would be required to file in a registration statement on Form S-1, bit if the issuer cannot obtain audited financial statements without unreasonable effort or expense, then only the issuer’s balance sheet, which shall be dated within 120 days of the start of the offering, must be audited, and (iii) for offerings over $7,500,000, the financial statement required in a registration statement on the form that the issuer would be entitled to use, but if the issuer cannot obtain audited financial statements without unreasonable effort or expense, then only the issuer’s balance sheet, which shall be dated within 120 days of the start of the offering, must be audited.  Special rules apply to issuers that are limited partnerships.
  5. (5)   Rule 503 (a) requires filing Form D within 15 calendar days after the first sale.  Amendments must be filed to reflect changes and to correct mistakes.
  6. (6)   Proposed rule change would require issuers in a Rule 506 (c) offering to file Form D 15 days before the first offer is made and to file advertising the same day the advertising occurs.
  7. (7)  Integration poses the biggest risk for businesses that are active in capital raising.  Integration is a concept the SEC and state securities regulators use to combine what are nominally two or more securities offerings into one securities offering.  Integration can destroy your exemptions.  It is unclear how the SEC will deal with crowdfunding and other offerings that are either being conducted at the same time or within six months of one another.

 

About Jim Verdonik

If you would like to learn more about learning how to grow your business or other issues important to your success, you can reach me at JFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075 or http://www.youtube.com/user/eLearnSuccess or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW
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About Chia-Li Chien

Chia-Li Chien

Chia-Li Chien, CFP®, CRPC, PMP; Chia-Li “like JOLLY,” Succession Strategist of Value Growth Institute, dedicated to helping private business owners increase their company equity value. She is the award-winning author of the books Show Me The Money and Work toward Reward and a faculty of the American Management Association. Her blog and newsletter was named a Top Small Business Resource by the New York Times You’re the Boss blog. Contact her at jolly@chialichien.com or (704) 268-9378 .

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