When the JOBS Act became law, for the first time, startup companies were permitted to raise funds publicly. This modification was made as part of the Title II JOBS Act in September 2013. The change removed the longtime ban on general solicitation. This was done by creating two separate Rules – 506(b) and 506(c) – from the existing Rule 506.
Fundraising Under Rule 506(b)
The original 506(b) exemption allows startup companies to raise money from an unlimited number of accredited investors and 35 non-accredited investors. The issuer relies on the word of the investor as to their accredited status. The startup may raise an unlimited amount of money under this Rule.
Rule 506(b) keeps paperwork to a minimum since it is not necessary under this Rule to verify if an investor is accredited other than by their word. Many startups in the seed stage have used this dependable exemption over the years.
A disadvantage to using 506(b) of the Title II JOBS Act as a startup is the prohibition against speaking publicly about selling the security in your company. You are not permitted to reveal or present the offering in any meeting or seminar in which those attending have been invited by general advertising or solicitation.
Fundraising Under Rule 506(c)
Rule 506(c), on the other hand, allows startups to raise money through general solicitation. However, the Rule prohibits investors from raising money from non-accredited investors. Also, startups must take reasonable steps to verify that all investors are accredited investors.
Startups can use Rule 506(c) of the Title II JOBS Act if they want to advertise the sale of their securities to the general public via TV, websites, billboards, public events, etc. Although general solicitation is permitted under this Rule, the investors who participate must be accredited investors. This means they must meet the requirements for such per the latest SEC requirements – many of which involve meeting certain income or wealth (net worth) criteria. Startups must also verify that the investors are accredited.
If the startup fails to take reasonable steps to verify the investors are accredited, it may have to return the funds raised and be prohibited from offering securities for an entire year.
