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Definition of Rule 506(b)

Rule 506(b) of Regulation D is the federal securities exemption that startups most often use to raise capital from investors. A startup relying on Rule 506(b) can raise an unlimited amount of money and sell securities to an unlimited number of accredited investors and up to 35 non-accredited investors without having to register the offering with the SEC. In practice, most startups only sell securities to accredited investors, as including any non-accredited investors in the round triggers substantial disclosure obligations under Rule 506(b). Startups must file Form D with the SEC within 15 days after the first sale of securities in the offering and make applicable state securities notice filings.

The reasons Rule 506(b) is a popular exemption for startups include the following:

  1. Startups can raise unlimited capital from investors.
  2. Rule 506(b) preempts state securities laws, meaning the startup won't have to go through the hassle and expense of complying with state laws (though state securities notice filings of Form D are often still required.

Fundraising scenarios where Rule 506(b) may not be viable include the following:

  1. If the startup intends to use general solicitation or advertising to market the offering, it cannot rely on Rule 506(b) as these practices are prohibited. It will instead have to rely on another rule that permits this, like Rule 506(c).
  2. If the startup intends to include non-accredited investors in the offering, it will likely want to look for another exemption. Technically, up to 35 non-accredited investors can be included in a Rule 506(b) offering, but if even one is included, it will necessitate substantial disclosure of information to these investors that often proves prohibitively time consuming and expensive.

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