# 506(b) vs 506(c) Decision Matrix ## Decision Flowchart ``` START: How will you source investors? | +--> Any general solicitation planned or already conducted? | | | YES --> 506(c) REQUIRED (no choice) | | | | | +--> Can you verify accredited status for every investor? | | | | | YES --> 506(c) confirmed. Design verification process. | | NO --> STOP. You cannot use Reg D 506(c) without verification. | | Consider Reg A+ or restructure to eliminate solicitation. | | | NO --> Continue to next question | +--> Do all investors have documented pre-existing substantive relationships? | | | YES --> 506(b) eligible. Continue evaluation. | NO --> For unrelated investors: | Option A: Build relationships first (takes months) | Option B: Use registered broker-dealer for introductions | Option C: Switch to 506(c) and accept verification burden | +--> Will any non-accredited investors participate? | | | YES --> 506(b) ONLY (506(c) prohibits non-accredited) | | | | | +--> Strongly discouraged. Cost of including non-accredited | | investors ($15K-$50K+ in additional legal/audit costs) | | typically exceeds their capital contribution. | | Consider helping them qualify as accredited or excluding. | | | NO --> Either exemption available | +--> What is your tolerance for verification burden? | Low burden preferred --> 506(b) (self-certification) High burden acceptable --> 506(c) feasible ``` --- ## Side-by-Side Comparison | Feature | 506(b) | 506(c) | |---|---|---| | **General solicitation** | PROHIBITED | ALLOWED | | **General advertising** | PROHIBITED | ALLOWED | | **Accredited investor verification** | Self-certification (questionnaire) | Third-party verification REQUIRED | | **Non-accredited investors** | Up to 35 "sophisticated" investors | PROHIBITED (zero) | | **Pre-existing relationship** | REQUIRED for all investors (unless through registered BD) | NOT required | | **Information requirements (accredited only)** | No specific disclosure required (but PPM is best practice) | No specific disclosure required (but PPM is best practice) | | **Information requirements (non-accredited)** | Detailed disclosure required (audited financials if practicable) | N/A (non-accredited prohibited) | | **Integration risk** | Multiple 506(b) offerings may be "integrated" if similar timing, purpose, class of investors | Same risk applies | | **Bad actor disqualification** | Applies (Rule 506(d)) | Applies (Rule 506(d)) | | **Form D filing** | Within 15 days of first sale | Within 15 days of first sale | | **State blue sky** | Notice filing in each state | Notice filing in each state | | **Typical cost of compliance** | Lower ($5K-$15K legal + filing fees) | Higher ($15K-$30K+ legal + verification costs) | | **Per-investor verification cost** | ~$0 (self-certification included in sub docs) | $50-$200+ per investor (third-party letter or document review) | | **Litigation risk profile** | Moderate (solicitation violations, relationship disputes) | Lower per investor (verified accreditation reduces "I didn't know" claims) | | **Best for** | Repeat syndicators with established networks | New syndicators, platform raises, digital marketing | --- ## Verification Method Comparison (506(c) Only) | Accreditation Basis | Verification Method | Documentation Required | Cost per Investor | Timing | |---|---|---|---|---| | Income ($200K/$300K) | Tax return review | 2 years W-2/1099/K-1 + written rep for current year | $0-$50 (internal review) | 1-3 days | | Income ($200K/$300K) | CPA letter | CPA confirms income meets threshold | $100-$300 | 3-10 days | | Income ($200K/$300K) | Attorney letter | Attorney confirms income meets threshold | $150-$500 | 3-10 days | | Income ($200K/$300K) | BD/RIA letter | Registered BD or RIA confirms income | $50-$200 | 2-7 days | | Net worth ($1M ex-residence) | Document review | Bank/brokerage statements + credit report (within 90 days) | $0-$50 (internal review) | 3-7 days | | Net worth ($1M ex-residence) | CPA letter | CPA confirms net worth meets threshold | $150-$400 | 5-14 days | | Net worth ($1M ex-residence) | Attorney letter | Attorney confirms net worth meets threshold | $200-$600 | 5-14 days | | Professional certification | FINRA BrokerCheck | Public record verification of Series 7/65/82 | $0 | Same day | | Entity ($5M assets) | Financial statement review | Audited or unaudited financial statements | $0-$100 | 1-5 days | | Entity (all owners accredited) | Individual verification of each owner | Each owner verified individually using applicable method | Varies by owner count | 5-14 days | | Prior verification (within 5 years) | Written representation | Investor re-certifies accredited status in writing | $0 | Same day | **Third-party verification services:** Several services provide streamlined 506(c) verification for syndicators with high investor volume: ``` Service Type Typical Cost Turnaround Attorney verification letter $100-$300/investor 3-7 business days CPA verification letter $150-$400/investor 5-10 business days Online verification platforms $50-$150/investor 1-3 business days (automated document review + letter) Broker-dealer verification $50-$200/investor 2-5 business days ``` For syndicators processing 50+ investors per offering, an online verification platform or a standing arrangement with a securities attorney provides the best balance of cost, speed, and compliance quality. --- ## Worked Examples ### Example 1: Experienced Syndicator, 10th Deal **Profile:** Sponsor has completed 9 prior CRE syndications over 6 years. Investor database of 220 contacts, of which 140 have invested in at least one prior deal. Plans to raise $4M equity for a 96-unit multifamily acquisition. No online marketing. All outreach through personal calls and emails to existing relationships. **Decision:** ``` General solicitation? NO (personal outreach to known investors only) Pre-existing relationships? YES (140 prior investors; remaining 80 are referrals and professional contacts -- review each) Non-accredited investors? NO (all prior investors were accredited) Verification preference? Self-certification (consistent with prior deals) Marketing strategy? None beyond personal outreach RECOMMENDATION: 506(b) RATIONALE: Classic 506(b) use case. Established relationships, no solicitation, no need for 506(c) verification burden. Self-certification through subscription agreement is sufficient. KEY RISK: Review the 80 non-prior-investor contacts carefully. Each must have a documented substantive financial discussion predating this offering. ``` ### Example 2: New Syndicator, First Deal **Profile:** Former property manager launching first syndication. Has 30 personal contacts who have expressed interest in investing. Wants to expand investor base through LinkedIn content, a CRE investing podcast, and webinars. **Decision:** ``` General solicitation? YES (LinkedIn, podcast, webinars = general solicitation) Pre-existing relationships? PARTIAL (30 personal contacts only) Non-accredited investors? UNKNOWN (some personal contacts may not be accredited) Verification preference? Must accept 506(c) verification (solicitation forces it) Marketing strategy? Aggressive digital marketing RECOMMENDATION: 506(c) RATIONALE: Any broad marketing activity (LinkedIn content about specific deals, podcast episodes discussing investment opportunities, webinars pitched to general audience) constitutes general solicitation and requires 506(c). CRITICAL: The 30 personal contacts can also invest under 506(c), but they must undergo the same third-party verification as investors sourced through marketing. No "hybrid" approach -- once you use general solicitation, the entire offering is 506(c). ALTERNATIVE: If sponsor is willing to forgo all digital marketing and raise only from the 30 personal contacts (plus referrals introduced through registered BD), 506(b) is available. But $4M from 30 contacts may be insufficient -- average $133K per investor is high for first-time syndicator. ``` ### Example 3: Platform-Based Raise with Broker-Dealer **Profile:** Sponsor partnering with an online syndication platform that is a registered broker-dealer. Platform has 5,000+ registered users. Platform markets the deal on its website and through email campaigns. Sponsor also markets through personal network. **Decision:** ``` General solicitation? YES (platform website and email campaigns) Pre-existing relationships? MIXED (personal network has relationships; platform investors do not) Non-accredited investors? NO (platform requires accredited status) Verification preference? Platform handles verification Marketing strategy? Platform + personal network RECOMMENDATION: 506(c) RATIONALE: Platform marketing constitutes general solicitation. 506(c) required. The platform (as registered BD) handles accredited investor verification as part of its subscription process, which satisfies the 506(c) verification requirement. ADVANTAGE: Platform absorbs the verification burden and cost. Sponsor focuses on deal economics and investor relations. The BD's compliance infrastructure provides a strong defense in any future regulatory inquiry. COST: Platform typically charges 1-3% placement fee on capital raised through the platform. Disclose this fee in Form D and PPM. ``` ### Example 4: Family Office Capital, No Outside Investors **Profile:** Sponsor raising $8M from 3 family offices. All three have invested in sponsor's prior deals. No other investors. **Decision:** ``` General solicitation? NO Pre-existing relationships? YES (prior deal investors) Non-accredited investors? NO (family offices are institutional accredited investors) Verification preference? Self-certification preferred (low friction) Marketing strategy? None RECOMMENDATION: 506(b) RATIONALE: Three institutional accredited investors with documented prior deal relationships. Textbook 506(b). Minimal compliance burden. NOTE: Even with only 3 investors, Form D filing is still required within 15 days of first sale. State blue sky filings are still required in each investor's state. Do not skip compliance steps because the offering is small or the investor base is sophisticated. ``` ### Example 5: Hybrid Approach Trap (WARNING) **Profile:** Sponsor plans to raise $6M. Wants to raise $4M from existing relationships (506(b) eligible) and then "open up" the offering to market to new investors for the remaining $2M. **Decision:** ``` THIS DOES NOT WORK. You cannot start a 506(b) offering and later add general solicitation. The offering is a single offering -- it is either 506(b) or 506(c), not both. If ANY general solicitation occurs at ANY point during the offering, the entire offering must be 506(c) from inception. OPTIONS: Option A: File as 506(c) from the start. Existing relationships still invest, but undergo third-party verification. New investors sourced through marketing also undergo verification. Option B: File as 506(b). Raise only from existing relationships. If $6M cannot be raised from existing relationships, reduce the raise amount or restructure the capital stack with more debt. Option C: Run TWO separate offerings (integration risk): Offering 1 (506(b)): $4M from existing relationships Offering 2 (506(c)): $2M from new investors sourced via marketing WARNING: These two offerings may be "integrated" by the SEC if they are for the same property, at the same time, with the same terms. Integration collapses both offerings into one, and the presence of general solicitation in Offering 2 would make the combined offering 506(c) -- exactly the result you were trying to avoid. Consult securities counsel before attempting this structure. RECOMMENDATION: File as 506(c) from the start if you anticipate needing to market to new investors. The verification burden is the cost of marketing flexibility. ``` --- ## Integration Risk Analysis **What is integration?** The SEC may "integrate" two or more offerings -- treat them as a single offering -- if they are part of the same plan of financing. If integrated offerings have different exemption types (one 506(b), one 506(c)), the combined offering must satisfy the more restrictive requirements. **Integration safe harbors (Rule 152):** ``` Safe Harbor 1: Offerings made more than 6 months apart (measured from completion of one to commencement of the next) are presumed to be separate. Safe Harbor 2: Offerings to different classes of investors under different terms and conditions are less likely to be integrated. Safe Harbor 3: Each offering complies with its own exemption requirements independently. Safe Harbor 4: For 506(b) and 506(c), the SEC has stated that issuers may conduct concurrent offerings under different Rule 506 exemptions without automatic integration, provided each offering independently satisfies all conditions of its claimed exemption. ``` **Practical guidance:** While the SEC has relaxed integration doctrine, concurrent 506(b) and 506(c) offerings for the same property remain risky. The strongest position is to choose one exemption and use it consistently for the entire offering. --- ## Bad Actor Disqualification (Rule 506(d)) Both 506(b) and 506(c) are subject to "bad actor" disqualification. The offering cannot rely on Rule 506 if the issuer or any "covered person" has a disqualifying event. **Covered persons:** - The issuer and its predecessors/affiliates - Directors, officers, general partners, managing members - 20%+ beneficial owners - Promoters - Persons compensated for soliciting investors (and their directors, officers, general partners) - Investment managers and their directors, officers, general partners **Disqualifying events:** - Criminal conviction (securities, financial fraud, insurance, banking) within 10 years (5 years for issuers) - Court injunction or restraining order (securities regulatory action) within 5 years - SEC disciplinary order within 10 years - SEC cease-and-desist order (scienter-based) within 10 years - SEC stop order or refusal order within 5 years - Suspension or expulsion from SRO membership - USPS false representation order within 5 years **Due diligence obligation:** The issuer must conduct reasonable inquiry to determine whether any covered person has a disqualifying event. "Reasonable inquiry" includes: questionnaires to all covered persons, background checks, and review of SEC EDGAR filings and FINRA BrokerCheck records. **Disclosure obligation:** If a disqualifying event occurred BEFORE September 23, 2013 (the effective date of Rule 506(d)), the event does not disqualify the offering but must be disclosed to investors in writing a reasonable time before the sale.