The internet’s first “fan-funding” site was launched in 2003 by a company known as ArtistShare. The platform meant to connect artists with their fans at the early stages of the creative process. A decade later, startups like Kickstarter found a way to emulate this funding model for a greater audience.
But when it came to crowdfunding in the real estate space, things got a little complicated. The Securities Act of 1933 prohibited securities of private investments from being marketed to the public, so sponsors faced restrictions from the SEC on how they used general advertising or solicitation to promote their offerings.
During this time, the demand for private real estate investments grew among accredited investors. Left with Real Estate Investment Trusts (REITs) and Commercial Mortgage Backed Securities (CMBS) to round out their portfolios, these high-net-worth individuals craved higher risk alternatives.
It would take the JOBS Act of 2012, a law intended to encourage funding of small businesses in the United States, to usher in the era of real estate crowdfunding as we know it. By easing many of the country’s securities regulations, it led to changes in SEC regulations that allowed sponsors to advertise their deals online.
Investors view modern real estate crowdfunding platforms as a portal that allows them to browse underwritten deals and invest in offerings that are best suited to their risk profiles and overall investment strategy.
“We are most excited about using RealCrowd to partner with so many new investors who have never had access to institutional real estate fund managers before. We look forward to providing transparent communication and performing for each of them.” — Origin Investments
Prior to the JOBS Act, sponsors relied on friends, family, or their own networks to fund their offerings because securities laws didn’t allow for general solicitation as noted above. The only way was via Rule 506 of Regulation D.
That was until Title II of the JOBS act was passed in September 2013 and split Rule 506 into two parts: 506(b) represented the old approach, and 506(c) welcomed a new era. Rule 506(c), in keeping with the age of transparency and sharing of information, allows general solicitation or advertising to the public.
In today's article, Mark Roderick, Securities Attorney at Flaster Greenberg PC, will teach you the three key differences between Rule 506(b) and Rule 506(c) that can have a significant impact on how you raise equity.
In a Rule 506(b) offering, the issuer may take the investor’s word that the individual or entity is accredited, unless the issuer has reason to believe the investor is lying.
In a Rule 506(c) offering, on the other hand, the issuer must take reasonable steps to verify that every investor is accredited. The SEC regulations allow an issuer to rely on primary documents from an investor like tax returns, brokerage statements, or W-2s, but they also allow the issuer to rely on a letter from the investor’s lawyer or accountant. In practice, that’s how verification is typically handled.
Jump to our blog post on "Demystifying Accreditation: An easy guide to Rule 506(c)'s most dreaded requirement" for more information.
I strongly recommend that issuers do not verify investors themselves. Instead, they should use a third party like Verifyinvestor (RealCrowd already partners with Verifyinvestor to provide all verification letters for our investors to sponsors at no charge to both parties.).
If an issuer handles verification itself and makes a mistake, it's possible that the entire offering could be disqualified. Conversely, once an issuer hands the task to Verifyinvestor, the issuer has, by definition, taken the "reasonable step" required by the SEC, and can sleep well at night.
If all the investors are accredited, there is no difference between Rule 506(b) and Rule 506(c) in terms of collecting information.
If there is even one non-accredited investor in a Rule 506(b) offering, on the other hand, the issuer must provide a lot more information, specifically most of the information that would be included in a Regulation A offering.
The technicalities are important to the lawyer, but to the issuer, the bottom line is that if non-accredited investors are included the offering will cost $5,000-$7,500 more, and will take a little longer to prepare.
In a Rule 506(b) offering you can advertise only the brand. In a Rule 506(c) offering, you can advertise the deal.
Ever watch the commercials for brokers and investment banks during a golf tournament? They feature an older guy and his very attractive wife, planning for a carefree and meaningful retirement. The message is: "We can help you achieve your dreams". But they don't show any of the actual investments they recommend! They're only advertising the brand.
That's the model for a website offering investments under Rule 506(b). We can advertise the website - the brand - but we cannot show actual investments. The website attracts investors who sign up and go through a KYC (know your customer) process following SEC guidelines.
We have the investor complete questionnaires, we speak with the investor on the phone a couple times, we learn about his or her experience and knowledge investing - we develop a relationship. Then, and only then, can we show the investor actual investments.
In contrast, a website offering investments under Rule 506(c) can show actual investments to everyone right away.
If I own a jewelry store I have two choices:
That's why I prefer Rule 506(c). Investors can see for themselves what you offer. They don’t depend on promises made.
But I also acknowledge three benefits of Rule 506(b):
You can start an offering using Rule 506(b), then switch to Rule 506(c), as long as you haven’t accepted any non-accredited investors.
Conversely, once you’ve advertised a Rule 506(c) offering, you cannot go back and accept non-accredited investors, claiming you’re relying on Rule 506(b).