The Pros and Cons of Using Rule 506(b) for Your Private Equity Offering

The Pros and Cons of Using Rule 506(b) for Your Private Equity Offering

By Daniel A. Perry, Esq.

Rule 506(b) is a rule that exempts a private offering from registration under the Securities Act of 1933. In general, the sale of securities must be registered unless the security qualifies as exempt from registration. This typically includes registration pursuant to the SEC and registration at the state level (referred to as the State Blue Sky Laws).

The seminal case for the determination of a security was decided in the case of SEC v. Howey. In this case, the Howey test was established by the court to determine what constitutes an investment contract:

1. It is an investment of money
2. There is an expectation of profits from the investment
3. The investment of money is in a common enterprise
4. Any profit comes from the efforts of a promoter or third party

If an investment falls under these guidelines, then the security is subject to registration with the SEC (unless the security qualifies for an exemption from registration). This could include raising money for your business, offering an equity share in your business in exchange for capital, and raising capital from a variety of parties for purposes of real estate investments.

Exempted 506(b) Securities for Accredited and Sophisticated Investors

One such exemption from registration is Rule 506(b). Under this rule, the security offering cannot be offered by any form of general solicitation. In addition, a security is exempt from registration if it is offered exclusively to accredited investors and no more than 35 sophisticated investors.

A sophisticated investor is someone with a superior knowledge of business and financial matters – a definition that leaves room for interpretation. However, the structure, establishment, and exemption of registration of any private equity or debt offering should not be undertaken without speaking with experienced counsel in securities and private equity matters.

If you have a question about Securities Law, Private Equity Offerings, Debt Offers, Hedge Funds, and compliance related to Rule 506(b), please contact our office at (513) 241-0400. You can also fill out our contact form and one of our Securities Attorneys will respond to your questions.