Normally, when a company raises capital by selling securities to investors, they are required to register their offering with the United States Securities and Exchange Commission, which is the governmental agency responsible for enforcing federal securities laws. While the registration process can provide access to a wide pool of potential investors, it can also be incredibly cumbersome and costly. For this reason, many firms turn to the private market to raise needed capital under a specific rule that exempts them from registration requirements.
Registration Exemption Requirements Explained
Rule 506 of Regulation D provides two distinct exemptions from registration when securities are offered and/or sold:
- Under Rule 506(b), a company is exempt from registration requirements if they sell securities to an unlimited number of “Accredited” investors and up to 35 “Sophisticated” investors. However, the company cannot use general solicitation or advertising to market the securities offering.
- Under Rule 506(c), a company is exempt from registration requirements as long as all of the investors in the offering are “Accredited” and they take reasonable verification steps. If they do, the company can broadly solicit and generally advertise the offering.
Companies that rely on Rule 506 exemptions can raise an unlimited amount of money and, instead of registration, they must file “Form D” with the SEC.
What is the Difference Between Accredited and Sophisticated Investors?
By definition, companies are exempt from registration requirements as long as they only deal with investors who are either accredited or sophisticated.
Rules for Accredited Investors are defined in Rule 506, which states that “an accredited investor, in the context of a natural person, includes anyone who meets one of the following requirements:
- Earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
- Has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
- Any trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person, or
- Any entity in which all of the equity owners are accredited investors.”
If an investor does not meet the financial requirements for accreditation, they may still be able to purchase securities if they can prove that they are “Sophisticated.” To do so, they must demonstrate that they have “sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment.” However, sophisticated investors are only allowed to invest in transactions that rely on the 506(b) exemption.
How is Accreditation Status Determined
For the majority of our transactions, we rely on the 506(c) registration exemption, which means that we are responsible for taking “reasonable steps” to verify that investors are accredited. In most cases, this means that we need to pre-qualify an investor by reviewing some combination of the following documents:
- Schedule K-1 statements
- Tax Returns
- Credit Reports
- Brokerage Statements
- Personal Financial Statements
- Bank Statements
Once an individual’s accreditation status is confirmed, they are able to invest in non-publicly traded securities.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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