506(b) vs 506(c): Understanding Regulation D Exemptions for Fund Managers

If you're launching a venture capital fund, raising a rolling fund, or structuring a private placement, you'll inevitably encounter two cryptic regulatory terms: Rule 506(b) and Rule 506(c). These aren't just technicalities buried in securities law. They represent a fundamental strategic choice that will shape how you raise capital, who you can accept money from, and how publicly you can market your offering.

For emerging managers and first-time GPs, understanding the distinction between these two exemptions under Regulation D can mean the difference between a compliant, efficient fundraise and a costly regulatory misstep. This guide breaks down everything you need to know about 506(b) versus 506(c), when to use each one, and the practical implications for your fund or offering.

What is Regulation D?

Before diving into the specifics of 506(b) and 506(c), it's essential to understand the regulatory framework they exist within. The Securities Act of 1933 requires that all securities offered or sold in the United States be registered with the Securities and Exchange Commission (SEC), unless an exemption applies. Registration is expensive, time-consuming, and involves extensive disclosure requirements that most private fund managers want to avoid.

Regulation D provides a safe harbor from registration for certain private placements. It establishes clear rules that, when followed, exempt your offering from the full registration process. Think of Regulation D as a carefully constructed set of exceptions that allow private companies and fund managers to raise capital from investors without going through the costly public offering process.

Within Regulation D, Rule 506 has become the dominant exemption for private fund offerings. It allows issuers to raise an unlimited amount of capital while avoiding registration, making it the go-to choice for venture capital funds, private equity funds, hedge funds, and other alternative investment vehicles. In the twelve months ending June 2021 alone, issuers raised over $2 trillion using Rule 506 exemptions, demonstrating just how central these rules are to private capital markets.

Rule 506 comes in two flavors: 506(b), the traditional approach that has existed for decades, and 506(c), a newer variant created by the JOBS Act of 2012 and implemented in September 2013. Each serves different fundraising strategies and comes with distinct requirements and trade-offs.

Rule 506(b): The Traditional Approach

Rule 506(b) represents the conventional path for private fund managers, and it remains by far the most popular choice. During the period from July 2020 to June 2021, issuers raised $1.9 trillion under 506(b), compared to just $124 billion under 506(c). This overwhelming preference reflects 506(b)'s flexibility and alignment with traditional relationship-based fundraising.

No General Solicitation or Advertising

The defining characteristic of a 506(b) offering is the prohibition on general solicitation and general advertising. This means you cannot publicly market your fund or investment opportunity. You cannot advertise in newspapers or magazines, broadcast information over television or radio, host seminars where attendees were invited through public channels, or post offering details on unrestricted public websites.

What does this look like in practice? You can reach out to individuals with whom you have a pre-existing, substantive relationship. You can contact people who are referred to you by trusted intermediaries. You can speak at private events where attendees were carefully screened. But you cannot run a LinkedIn ad campaign for your fund, publish a blog post soliciting investors, or list your offering on a public investment platform that anyone can access.

The SEC has not provided bright-line rules for what constitutes a "pre-existing relationship," but generally, you should have enough contact with a potential investor to evaluate their financial sophistication and circumstances before making an offer. A single introduction at a networking event typically doesn't suffice; you need meaningful interaction over time.

Up to 35 Non-Accredited Sophisticated Investors

Rule 506(b) allows you to accept investment from an unlimited number of accredited investors plus up to 35 non-accredited investors. This is a significant advantage over 506(c), which requires all purchasers to be accredited.

However, there's an important caveat: any non-accredited investors must be "sophisticated." This means they must have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment, either alone or with the help of a purchaser representative. You cannot simply accept money from anyone; the non-accredited investors must demonstrate genuine financial sophistication.

In practice, most venture capital and private equity funds avoid accepting non-accredited investors entirely, even though 506(b) permits it. The reason is disclosure: if you accept even one non-accredited investor, you must provide all purchasers with extensive financial information and disclosures similar to those required in registered offerings. This creates significant additional compliance burden and cost.

Self-Certification of Accredited Status

One of the most practical advantages of 506(b) is how you verify accredited investor status. You need only have a "reasonable belief" that each purchaser is an accredited investor. In practice, this means investors can self-certify their status by completing a questionnaire or checking boxes in a subscription agreement.

You don't need to collect tax returns, bank statements, or third-party verification letters. As long as you don't have actual knowledge that contradicts an investor's self-certification, and as long as you've taken reasonable steps to form a belief about their status (considering factors like their profession, experience, and relationship with you), self-certification is generally sufficient.

This makes the investor onboarding process significantly smoother and less invasive. High-net-worth individuals value their privacy and often resist sharing sensitive financial documents. Rule 506(b) respects that preference while still providing investor protection through the sophistication requirement and relationship-based approach.

Relationship-Based Fundraising

The architecture of 506(b) naturally aligns with how most emerging managers actually raise their first fund. You start with your existing network: former colleagues, successful entrepreneurs you've worked with, angel investors you know from previous ventures, family offices that trust you. You get introductions through mutual connections. You build relationships over coffee meetings, advisory board positions, and industry conferences.

This relationship-driven model has several advantages beyond regulatory compliance. Investors who know you personally are more likely to commit quickly, provide larger check sizes, and become long-term partners across multiple funds. They understand your investment thesis because they've seen your work firsthand. They're also more likely to make valuable introductions and provide operational support to your portfolio companies.

Rule 506(c): The JOBS Act Innovation

Rule 506(c) emerged from the Jumpstart Our Business Startups (JOBS) Act of 2012, specifically Section 201(a), which directed the SEC to permit general solicitation and advertising in Rule 506 offerings. After public comment and deliberation, the SEC adopted Rule 506(c) on July 10, 2013, with an effective date of September 23, 2013.

The intent was to democratize access to private capital by allowing issuers to reach beyond their immediate networks. Proponents argued that the prohibition on general solicitation was an outdated constraint that prevented promising companies and funds from connecting with interested, qualified investors. Critics worried that public advertising would increase fraud risk and expose unsophisticated investors to inappropriate investments.

The compromise was Rule 506(c): you can advertise publicly, but you must verify that every single purchaser is accredited, and you cannot accept any non-accredited investors regardless of their sophistication.

General Solicitation Permitted

Under 506(c), you can engage in general solicitation and general advertising to market your offering. This opens up an entirely different fundraising playbook. You can publish blog posts about your fund's investment thesis and invite readers to invest. You can run targeted ads on social media platforms. You can list your offering on investment platforms like AngelList, Republic, or SeedInvest. You can speak at public conferences and explicitly pitch your fund to attendees.

You can maintain an unrestricted website with detailed information about your fund, performance data, and a call-to-action for investors to commit capital. You can send cold emails to potential investors you've never met. You can publish press releases announcing your fundraise and inviting participation.

This dramatically expands your potential investor pool beyond people you know personally or who are introduced through trusted intermediaries. For managers without established networks, this can be transformative. It levels the playing field, allowing talented emerging managers from non-traditional backgrounds to compete with established firms that have decades of LP relationships.

All Investors Must Be Accredited

The trade-off for general solicitation is strict: 100% of your investors must qualify as accredited investors. There is no allowance for sophisticated non-accredited investors, even if they have extensive business experience or significant assets that don't meet the technical definition.

As a reminder, the most common categories of accredited investors include individuals with income exceeding $200,000 in each of the two most recent years (or $300,000 combined with a spouse) with a reasonable expectation of the same income level in the current year, or individuals with net worth exceeding $1 million, excluding the value of their primary residence. Various entity and professional certification categories also exist.

This all-or-nothing requirement means you may need to turn away otherwise sophisticated investors who fall just short of the accredited investor thresholds. A successful entrepreneur who recently sold their company for $900,000 cannot invest, even though they may have deep industry expertise and genuinely understand the risks.

Mandatory Verification of Accredited Status

The most operationally burdensome aspect of 506(c) is the verification requirement. You cannot simply accept an investor's self-certification that they are accredited. You must take "reasonable steps to verify" that each purchaser actually meets the accredited investor definition.

The SEC established a principles-based verification framework, meaning what counts as "reasonable steps" depends on the facts and circumstances of each purchaser and transaction. However, the rule provides a non-exclusive safe harbor list of acceptable verification methods, including reviewing IRS forms like W-2s, Form 1099s, Schedule K-1s, or tax returns for the two most recent years to verify income; reviewing bank statements, brokerage statements, tax assessments, credit reports, or appraisal reports to verify net worth; or obtaining written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or certified public accountant that they have verified the investor's accredited status within the prior three months.

Each of these methods has practical challenges. Many investors are uncomfortable sharing tax returns or detailed financial statements with fund managers, viewing it as an invasion of privacy. Third-party verification letters from CPAs or attorneys cost money (typically $500 to $2,000 per investor) and take time to obtain. Some professional advisors are reluctant to provide verification letters due to liability concerns.

Side-by-Side Comparison: Understanding the Key Differences

When evaluating 506(b) versus 506(c), several critical distinctions emerge. On general solicitation and advertising, 506(b) prohibits any form of public marketing, while 506(c) explicitly permits general solicitation and advertising to market the offering. This fundamentally shapes your outreach strategy.

Regarding eligible investors, 506(b) allows unlimited accredited investors plus up to 35 sophisticated non-accredited investors, whereas 506(c) requires that all purchasers be accredited investors with no exceptions for sophisticated non-accredited individuals. This makes 506(b) more flexible in theory, though most funds avoid non-accredited investors due to enhanced disclosure requirements.

The verification requirements differ substantially. With 506(b), issuers need only a reasonable belief that investors are accredited, typically satisfied through self-certification in subscription documents. In contrast, 506(c) mandates that issuers take reasonable steps to verify accredited status, generally requiring review of financial documents or third-party verification letters.

Both exemptions allow issuers to raise unlimited capital and require filing Form D with the SEC within 15 days of the first sale of securities. Both are subject to bad actor disqualification provisions that prevent certain individuals with criminal or regulatory violations from participating in the offering. Both result in restricted securities that cannot be freely resold without registration or an applicable exemption.

The market demonstrates a strong preference for 506(b). From July 2020 to June 2021, issuers raised approximately $1.9 trillion under 506(b) compared to just $124 billion under 506(c). This 15-to-1 ratio reflects the continued dominance of relationship-based fundraising and the historical reluctance of issuers to navigate the verification requirements of 506(c).

When to Use Rule 506(b)

Rule 506(b) remains the default choice for most venture capital and private equity funds, and for good reason. It's the right fit when you have an established network of potential investors with whom you have pre-existing relationships. If you've built credibility in an industry over many years, worked with successful entrepreneurs who trust your judgment, or cultivated relationships with family offices and institutional investors, 506(b) allows you to leverage those relationships efficiently.

The exemption is particularly valuable if you want to include a small number of sophisticated non-accredited investors. Perhaps you have a strategic investor who brings valuable industry expertise, operational capabilities, or network access but doesn't quite meet the accredited investor thresholds. Under 506(b), you can accept up to 35 such investors, provided they are sophisticated. This flexibility disappears entirely under 506(c).

Cost and efficiency considerations also favor 506(b). Avoiding the verification process saves both money and time. You don't need to engage third-party verification services, collect sensitive financial documents, or delay closings while investors scramble to get verification letters from their CPAs. The investor onboarding process is streamlined, creating a better experience for your LPs.

Privacy is another significant factor. Many high-net-worth individuals are extremely protective of their financial information. They don't want to share tax returns with anyone beyond their accountant and the IRS. They view detailed disclosure of their assets as a security risk. Rule 506(b) respects this preference by allowing self-certification, which often strengthens investor relationships and increases commitment rates.

The market data supports this approach: the vast majority of institutional-quality venture capital and private equity funds rely on 506(b). It's the tested, understood path with decades of regulatory precedent. Legal counsel is intimately familiar with the requirements, and best practices are well-established. For emerging managers raising a Fund I from their professional network, 506(b) is almost always the right choice.

When to Use Rule 506(c)

Rule 506(c) serves a different set of use cases, primarily centered around broad, marketing-driven fundraising strategies. It's the natural fit if you plan to raise capital through public investment platforms like AngelList, Republic, Wefunder, or SeedInvest. These platforms are built around general solicitation, they market opportunities to their entire user base, and they typically handle the verification process for you as part of their service offering.

Rolling funds, popularized by AngelList, almost universally use 506(c). The rolling fund model depends on continuous fundraising through quarterly closes, with investors subscribing through an online portal. This is inherently a general solicitation activity. Fund managers often market their rolling funds through social media, newsletters, podcasts, and blog posts, all of which constitute general solicitation.

The exemption is also valuable for emerging managers from non-traditional backgrounds who lack an established network of high-net-worth investors. If you don't have decades of industry relationships but you do have a compelling investment thesis and the ability to market yourself effectively, 506(c) provides a path to reach investors you've never met. You can build an audience through content marketing, speak at public conferences, run targeted advertising campaigns, and convert interested parties into LPs.

Certain fund strategies benefit from maximum visibility. If you're launching a sector-specific fund in an emerging technology area and you want to position yourself as a thought leader, the ability to publish articles about your fund, share performance data publicly (subject to other regulatory constraints), and openly discuss your fundraise can be strategically valuable beyond just raising capital.

Practical Considerations That Apply to Both Exemptions

Bad Actor Disqualification

Both 506(b) and 506(c) are subject to bad actor disqualification provisions. These rules prevent issuers from relying on Rule 506 if certain covered persons (including the issuer, predecessors, affiliated issuers, directors, general partners, managing members, executive officers, and certain other participants in the offering) have relevant criminal convictions, regulatory sanctions, court injunctions, or other disqualifying events.

Before relying on either exemption, you must conduct reasonable care, factual inquiry into whether any bad actor disqualifications exist. This typically involves collecting questionnaires from all covered persons and reviewing public records. If a disqualifying event exists, you cannot use Rule 506 unless the SEC grants a waiver, which is rare and requires demonstrating that disqualification would be unjust under the circumstances.

State Blue Sky Preemption

One of the most valuable aspects of Rule 506 offerings, whether 506(b) or 506(c), is federal preemption of state registration requirements. Under the National Securities Markets Improvement Act of 1996, Rule 506 offerings are "covered securities" that cannot be subject to state registration requirements.

This doesn't mean states have no role. States can still require notice filings (typically just filing Form D and paying a fee), require disclosure documents to be filed, and bring enforcement actions for fraud. But you avoid the patchwork of different state registration regimes that would otherwise apply when selling securities to investors across multiple states.

In practice, this means you'll need to file notice filings in each state where you have purchasers, usually within 15 days of the first sale to a resident of that state. Fees vary by state but typically range from $200 to $1,000 per state. Many fund administrators and law firms handle this process as part of their standard service offering.

Form D Filing Requirements

Both exemptions require filing Form D with the SEC within 15 days after the first sale of securities in the offering. Form D is a relatively simple notice filing that includes basic information about the issuer, the offering, and the persons involved. It's filed electronically through the SEC's EDGAR system.

Form D must be amended if certain information becomes materially inaccurate, though as a practical matter, many issuers only file amendments to correct significant errors or to report additional closings if required by state law. While failure to file Form D doesn't automatically disqualify you from the exemption, it can have practical consequences, including inability to rely on federal preemption of state registration and potential SEC enforcement action.

The Verification Burden in Practice

Understanding the practical aspects of verification remains essential for any 506(c) offering. The verification requirement was historically the single biggest deterrent to using 506(c), and it remains relevant for investors below minimum investment thresholds or where managers prefer additional verification layers.

Third-Party Verification Services

Several companies have built businesses around accredited investor verification for 506(c) offerings. Services like Verify Investor, Accreditation.io, and others charge per-investor fees (typically $50 to $300) to verify accredited status through document review or integration with financial institutions.

These services streamline the process significantly. Investors upload their documents to a secure portal, the service reviews them and either confirms or denies accredited status, and the issuer receives a verification certificate. The service maintains the records and assumes some liability for verification accuracy, providing defensive value if verification is later questioned.

Professional Verification Letters

The safe harbor allows issuers to rely on written confirmation from registered broker-dealers, SEC-registered investment advisers, licensed attorneys, or certified public accountants. This shifts the verification burden to a professional who already has access to the investor's financial information through an existing professional relationship.

In practice, this means an investor can ask their CPA or attorney to provide a letter confirming accredited status based on their existing knowledge of the investor's financial situation. The professional reviews the investor's tax returns and financial records (which they likely prepared or reviewed anyway) and issues a brief letter confirming the investor meets the definition as of a certain date.

Making the Strategic Choice

The decision between 506(b) and 506(c) is fundamentally strategic, not just legal. It reflects your fundraising approach, your target investor base, your existing network strength, and your marketing capabilities.

For most emerging managers raising a traditional venture capital or private equity fund from an established network of sophisticated investors, 506(b) remains the optimal choice. It minimizes compliance burden, respects investor privacy, allows flexibility for sophisticated non-accredited investors if needed, and aligns with relationship-driven fundraising that tends to produce higher-quality, longer-term LP relationships.

For managers pursuing platform-based fundraising, rolling funds, or marketing-driven strategies where general solicitation is central to the model, 506(c) is the clear answer. The verification burden, while real, has been substantially reduced for funds with appropriate minimum investment amounts. The ability to market publicly, reach new investors, and build a brand through thought leadership can justify the additional compliance complexity.

Whatever path you choose, make the decision deliberately and early in your fundraising planning. Your exemption choice shapes your marketing materials, your investor outreach strategy, your compliance systems, and your legal costs. Switching mid-fundraise is possible but complicated by integration concerns and the need to satisfy the requirements of both exemptions for integrated offerings.

Work with experienced securities counsel to structure your offering appropriately. While the rules may seem straightforward in outline, the practical application involves nuances that can create significant risk if mishandled. The cost of competent legal advice is a small fraction of the regulatory and reputational cost of getting these foundational decisions wrong.

Understanding 506(b) versus 506(c) isn't just about compliance. It's about understanding the full spectrum of how you can legally raise capital in the private markets and choosing the approach that best aligns with your strategy, strengths, and investor base. Both exemptions provide powerful tools for fund managers. The key is knowing which tool fits your specific situation and using it effectively to build a successful fund that serves your investors and generates strong returns.