Why to Use Only Accredited Investors in Your Rule 506(b) Offerings

Regulation D Rule 506(b) is part of federal securities laws and is used widely to complete private placements according to these laws. Accredited investors are an important part of this Rule. This type of offering is preferred by many companies for various reasons. These include:

  • No restriction on the number of accredited investors
  • No regulatory mandate to provide specific information to accredited investors
  • Exemption from state law is given to the issuer regarding qualification and registration requirements

The Increased Cost of Including Non-Accredited Investors

Non-accredited investors can be included in Rule 506(b) offerings only if additional costly requirements are met. A maximum of 35 non-accredited investors may be used. However, each one of these investors must be given a comprehensive disclosure document that is highly detailed.

Often, the expense of providing the information mandated under Rule 502(b)(2) is not worth the limited amount of capital that often can be raised from non-accredited investors, considering the fact that these are typically not high net worth individuals.

Under Rule 506(b), these non-accredited investors must be sophisticated. They must have sufficient eknowledge and experience in financial and business matters in order to properly evaluate the risks and merits of a potential investment. Generally, it is more advisable for the issuer to provide a purchaser representative to represent the entire group of non-accredited investors, to ensure that the necessary sophistication requirements are met. In doing so, however, the issuer incurs another cost for the inclusion of non-accredited investors.

After the issuer includes non-accredited investors in one of its offerings, it is generally restricted from changing its offering exemption at a later point in time – for instance, changing from Rule 506(b) to Rule 506(c) to take advantage of general solicitation to accredited investors.

Practical Reason for Excluding Non-Accredited Investors

A practical reason for only using accredited investors is that non-accredited investors are typically not high worth individuals. These investors may deem a $25,000 investment as one of their most significant financial investments during a lifetime. The risks associated with many investment opportunities involving accredited investors are too great for many non-accredited investors. As a result, these non-accredited investors may be more critical or litigious if the enterprise is failing to perform up to expectations.

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