Section 506: Overview, definition, and example
What is Section 506?
Section 506 refers to a provision under Regulation D of the U.S. Securities Act of 1933, which allows companies to raise capital through private securities offerings without registering with the Securities and Exchange Commission (SEC). It provides exemptions for private placements, enabling businesses to secure funding from accredited investors with fewer regulatory requirements than a public offering.
For example, a startup seeking investment can use Section 506 to raise funds from venture capital firms and accredited investors without undergoing the costly and time-consuming SEC registration process.
Why is Section 506 important?
Section 506 is crucial for businesses, especially startups and private companies, because it simplifies capital-raising efforts while maintaining legal compliance. It allows companies to attract investment without the burdens of a full SEC registration, provided they meet certain conditions.
There are two key exemptions under Section 506:
- Section 506(b): Allows companies to raise unlimited funds from accredited investors and up to 35 non-accredited investors, but prohibits general solicitation or advertising.
- Section 506(c): Allows general solicitation and advertising but requires all investors to be accredited and verified as such.
For businesses, understanding Section 506 ensures they can raise capital efficiently while complying with federal securities laws.
Understanding Section 506 through an example
Imagine a technology startup wants to raise $5 million from investors. Instead of going through an IPO, the company opts for a Section 506(b) private placement. It approaches accredited investors privately, providing them with investment terms and documentation. Since the company does not publicly advertise the offering, it remains compliant under Section 506(b) and avoids SEC registration requirements.
In another case, a real estate investment firm wants to attract new investors through online marketing. To do so legally, it uses Section 506(c), ensuring that only accredited investors participate and that their financial status is verified before accepting funds.
An example of a Section 506 clause
Here’s how a clause like this might appear in a securities agreement:
“This Offering is conducted pursuant to Rule 506 of Regulation D under the Securities Act of 1933. The Company represents that the Offering shall be limited to accredited investors, as defined by SEC regulations, and shall comply with all applicable securities laws and exemptions.”
Conclusion
Section 506 provides businesses with a streamlined way to raise capital through private placements while maintaining compliance with federal securities laws. Whether using 506(b) for private fundraising or 506(c) for public solicitation, understanding these exemptions helps businesses attract investment efficiently while avoiding the complexities of SEC registration.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.