What Is Rule 506(b)?
Rule 506(b) is a safe harbor under Regulation D of the Securities Act of 1933 that permits private offerings without SEC registration, provided the issuer does not engage in general solicitation or general advertising. It is the most widely used exemption for private fund offerings in the United States. According to SEC data, Rule 506 offerings (both b and c combined) account for the majority of capital raised in the exempt market each year, with 506(b) representing the dominant share.
How It Works
Under Rule 506(b), an issuer can raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 non-accredited investors who meet a “sophistication” standard. There is no cap on the offering size, and the securities are exempt from state registration under federal preemption (though Form D filing and state notice filings under blue sky laws are still required).
The critical constraint is the prohibition on general solicitation. You cannot publicly advertise the fund, post about the raise on LinkedIn, send offering materials to investors you have no prior relationship with, or present at a conference where attendees have not been pre-qualified. The SEC has interpreted “general solicitation” broadly, and violations can disqualify the entire offering.
The Pre-Existing Relationship Requirement
The no-general-solicitation rule means that every investor you approach must have a pre-existing, substantive relationship with the issuer or someone acting on its behalf (such as a placement agent). “Substantive” means you have enough information about the investor to evaluate their accredited status and investment sophistication before sharing offering details.
In practice, this is why LP networks, warm introductions, and established relationships with institutional allocators are so critical to fundraising under 506(b). The rule effectively codifies what good fundraising practice already looks like: you are talking to people you know, not broadcasting to strangers.
Disclosure Requirements
If a fund accepts any non-accredited sophisticated investors (the 35-investor allowance), the issuer must provide disclosure documents comparable to what would be required in a registered offering. This means detailed financial statements, risk factors, and business descriptions. For this reason, most fund managers simply limit the offering to accredited investors only, which reduces the disclosure burden to whatever is specified in the PPM and subscription documents.
Even when limiting to accredited investors, Rule 10b-5 antifraud provisions apply. The issuer must not make material misstatements or omissions. The PPM serves as the primary disclosure vehicle and provides legal protection against fraud claims, regardless of whether non-accredited investors participate.
Why 506(b) Remains Dominant
Despite Rule 506(c) being available since 2013, the vast majority of private fund offerings still rely on 506(b). The reasons are practical: 506(c) requires issuers to take “reasonable steps” to verify accredited investor status (tax returns, bank statements, third-party verification letters), which adds friction to the subscription process. Under 506(b), the issuer can rely on investor self-certification in the subscription agreement.
For general partners raising from institutional limited partners, the verification burden of 506(c) is unnecessary since pensions, endowments, and family offices are self-evidently accredited. The tradeoff is clear: 506(b) gives you a smoother close process at the cost of keeping your fundraising private.
Frequently Asked Questions
Can a fund using Rule 506(b) advertise to find investors?
No. Rule 506(b) prohibits general solicitation and general advertising. The issuer must have a pre-existing substantive relationship with each investor before discussing the offering. This means no public marketing, no mass emails to cold contacts, and no social media posts about the raise.
What is the difference between Rule 506(b) and Rule 506(c)?
Rule 506(b) allows up to 35 non-accredited but sophisticated investors and prohibits general solicitation. Rule 506(c) permits general solicitation and advertising but requires every investor to be an accredited investor with reasonable steps taken to verify their status. Most private funds still use 506(b) because it avoids the verification burden.
Who counts as a 'sophisticated investor' under Rule 506(b)?
A sophisticated investor is a non-accredited investor who has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the investment. The issuer must reasonably believe this before accepting the investment. In practice, most fund managers avoid relying on this provision and limit participation to accredited investors.
