By Cliff Ennico

“My partners and I formed a technology startup last year. We’ve done a ‘friends and family’ round of financing and have perfected our product.

Now we need $2 million to bring this product to market. I’ve been reading about the new federal rules allowing companies like ours to advertise our offering and solicit investors through the Internet, radio and TV ads. Given the broad general appeal of our product, we think such an offering would be highly successful.

Our financial advisor and accountant both seem nervous about the idea, however. What are the downsides of this type of offering, and should we go for it?”

Being the extremely conservative folks that we are (and with one eye always on our malpractice insurance policies), accountants, financial advisors and (yes) lawyers are often reluctant to recommend anything “new and different” to our clients, even if the law clearly allows it, until it has been fully tested and the “bugs” have been worked out.

First, a little background. Under the federal securities laws, administered by the U.S. Securities and Exchange Commission (SEC), companies looking to raise money from strangers must – must – engage in an initial public offering (IPO) unless one of a number of exceptions is available. These exceptions – known as “private placements” – are contained in the SEC’s Regulation D (

To launch an IPO, your company must prepare a detailed offering statement (called a “prospectus”) and register it with the SEC before you begin offering your shares to strangers. Preparing and registering the prospectus can run up to hundreds of thousands of dollars in legal, accounting and other fees. Unless your company has generated that kind of capital, you will need to fall into one of the “exceptions” to the IPO registration requirement.

If you are raising up to $1 million, you are not subject to the IPO registration requirement as long as you do not advertise your offering or solicit investors using public means of communication such as radio, TV or the Internet.

If you want to raise more than $1 million, however, you have to make sure you fall within one of two exceptions – known as “Rule 506(b)” and “Rule 506(c)”.

Under Rule 506(b), which has been around in one form or another since the 1970s, you can raise more than $1 million without having to go through an IPO if:

  • You do not advertise your offering or solicit investors using public means of communication; and
  • You sell your shares only to “accredited investors” (basically, extremely rich and/or sophisticated people who the SEC feels don’t need the protection of the securities laws because they can fend for themselves) and up to thirty-five (35) other people; and
  • You can rely on a questionnaire filled out by each investor to determine whether or not they are “accredited.”

Under Rule 506(c), which the SEC adopted only a couple of years ago, you can raise more than $1 million without having to go through an IPO, and advertise your offering using public means of communication, if:

  • You sell your shares only to “accredited investors”; and
  • You make an independent investigation to determine if each investor is “accredited” or not (i.e. You cannot rely on an investor questionnaire the way you can in a rule 506(b) offering).

In order to launch a Rule 506(c) offering, you have to be 100% certain that each and every person who invests in your company is an “accredited investor”. Make one mistake, and you’re toast. You would be subject to fines, penalties, and perhaps some jail time.

To make sure someone is an “accredited investor” under Rule 506(c), you and your advisors must review the investor’s federal and state income tax returns, bank and brokerage statements, real property tax assessments and credit reports, among other documents. You must also get a statement from each investor swearing that those documents are accurate and complete, and that they haven’t withheld any information that would make them incorrect (such as a million-dollar lawsuit pending against them).

Many investors – especially those who learned about your company on the Internet – will be extremely reluctant to share that information with you without making you swear ten ways ‘til Tuesday that the information will be kept private and confidential. Strangers can be difficult that way.

Also, if an investor lies through their teeth and leads you to believe they are “accredited” when they are not, you are still liable for violating the securities laws.

This is why your accountant and financial advisor are nervous about a 506(c) “advertised” offering. They feel much safer with a 506(b) “non-advertised” offering, because the rules are much more forgiving. You can make up to 35 mistakes about someone’s “accredited investor” status and still fall within the exception.

I would listen to my advisors and stick with the old-fashioned 506(b) offering for now. At least until we have some case law telling us how strictly the courts will enforce the new 506(c) rules.

Cliff Ennico ( is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. Follow him at @cliffennicoThis column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at COPYRIGHT 2015 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC.