Moving from 506(b) to 506(c) in Real Estate Syndication

In this episode, Dugan Kelly discusses the transition from a Regulation D Rule 506(b) offering to a Rule 506(c) offering, shedding light on the differences, implications, and challenges involved. He explains how this transition can be a strategic move for those aiming to engage in general solicitation while navigating the intricate world of real estate syndication.

Understanding the Transition: 506(b) to 506(c)

If you’ve been successfully raising capital for your real estate syndication venture under Rule 506(b) and are now looking to take your fundraising efforts to the next level, transitioning to Rule 506(c) could be the strategic move you need.

The Starting Point: A Real Estate Opportunity
Imagine you’re in the shoes of an aspiring real estate syndicator. You’ve identified an appealing apartment building with a purchase price of $3 million. You believe you can secure $1.5 million in investments from your friends and family. Now, the question is, how can you raise this capital and potentially attract additional investors?

Setting Up the Syndication Entity
The first step in the process is to create a legal entity, typically a limited liability company (LLC) or a limited partnership (LP). You will provide a comprehensive business plan outlining potential returns, investment terms, distribution strategies, and more. This business plan becomes a crucial part of the private offering.

The Decision: 506(b) or 506(c)?
One significant decisions you must make is whether you will engage in general solicitation or not. Historically, Rule 506(b) prohibited general solicitation, which meant no advertising or approaching individuals without a pre-existing relationship. However, Rule 506(c), introduced with the JOBS Act, allows for general solicitation but comes with distinct requirements.

Key Differences Between 506(b) and 506(c)
Advertising: The primary distinction is that Rule 506(c) allows advertising, while 506(b) does not. You must decide whether you wants to take advantage of this newfound ability to reach a broader audience.

Investor Qualification: Under 506(b), investors can self-certify their accredited status through a questionnaire, and up to 35 sophisticated investors (non-accredited but with experience) are allowed. In contrast, 506(c) requires independent verification of accredited status for all investors who wish to participate, prohibiting sophisticated investors.

The SEC’s Perspective
Understanding the SEC’s goals helps explain these distinctions. The SEC aims to protect investors, promote capital formation, and govern securities transactions. The shift to 506(c) is in line with the evolving landscape of advertising and the need for transparency in investment opportunities.

Converting from 506(b) to 506(c)
What if you initially choose 506(b) but later wants to engage in general solicitation? The SEC allows conversions from 506(b) to 506(c). This process involves closing the 506(b) offering, notifying the SEC, paying necessary fees, and then launching a 506(c) offering.

Considerations and Challenges

While the transition offers advantages, there are critical considerations and challenges to keep in mind:

Investor Conversion: Converting potential investors, especially strangers, into actual investors through advertising can be challenging and time-consuming.

Administrative Costs: Transitioning from 506(b) to 506(c) involves added administrative costs and complexities due to closing and relaunching the offering.

Diligent Verification: In 506(c), diligent steps are required to independently verify investor accreditation, which can be more rigorous and demanding.

Honesty and Transparency: Regardless of the chosen rule, you must always maintain honesty and transparency, disclosing both the merits and risks associated with the investment.

Transitioning from Rule 506(b) to 506(c) in real estate syndication can be a strategic move for syndicators who want to leverage general solicitation to raise capital. While it comes with benefits, it’s essential to understand the distinctions, challenges, and compliance requirements associated with each rule. Proper planning, a clear business strategy, and a legal team experienced in real estate syndication can help navigate this transition successfully.

In the next episode of the Syndication Closer, we’ll delve deeper into the differences between accredited and sophisticated investors, as well as touch on the intriguing topic of fund-to-funds. Stay tuned for more insights and guidance on your journey in the world of real estate syndication.