Most private real estate equity is raised without registering the offering with the Securities and Exchange Commission. That is possible because the offering is conducted under an exemption from registration, and in the great majority of real estate syndications, joint ventures and funds, that exemption is Rule 506 of Regulation D. Rule 506 offers two paths. The path a sponsor takes determines how the offering may be marketed, who may purchase, and what the sponsor must do to confirm that its investors qualify.

What an exemption is, and what it is not

An interest in a limited liability company or limited partnership formed to acquire real estate is generally a security. Its offer and sale must be registered under the Securities Act of 1933 unless an exemption applies. Regulation D provides a set of safe harbors, and Rule 506 is the one most commonly used because it has no cap on the amount raised and because securities sold under it are treated as covered securities, which preempts state registration and merit review.

One framing point is worth stating plainly, because it is a common misunderstanding. An exemption is a set of conditions, not a filing. It is available only if the conditions are satisfied in connection with the offering itself. Filing a Form D does not create the exemption, and a sponsor that has conducted an offering in a way that fails the conditions cannot cure the problem by filing a form afterward.

Rule 506(b): no general solicitation

Rule 506(b) permits a sponsor to raise capital from an unlimited number of accredited investors and, in addition, from a limited number of non-accredited purchasers who are sophisticated. In practice most sponsors accept only accredited investors, because admitting non-accredited purchasers triggers substantial affirmative disclosure obligations that begin to resemble those of a registered offering.

The defining constraint of Rule 506(b) is that the offering may not be conducted by general solicitation or general advertising. Publicly posting a deal on a website, promoting it on social media, presenting it at an event open to the public, or emailing people with whom the sponsor has no relationship are the kinds of activity that raise the question.

Pre-existing substantive relationships

If a sponsor may not solicit generally, how does it find investors? The answer, in a Rule 506(b) offering, is the pre-existing substantive relationship. Both words carry weight. The relationship should pre-date the commencement of the offering, and it should be substantive — meaning the sponsor knows enough about the prospective investor’s financial circumstances and sophistication to evaluate whether the investment is suitable. An exchange of contact details at a conference is generally not a substantive relationship.

The practical consequence is one of sequencing. Relationships must be built and documented before a specific deal is launched, not after. Sponsors who maintain investor questionnaires, keep records of when and how each relationship was established, and impose some discipline on their contact management are in a materially better position than sponsors who assemble a list once a property is under contract. A sponsor that identifies a deal first and looks for investors second has the sequence backwards.

Rule 506(b) also permits the sponsor to rely on a reasonable belief that a purchaser is accredited. That belief is ordinarily supported by a completed investor questionnaire and the investor’s written representations, absent facts that call them into question.

Rule 506(c): solicitation permitted, verification required

Rule 506(c) permits general solicitation and general advertising. A sponsor relying on it may describe the offering publicly — on its website, at conferences, in newsletters and through social channels — and may approach prospective investors it has never met.

The trade-off is twofold. Every purchaser must in fact be an accredited investor, and the issuer must take reasonable steps to verify that status. Verification is a higher standard than the reasonable belief that supports a Rule 506(b) offering. An investor’s own check-the-box certification, standing alone, is generally not sufficient.

The rule contemplates several methods of verification, and the reasonableness of the steps taken is evaluated in light of the facts. Approaches commonly used include:

  • Reviewing income documentation for the relevant periods, together with a written representation about the investor’s expectations for the current year.
  • Reviewing recent documentation of both assets and liabilities to establish net worth. The liability side matters as much as the asset side, and is ordinarily confirmed by reference to a consumer credit report. Net worth is calculated excluding the value of the investor’s primary residence.
  • Obtaining written confirmation from a registered broker-dealer, an investment adviser registered with the Commission, a licensed attorney or a certified public accountant that the person has taken reasonable steps to verify the investor’s status.
  • Relying, in defined circumstances, on a written certification from an investor the issuer previously verified.

Many sponsors engage a third-party verification service. The practical attraction is not only efficiency but also that the sponsor avoids collecting and retaining sensitive personal financial records.

Accredited investor status

The definition of accredited investor is set by rule. It covers natural persons who satisfy an income test or a net worth test, various entities that meet asset or ownership tests, and — following amendments adopted in recent years — persons holding certain professional certifications and designations, and knowledgeable employees of private funds. Both the categories and the thresholds have been amended over time. The current definition should be confirmed at the outset of each offering rather than assumed from a prior deal’s questionnaire.

Form D and state notice filings

An issuer relying on Rule 506 files a Form D with the Commission. Form D is a notice filing, and it generally must be filed within fifteen calendar days after the first sale of securities in the offering. It is not an application, it is not reviewed or approved, and — as noted above — it does not itself establish the exemption. Failure to file the Form D on time does not, by itself, eliminate the availability of the Rule 506 exemption, although noncompliance can carry other consequences, including at the state level.

Although states may not require registration of a Rule 506 offering, applicable states may require a notice filing and a fee in connection with offers and sales made in those jurisdictions. These filings typically mirror the Form D, but deadlines, fee amounts and mechanics vary among states. Amendments may also be required — annually while an offering continues, and upon certain changes to the information previously reported. Missed state notice filings are among the more common and more easily avoided administrative problems in a private raise.

Practical considerations for sponsors

  • Decide between Rule 506(b) and Rule 506(c) before any marketing begins. General solicitation can materially affect the availability of Rule 506(b) for an offering, and whether the issuer may then rely on another exemption or proceed under a different offering structure depends on the facts and on the applicable integration rules.
  • Consider whether the program is deal-by-deal or continuous. Repeated raises raise integration questions, and a program that grows may implicate Investment Company Act exclusions and investment adviser status.
  • If relying on Rule 506(b), build and document the investor relationships before the transaction, and keep records showing when each relationship began.
  • If relying on Rule 506(c), treat verification as a gating item in the closing timeline rather than an administrative step at the end.
  • Keep marketing materials and the offering documents consistent. Projections or descriptions that appear in a deck but not in the offering memorandum create avoidable disclosure exposure.
  • Complete bad-actor diligence on the covered persons associated with the offering before the raise, not after a subscription is received.
  • Track state notice filing obligations for the jurisdictions in which offers and sales are made, and calendar the amendment deadlines.

A practical takeaway

The choice between Rule 506(b) and Rule 506(c) is a business decision with legal consequences that are difficult to reverse. A sponsor with a deep and well-documented investor base often finds Rule 506(b) simpler and less administratively burdensome. A sponsor building a platform, or raising from people it has not previously met, may conclude that the ability to solicit publicly is worth the verification obligation that comes with it. What does not work well is making the decision after marketing has already begun.