Raising capital is a top priority for startups, and Regulation D has been transformative to startup capital raising efforts since its introduction. Regulation D provides a set of rules that allow startups to raise funds with more certainty that the securities are exempt from registration under the Securities Act of 1933. The concept of an "accredited investor", central to Rules 506(b) and Rule 506(c) under Regulation D, narrows who can participate in a startup’s fundraising rounds under these rules.
On March 12, 2025, the Division of Corporation Finance of the Securities and Exchange Commission (“SEC”) issued a no-action letter clarifying that a high minimum investment amount in addition to certain investor representations could constitute "reasonable steps" for verifying accredited investor status in Rule 506(c) offerings. Understanding the nuances of Rules 506(b) and 506(c) is essential for compliance and effective fundraising.
Let's explore the details and implications of the no-action letter.
Understanding Rules 506(b) and 506(c): What Startup Founders Need to Know
As we've discussed, the concept of an "accredited investor" is central to Rules 506(b) and 506(c) under Regulation D, limiting who can participate in fundraising rounds. These rules, while both falling under Regulation D, have distinct features that can significantly impact a startup's fundraising strategy. Here’s a breakdown:
Rule 506(b)
- Allows up to 35 non-accredited investors and unlimited accredited investors.
- Investors can self-certify their accredited status.
- Prohibits general solicitation or advertising of the offering.
Rule 506(c)
- Requires all investors to be accredited.
- Mandates the company take “reasonable steps” to verify accredited investor status.
- Permits solicitation or advertising of the offering.
While Rule 506(c) offers broader reach to investors through general solicitation and advertising, its stricter verification requirements present challenges:
- Increased costs and potential delays due to document collection and review of investors’ financial records.
- Investors may have privacy concerns that deter them from sharing their financial records.
As a result, our startup clients generally favor Rule 506(b), sacrificing the ability to generally solicit and advertise in exchange for a simpler investor onboarding process.
SEC’s New Guidance on Investor Verification: The Latham & Watkins No-Action Letter
The SEC's Division of Corporation Finance issued a no-action letter to Latham & Watkins LLP on March 12, 2025, clarifying what constitutes "reasonable steps" for verifying accredited investor status in Rule 506(c) offerings. This guidance focuses on the use of a high minimum investment amount combined with written representations from investors to verify accredited investor status. Here are our key takeaways:
- High Minimum Investment Amount is a Relevant Factor: The no-action letter described that a high minimum investment amount can be a relevant indicator of a prospective investor’s accredited status. While the no-action letter doesn't specify an exact minimum investment amount, the request by Latham & Watkins for guidance outlined these proposed levels:
- At least $200,000 for natural persons.
- At least $1,000,000 for legal entities.
- For entities accredited based on their equity owners' status, a tiered approach was proposed, including a minimum of $200,000 per natural person equity owner (if fewer than five) or a total of $1,000,000.
- Importance of Written Representations: A startup’s reliance on minimum investment amounts must be paired with obtaining written representations from the investor, affirming that (1) they meet the accredited investor criteria under Rule 501(a) and (2) the investor's minimum investment amount has not been financed by any third party for the specific purpose of making the investment.
- No Knowledge of Contradictory Information: The startup must not have any knowledge that suggests the investor is not an accredited investor or that their investment is being improperly financed.
- Different Verification Methods: A startup can use different methods of verification for each investor in a fundraising round, offering options to comply with Rule 506(c)’s heightened verification standard. For example, a startup could allow investors in a fundraising round to opt in to a high minimum investment amount as an option to forgo the hassle of disclosing their financial records. Investors who do not want to invest at the minimum could provide their financial records for the startup to verify their accredited status.
Implications for Startups: A Realistic View
The no-action letter introduces high minimum investment thresholds as one basis for verifying investors’ accredited status, making it more administratively efficient to conduct a Rule 506(c) offering. A startup’s ability to take advantage of this new development may depend on the size of its fundraising round and its ability to find investors able to meet the minimum investment threshold. To illustrate, the new thresholds ($200,000 for individuals & $1,000,000 for entities) significantly exceed typical SAFE investments in pre-seed rounds. Carta’s State of Pre-Seed: Q1 2024 report revealed:
- In rounds under $250,000, 90% of SAFEs were less than $100,000.
- In larger rounds ($2.5M to $4.9M), 55% of SAFEs were below $100,000.
In smaller fundraising rounds, the additional costs of a Rule 506(c) offering might not outweigh the benefits of general solicitation and advertising. However, in larger fundraising rounds, startups might find 506(c) more appealing to access a wider pool of potential investors. That said, some investors may still shy away from high minimum investment requirements or feel uncomfortable sharing financial records to verify their accredited status. To address these concerns, a startup could raise money from a limited pool of investors under Rule 506(b) prior to engaging in general solicitation or advertising. Then, a short period afterward, (such as 31 days, to comply with a safe harbor rule), the fundraising round could be opened up to a broader pool of investors under Rule 506(c).
The no-action letter could also boost fund-led venture activity by allowing larger venture capital funds to raise more capital for startup investments. Though, the full impact on capital flow into the venture market may take years to fully materialize.
We advise startup founders to carefully consider the requirements of Rules 506(b) and 506(c) when planning their fundraising strategies.
Conclusion
The SEC's recent no-action letter is a significant milestone in the evolution of startup fundraising under Regulation D, offering another path for verifying accredited investors under Rule 506(c). This development reduces compliance burdens and friction in onboarding investors. Its impact on early-stage startups will likely depend on factors such as the size of the round and the qualities of the startup’s investor base. Experienced startup legal counsel can help founders leverage Rules 506(b) and 506(c) to raise capital more efficiently while maintaining compliance with securities laws.
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