Video: Investing Through 506(c) Offerings
At the most recent ADISA conference, The DI Wire interviewed Louis Rogers, founder and chief executive officer of Capital Square, which specializes in tax-advantaged real estate investments, including Delaware statutory trusts for Section 1031 exchanges and qualified opportunity zone funds for tax deferral and exclusion.
Rogers discusses the transition of Regulation D private placement offerings and explains the differences between the traditional 506(b) and the newer 506(c) structures with respect to general solicitation rules and the certification of accredited investors. According to Rogers, 506(c) offerings provide a number of advantages to investment sponsors, broker-dealers and wealth advisors.
Video Transcript
Damon Elder  00:08
Welcome to another edition of Focus on Alternatives, sponsored by ADISA. I’m Damon Elder, the publisher of The DI Wire.com. And I’m joined today by Louis Rogers, the founder, and CEO of Capital Square. One of the leading sponsors of tax advantage real estate investments. Today we’ve got an exciting topic to discuss, we’re going to talk about 506 C offerings under Regulation D. Louis, thanks for joining us.
Louis Rogers  00:29
Thanks for having me.
Damon Elder  00:30
So traditionally private placements have been structured as Reg. D 506 B’s.
Louis Rogers  00:36
Yes.
Damon Elder  00:37
Again, with the 2012 tax reform laws, we introduced exemption C. What are the differences between the two Louis?
Louis Rogers  00:44
Many differences, first just a little bit of background. All securities offerings are either registered with the SEC or exempt. Registering with the SEC is a time-consuming and expensive process. Most securities offerings are Reg. D private placements and most of them overtime have been B’s are the historical exemption you’re either registered or you’re exempt most are exempt B is the traditional exemption and it has worked fairly well over the years. But it was based on a different time in a different place before the Internet before cell phones before the modern world.
It’s based on a direct relationship to qualify for the be exemption, the issuer must have a preexisting business relationship with the potential purchaser and that means no general solicitation no advertising so we’re talking about I know you I have a relationship with you in advance of offering to sell you securities. Now along comes the Internet millions of people potentially wanting to buy securities, and that general solicitation prohibition simply doesn’t work.
Damon Elder  01:58
So Louis, it sounds to me like the most significant difference between the 506 B and the 506 C. Is this concept of general solicitation. Why don’t we dive into that a little bit more what exactly does that mean general solicitation?
Louis Rogers  02:13
General solicitation is an advertisement it’s a solicitation to the public in general or not tailored towards the specific people where you have a pre-existing business relationship that’s the term of art. Under 506 C you’re allowed to solicit to advertise to market you can go out to the to the world at large use the the worldwide web something that didn’t exist back when Reg. D was first promulgated.
Damon Elder  02:40
So, one of the real tenants of Reg. D private placements are that the investors have to be accredited and under 506B generally the investor will simply sign a statement saying that they’re net worth is so and so
Louis Rogers  02:54
Self-certify.
Damon Elder  02:55
They self-certify, so I think my understanding is that with the 506 C’s that self certification has gone away. Now liability is placed upon the sponsor broker dealer once you kind of walk us through that what exactly has changed in that regard?
Louis Rogers  03:09
The sponsor has has a duty to make sure that the prospective investor is accredited, to take reasonable measures.
Damon Elder  03:17
And what are those reasonable measures?
Louis Rogers  03:19
The one most typically used is having the attorney, CPA, or financial advisor for the prospective investor sign a certification letter. That’s the bulk of the times or financial statement tax return depending on how you get to be accredited. $1,000,000 net worth you would look at assets $200,000, $300,000 of income you’d look at a tax return. And the the sponsor could confirm that the investors accredited. But most of the time a third party is providing a certification letter.
Damon Elder  03:51
So, does that add a significant new burden on the sponsors or the financial advisor the broker dealer?
Louis Rogers  03:57
We might have thought it was a burden, but it’s become a standard practice. Investor knows they need to get a certification from a professional that they’re accredited hasn’t been a problem.
Damon Elder  04:07
Well, I understand that Capital Square your firm again you issue you know more than a dozen private placements each year and you are correct me if I’m wrong, but my understanding is at least…
Louis Rogers  04:18
Primarily 506 C
Damon Elder  04:19
Beginning of 2019…
Louis Rogers  04:21
506 C, yes
Damon Elder  04:21
Primarily use 506 C’s
Louis Rogers  04:22
Yes.
Damon Elder  04:22
And how has that worked for your firm? What changes have you had to make in order to allow for the use of this more liberal regulation?
Louis Rogers  04:29
It’s changed in a positive way; our business has increased we’ve been able to show offerings on our website. We sell through broker dealers and the broker dealers, and their reps can now see the offerings more easily right on the website. So, it’s helped business, we’ve worked the certification into the accreditation process, and it hasn’t really been a problem. We’re comforted that there’s a safe harbor for for our offerings when we use 506 C. The concern in B is if you blow the exemption your whole offering could be undone.
Damon Elder  05:07
How do you blow the exemption?
Louis Rogers  05:08
let’s say an investor isn’t accredited let’s say you have one…
Damon Elder  05:13
Why would that be a liability for the issuer or the broker dealer, if they signed a document stating they were accredited, and they ultimately weren’t?
Louis Rogers  5:21
Yeah, I mean it can it can expose the sponsor to rescission, just having to buy back the offering plus a rate of return under different under various states but it could be catastrophic. So C… C gives us comfort we follow the protocol and we have a safe harbor and it actually gives us more comfort than we had under B plus all the benefits of being able to market and advertise.
Damon Elder  5:44
So let’s talk a little bit about liability and the safe harbor and whatnot so obviously in the investment world everybody wants to avoid liability you know you wanna do good job for your clients you don’t want to get in trouble you don’t wanna get sued you don’t want that greater expense…
Louis Rogers  5:56
We must have an exemption.
Damon Elder  5:58
Ok, ok so let’s talk about that then. It sounds to me like what you’re saying is that 506 C actually seems to reduce liability.
Louis Rogers  6:07
We think it does, we think it makes for a safer investment for the issuer for the investor for the broker dealers who sell the securities by virtue of having a safe harbor and following it we have a comfort level that we never get into a position where there’s a bad Reg. D private placement that could result in rescission. that’s the end of the world for an issuer.
Damon Elder  6:33
Well list it sounds like there’s quite a bit of similarity between these 506 C private placement offerings and crowdfunding which we’re increasingly seeing people selling direct to investors. Is that accurate are they very similar, are they’re differences.
Louis Rogers  6:45
They’re similar but very different. Crowdfunders use 506 C as well, but they sell directly to investors. Firms like capital square sell through broker dealers and registered reps to investors so it’s an entirely different sales pattern.
Damon Elder  7:03
So, Louis it’s been what seven years now.
Louis Rogers  7:06
Seven years.
Damon Elder  7:07
Since 506 C’s were introduced and allowed how has the industry responded? You know my understanding is that it’s been very slow to embrace the C’s but we’re starting to see some traction.
Louis Rogers  7:16
It’s been very slow but we’re we’re beginning to see adoption of C’s. I really don’t know why more broker dealers didn’t sign on earlier maybe because it was new. But it has been in use now for seven years. C is an overnight sensation it’s definitely a game changer for the issuers for broker dealers and for reps. And I think you’ll see greater adoption overtime.
Damon Elder  7:42
In fact, I’ve heard that in 2019 some industry groups are projecting that 506 C private placements will actually raise around 20% of the equity of all private placements and obviously there are thousands of private placements each year raising billions of dollars. Is that what you’re seeing, I mean I know you’ve enjoyed some great success with the 506 C structure?
Louis Rogers  08:03
That’s what the Mountaindale stats tell us, 20% are growing.
Damon Elder  08:07
So, I mean how is is that a massive leap from even 2018.
Louis Rogers  08:11
Massive.
Damon Elder  08:12
OK so we’re really starting to see some real influence.
Louis Rogers  08:14
We are we’re starting to see traction.
Damon Elder  08:16
And you attributed that simply to the fact that people are growing more comfortable with it?
Louis Rogers  08:19
Greater knowledge, understanding at first it was brand new. For decades solicitation and advertising was prohibited all of a sudden it was allowed. It took a while for people to warm up to the notion.
Damon Elder  08:34
So, Louis based on what we’re seeing in the industry and what we’ve learned from you today, it sounds to me like 506 C not only frees issuers to allow them to advertise and more generally solicit their offerings to to investors, but it actually provides greater safety and security to both the issuer and the broker dealer through the safe harbor. Which leads me to ask why in the world would anyone not use 506C and continue to issue offerings as a 506 B offering?
Louis Rogers  09:02
At this stage I really don’t know why. Early on it was brand new, people were concerned that there might be some wrinkles there haven’t been any wrinkles it’s worked perfectly well. We’ve created protocols to accredit investors and the systems are working perfectly well. So, I think overtime you’ll see greater adoption I’d be surprised if we don’t cross 50% in the coming years.
Damon Elder  09:26
Louis, why did Congress and the White House make this change? Why did they introduce 506 C?
Louis Rogers  09:31
We were coming off the Great Recession, and this was actually back in the Obama administration. And the idea was to increase economic prosperity economic growth through capital raising.
Damon Elder  09:42
So really allow more investors to participate raise more equity let it flow into the private sector?
Louis Rogers  09:48
More capital funding more businesses more growth, and maybe the contemplation was more technology, more small businesses. Wasn’t really focused on real estate specifically but it works for virtually any issuer.
Damon Elder  10:04
Louis, thank you so much for joining us today. I think you’ve shed a lot of light and shared some wisdom on a topic that many in our industry still don’t understand. So, thank you so much.
Louis Rogers  10:12
It’s a pleasure thank you.
Damon Elder  10:13
And for more information on 506 C offerings private placements all things alternative investing, please visit adisa.org. Thank you for watching.
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